Investment styles tied to value vs. growth investing
December 23, 2004
There have been deliberations over the years as to whether value or growth style of equity investing yielded the better returns.
Recently value investors have appeared to enjoy more success. A recent paper, “Staying in Style,” written by Bill Montague, a senior writer at SmithBarney Consulting Group, discusses investment styles specifically tied to value versus growth investing. Highlighted below are excerpts from his report I feel may be of interest.
According to performance data collected by the Consulting Group, over the 25 years ending in October of this year, the Russell 1000 Value Index – a benchmark for large-capitalization stocks with typical “value” characteristics, such as relatively low price-to-earnings ratios – outperformed its growth counterpart, the Russell 1000 Growth Index, by almost 2.3 percentage points in annualized return. Over that same period, a $1 million investment in the value index could have grown to almost $28 million, versus just $16.9 million for the growth index, the data shows.
Shorter-term performance also has seemed to favor value investors. In fact, Consulting Group’s data shows the Russell 1000 Value has posted higher returns than the Russell 1000 Growth the past four years in a row, as well as through the first three quarters of 2004.
This performance difference has helped convince a number of analysts that the value style also offers investors a more attractive long-term risk and return combination – particularly given the value benchmark’s relatively lower volatility. One common way to measure risk is to look at the standard deviation of returns – a kind of average of the variation from quarter to quarter. According to Consulting Group, from the inception of the Russell style benchmarks at the beginning of 1979 through September of this year, the Russell 1000 Value Index has shown a standard deviation of 14.38 percent, compared to a 19.76 percent standard deviation for the Russell 1000 Growth Index.
Many investors appear to agree. Lately, many of them have shifted money from growth-oriented asset managers to value managers, or have even eliminated growth stocks from their portfolio entirely. In some cases, these moves have been the result of impulsive or ad hoc decisions, instead of a prudent strategic reallocation.
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Before abandoning growth investing entirely, though, Montague suggests investors take a closer look at the track records for the two styles since the Russell value and growth benchmarks were created in 1978. While past performance is certainly no guarantee of future results, it can alert us to patterns that may reappear in the future. In the case of value and growth, this pattern is highly cyclical, suggesting value’s current performance edge may not always be as pronounced as it is now. If the past several cycles are any guide, the balance could shift abruptly.
This potential for shifts in style performance is one reason why Consulting Group has long recommended investors diversify their portfolios across both growth and value. This may reduce the risk of getting whipsawed by an extreme tilt toward one style or another, just as that style passes out of favor.
A review of the past 25 years of value and growth style performance raises a couple of points that investors might want to keep in mind as they think about their long-term investment strategy:
n Recent history suggests value and growth stocks tend to perform differently under changing economic and monetary conditions. The timing of these cycles can be tough to predict.
n The performance history of the past 25 years has convinced some financial experts that the value style offers investors a more attractive risk-return combination. However, the magnitude and persistence of this relative advantage is still not clear.
n By continuing to include both style sectors in their equity portfolios, investors may be able to reduce the risk of being caught on the wrong side of a sudden shift in relative style performance.
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If you would like more information on the elements of growth and value investing, e-mail email@example.com or call 689-8704.
Smith Barney does not provide tax and/or legal advice. Please consult your tax and/or legal advisors for such advice.
William Creekbaum, MBA, CFP, a Washoe Valley resident, is senior investment management consultant of SmithBarney, a financial-services firm serving Northern Nevada.
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