6 minute read
INVESTMENT COMMENTARY
from ASSET Winter 2022
by ASSET
REGULARS | INVESTMENT COMMENTARY
The Importance of Style
You know style when you see it on the street. You may even know your own. But what about investment style? David van Schaardenburg looks at the various merits of value and growth investment styles.
According to Yves Saint Laurent, “Fashions fade, style is eternal”, but what about investment style?
Much debate in New Zealand investment circles has centred around the relative merits between a low-cost (hopefully), passive/index approach versus the usually higher-cost, active approach to investing in shares.
Unlike overseas, in recent years I have seen little local debate assessing the relative merits between the two predominant styles, or approaches, when it comes to active share investing: value and growth.
Notwithstanding possibly a lower level of local-investor interest in this debate, this column re-examines the relative merits and logic of value versus growth investing in portfolio construction.
Risk management options for shares
In a world of low-yet-rising interest rates and relatively high inflation (the foreseeable future!), my past columns have highlighted two things: the risk of negative real returns from ‘defensive’ assets, and the importance of having portfolios substantially oriented towards shares not bonds or cash.
If an investor’s portfolio is substantially (if not totally) made up of shares, it is increasingly important to consider the strategies available to manage risk.
Risk management options span diversifying by geography, business industry, individual security, cyclicality versus stability of business model, and investment style
Let’s focus on the last of these riskmanagement options: diversifying investment style.
What’s the difference between value and growth investing?
Value investing refers to an approach focused on finding shares which are trading below their fundamental value, more than often defined by, say, a low price-to-earnings (P/E) or price-to-book ratio (P/B) or high-dividend yield. This can also be assessed not just in absolute terms but also relative to historic, peer group or market averages.
These companies are normally found in ‘out of fashion’ industries, or where a company has had negative news, often unanticipated. Hence their share prices in recent times have often been in a downward trend.
In contrast, growth investors are looking for companies which display signs of above-average growth, currently and/or forecast (in revenues and/ or profit), even if their share price appears expensive in terms of the above fundamental metrics.
No surprise then that value investors are sometimes termed pessimists - they find joy in negativity - and growth investors are viewed as optimists.
Complicating things further are investment approaches which are variants of growth/value such as GARP – growth at reasonable price, or high dividend funds.
Examples of ‘style’ shares
The shares of any company can, in theory, fit either mainstream investmentstyle category at a point in time.
However, broadly speaking, value stocks tend to come more from traditional ‘smokestack’ industries like commodities extraction or
manufacturing, while growth stocks tend to be more often found in knowledgebased sectors like IT and health services. But not exclusively.
When one looks at the industry composition of the S&P500 value index relative to the growth index, for example at 28/2/2022: • IT makes up 12 versus 45% • Manufacturing makes up 13 versus 3% • Financials make up 16 versus 7%
The largest component of the value index is Berkshire Hathaway, an investment conglomerate, while that of the growth index is Apple, a diversified IT company. Ironically, Berkshire’s largest investment is Apple.
Both investment styles carry risk
Although Yves St Laurent famously declared, “Fashions fade, style is eternal”, style in the investment world can go out of fashion - for a while.
Over the three years to the end of February 2022, the S&P500 value index (USD) has underperformed the growth index by a cumulative 36.3%.
So, it’s no surprise that popular shares promoted on direct-investment platforms like Hatch and Sharesies tend to be growth shares, typically those operating in the IT industry.
Does that mean growth will always outperform value? Nope.
In the three months to the end of February, there has been a radical reversal in medium-term relative performance between the two styles. In this short period, the value index has outperformed the growth index by 14%.
Taking a longer-term view, since the style indices started nearly 30 years ago in 1992, the total return of the value index series is cumulatively 1.3% above growth, which works out at about… 0.03% per annum.
So, style return variations are negligible in a longer-term sense, but meaningful in the short-to-medium term.
At an individual share level, both investment styles have risks.
Companies or industries which are out of favour yet look attractive in terms of value fundamentals can continue to stay out of favour due to irreversible technological or social change. Examples of these in the last 20 years include coal mining, video stores, and telecoms industries. Value investors need to be careful not to ‘catch the falling knife’.
Conversely, a growth stock can hit a ‘bump’ in the expansion of its business. This often occurs due to the maturing in demand for their products, increased competition, or a failure to execute primary business plans.
How to access differing share investment styles
With a rather narrow set of quality companies in the New Zealand sharemarket, it’s not easy to build a portfolio exclusively based on either a value or growth style.
Hence you don’t tend to hear New Zealand share managers talk much about having a particular growth or value investment style, though each may have a ‘bias’ towards one or the other.
Notwithstanding this, with the increased number of ‘knowledge based’ shares in the New Zealand market, you could feasibly build a growth portfolio centred around technology stocks such as Ebos, F&P Healthcare, etc.
On the opposite side, there are shares in traditional sectors like construction, oil and gas, and banking which might give an investor a value-biased NZ share portfolio.
However, when looking at the US or global sharemarkets, there are plenty of options to access particular investment styles - which is great for the style conscious.
Style-based investment options span a variety of New Zealand based funds (PIEs), exchange traded funds or offshore managed funds like Australian unit trusts. Within these fund groupings there are actively managed style-based funds such as Harbour’s T.Rowe Price Global Equity or Nikko’s ARK Disruptive Innovation Fund, as well as style-based index trackers (such as promoted by Kernel).
Value or growth style: which is best
Which investment style is better, value or growth? It depends.
However, given the relatively extreme valuation gap between the value and growth share universes, rising interest rates, and an increasingly uncertain economic growth outlook, my style preference post Covid crash, and up to late 2021, has leaned towards overweighting towards value shares.
But fashions don’t stay the same: the recent significant reduction in price of many popular growth companies, while many previously ‘value’ stocks have soared, should make one reconsider.
Value is a relative measure, so yesterday’s cheap stock can become expensive while an expensive growth company can become cheap.
A bit of both - staying open-minded - may be the best way to help manage style risk in your share allocations, while not forgetting that, as Giorgio Armani said, “The difference between fashion and style is quality”. A
