The AI theme has remained the dominant market driver once again this year, so it might be counterintuitive to note that by some measures the Growth style has underperformed the Value style by over 14%1 so far this year. Based on the Russell 1000 indices, Value is up nearly 21%, while Growth is up only 7%. The S&P 500 and Nasdaq are up 13% and 16%, respectively, so what’s going on with these Russell indices, impacting $6T of active and passive AUM? As we noted in late June, this divergence is a result of the rebalancing methodology utilized by Russell, the index provider. Normally, an index reconstitution is largely mechanical, but this year it was hugely consequential given churn within the market’s perception of AI “winners and losers”. This highlights the need for investors to ensure their portfolios actually mirror the investment decisions they are making at the outset; simply put, being passive is an active decision!
The first half was dominated by semiconductors – a large weight in the value index
Before the rebalance in the first half of the year, the AI theme was dominated by investors rewarding the buildout’s “picks and shovels” (especially memory semiconductors) at the expense of the capex spenders themselves (the hyperscalers). In the Russell 1000 Value Index, semiconductors2, who received the checks, were up 323% (including the best quarterly performance on record in 2Q) and represented 9% of the index, while in the Russell 1000 Growth Index, hyperscalers3, who wrote the checks, were down 8% and weighed 22%.
The third quarter saw the return of the hyperscalers – which had just become a big weight in the value index
On June 26th, Russell reconstituted these indices, resulting in meaningful shifts. Semiconductors2 shifted from Value (only 2%) to Growth (now 9%). The opposite occurred among the hyperscalers3, whose weight in the Value index increased to 11% and declined by 3% in the Growth index to 19%. The Russell Rebalance coincided with a market inflection as semiconductors corrected (including a 20% decline in July), while some hyperscalers rebounded. Once again, this churn in the AI theme favored the Value index at the expense of the Growth index.
What you own may not be what you think you’re investing in
For investors, this highlights the importance of ensuring portfolio exposure matches their intentions. An investor might expect their Growth exposure to reflect exciting opportunities in technology and the AI landscape and their Value exposure to reflect more traditional, cyclical areas of the market (like financials). Active managers can take back the decision making from passive index providers. In addition, the reality is that timing style exposure is extremely difficult. While in a given year there can be a 20% spread between styles, over the past five years annualized returns in Growth and Value have been almost the same.
These swings highlight the need for active management rather than outsourcing that decision-making to passive index providers.