Picking the right team: Value or growth?Contributor Tilmann Galler
Investors may wish to turn increasingly towards their steady, experienced players-the value stocks-while keeping a selection of growth players to position for the future.
Given the maturity of this economic and market cycle, investors may wish to shift towards value stocks to increase portfolio resilience. However, it may not pay to abandon growth as a style completely given the rapid pace of technological change and disruption.
Managing investments can be like managing a club football team-you can’t just pick all the most up-and-coming, expensive players. It’s better to include some footballers who are past the peak of their international careers and hence a bit of a bargain, but are still likely to be solid and reliable members of the team for several years to come. Carefully selected value stocks work for a portfolio in a similar way. Growth stocks, on the other hand, are the potential stars of the future. Like promising young footballers, they have a bit of work to do in the coming years and lots of room for development. They are more risky, though, because they could get injured before their large transfer fee pays off. But they also have the potential to take the team to the next level.
Managers will want a team with both types of player. But late in a difficult game they might wish to switch towards the value players-those with a bit more experience-which can pay dividends when the pressure is on.
MSCI use several metrics to characterise a stock as value or growth, such as the price-to book (P/B) ratio, 12-month forward price-to-earnings (P/E) ratio, dividend yield, and short and long-term earnings and sales growth. Value stocks-the steady players-have a lower P/B, a lower P/E and a higher dividend yield than the market average.
Growth indices are often highly skewed towards technology stocks. Information technology currently has a weight of 23% 1 in the MSCI World Growth Index (in Europe the growth index is more evenly split across sectors). It is no surprise that the growth style has performed particularly well when investors have been excited by the potential returns from rapid technological innovation, such as during the 1990s tech boom. By contrast, the MSCI growth index underperformed through the stock market expansion of the 2000s, which was focused on housing, finance and commodities rather than technological innovation.
The composition of the value index has changed more significantly through time. At present, value indices are dominated by the financials sector, which makes up 25% of the MSCI World Value Index. Health care is the second largest sector weighting in the value index, while consumer discretionary is the second largest in the growth index behind technology.
1Technology weighting in the MSCI World Growth Index was 30% in October 2018, which was prior to the reclassification of some Technology stocks into the Communication Services sector. Communication Services now makes up 10% of the index.
When does growth tend to outperform?
In periods of rapid technological innovation or disruption, growth stocks will tend to tempt investors. Rapid technological change and cheap starting valuations for growth stocks after the financial crisis have proven particularly potent for growth stocks for much of the current market expansion.
EXHIBIT 1: RELATIVE PERFORMANCE OF VALUE AND GROWTH
MSCI World Growth/Value relative performance and S&P 500 downturns
Relative index level, rebased to 100 in 1975
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