Friday Highlight  

Growth is starting to underperform value

Growth is starting to underperform value

For several years “Growth” as an investment style has outperformed, to the point that now the vast majority of the top performing funds over the last three years have a “Growth” bias in their portfolio holdings (based on Bloomberg style analysis).

In fact, to a large extent this bias is probably why they are the top performing funds.

The outperformance of the “Growth” style might continue, but it might not.

Either way, there is a risk lurking and the last two to three months have brought that risk into sharp focus with “Growth” underperforming “Value” and the majority of the top performing funds in the IA global sector underperforming Global equity indices.

The chart below is illuminating.

Where data is available we have plotted the performance over the last three months of the top ten percentile of IA Global Sector funds, over the last three years, against the extent of their exposure to the “Growth” style (as measured by “Growth” exposure minus “Value” exposure).

Firstly, almost all of the funds in that group would be considered “Growth” funds (defined by “Growth” exposure of over 30 basis points relative to Global Equity average).

Only two funds, plotted in green, have an exposure below 30 basis points meaning we can consider them ‘style neutral’.

Secondly, almost all the funds have underperformed over the last three months, some very significantly.

The closer to a neutral style exposure a fund has, the better chance of outperformance over the period.

In fact the fund that is very close to ‘style neutral’ is the top performing fund over the last three months (the large green data point).

Interestingly, this fund has delivered three year performance similar to the “Growth” funds, but without the “Growth” style bias and now, since style has changed it has outperformed again.

They say “style never goes out of fashion”, but in investment it clearly does sometimes, and when it does, it provides a ‘learning opportunity’.

So what is a fund selector expected to do to stay in fashion when styles change?

Historically the performance of the “Growth” style compared to the “Value” style has been well correlated with the shape of the yield curve.

Therefore, if one can predict the shape of the yield curve, staying in fashion when the investment style changes is not a risk.

However, it is tough to make predictions, especially about the future, and predicting the shape of the yield curve is no different.

So for most investors investment style risk should be very much of concern.

Naturally the funds of investor interest are the ones with a proven track record of outperformance, but since most of the best performing funds have a “Growth” style, which is the risk we want to diversify, we are not left with many options.

Moreover, since it has been so difficult to outperform without a “Growth” style it does beg the question, how have the funds that have done it, done it?

We highlight three things that do not go out of fashion and can form the basis of solid returns without taking excessive investment style risk.