Understanding the behaviour of Growth and Value investment strategies

Introduction

Growth or value? This question rarely escapes any discussion about investment philosophy, strategy or process, particularly when it comes to equity investing. To have a meaningful discussion on this, investors must have a deep understanding of how these two strategies perform in different market environments and the drivers of their returns. This article seeks to address these questions.

Long term performance

A large body of research shows that, globally, value has outperformed growth over the long term. However, this finding has not gone unchallenged, as a number of authors have pointed out that this outperformance is a result of the use of a wrong definition for growth in many of these studies. They argue that if growth is defined as it is normally defined in practice that the reported outperformance by value is not as clear-cut, e.g. Brush (2007). Brush points out that there is a widespread convention of defining growth as ‘bad value’ in academic research, i.e. as stocks with high price-to-book or high price-to-earnings ratios. This definition is disconnected from reality as it is highly implausible that a growth portfolio manager will primarily search for overpriced stocks in constructing a portfolio.  We think a definition that uses growth variables such as earnings growth, sales growth, etc, is more appropriate in capturing the risk and return characteristics of a growth strategy. For example, the MSCI growth index uses a combination of variables with a focus on growth such as forecast earnings per share growth, historical earnings per share growth, sales per share growth and current internal growth rate. Using this definition, contrary to Brush’s findings, the MSCI indices show that, globally, value has significantly outperformed growth since 1974 (see figure 1). However, evidence of this differs from region to region. At this point all we can say is that the debate regarding the long-term performance of value versus growth rages on!  

Be that as it may, there is very little disagreement amongst academics and investors that the relative performance of the two strategies is very cyclical, with wide performance swings relative to each other over time. The last few years have been notably different though; growth experienced its strongest and longest period of outperformance relative to value (see figure 2). From January 2009 to December 2018, the MSCI World Growth index, which is representative of the growth style, outperformed the MSCI World Value index by an annualised 2.4%.

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