Growth and Value: Definitely Still Useful

By Matt Hougan

The “style is dead” meme has been around for a decade and it’s been wrong the whole time.

Dave Nadig's recent blog presents the same tired argument: Growth and value show high correlations to one another. Therefore, why bother using them in a portfolio?

I’ll tell you why: Because they work.

People who argue differently have their heads stuck in the ivory tower, too worried about “correlation quotients” to think about what actually matters to investors, which is returns.

Let’s take a simple case. Since the market bottomed on March 9, the rolling three-month correlation between the iShares Russell 3000 Growth ETF (NYSE: IWZ) and the iShares Russell 3000 Value ETF (NYSE: IWW) has been well over 0.90. To academics, the two are essentially identical.

But in the real world, there’s been a huge difference: IWV has outperformed IWW by more than 7 percent, in a period of just 6 months. It has also beaten the broad market iShares Russell 3000 ETF (NYSE: IWV) by 3 percent.

Now consider a different stretch: from Sept. 15, 2008 (the day Lehman Brothers went bankrupt) through March 9, 2009. The correlation between IWW and IWV over that stretch was again consistently above 0.90, but on a performance basis, IWW outperformed IWV by 10 percent.

What happened is obvious: After Lehman’s bankruptcy, the market started punishing risk. Not surprisingly, growth stocks (which have stronger fundamentals than value stocks) outperformed. When the market bottomed, investors started to reward risk again, and value gained.

An investor who timed that transition perfectly … who bought growth on Sept. 15 and switched into value on March 9 … is now 8 percent ahead of an investor who just bought the market and held on.

I’m not saying it was easy (or even possible) to call that transition perfectly. But even if you missed it by a week or a month, you still did well.

Not everyone has the inclination or temperament to tweak the risk focus in their portfolios on a real-time basis. I don’t. But I know some investors and advisers that do, including some who have been doing it successfully of late. For them, growth and value (like large-caps and small-caps) are useful.

Original post

Comments

[David Van K...:]

Growth stocks have less risk and stronger fundamentals than value stocks? I thought it was the other way around. I'd love to have the author come back and explain what he means, or cite to a source for more information about the inherent riskiness of growth and value stocks. How are they even defined? I thought Russell merely took the stocks with higher P/B values and called them "growth" and stocks with lower P/B values and called them "value."

Sep 29 07:52 AM

[Avooch:]

Matt,

Value vs. Growth will continue to be a useful initial screening tool.

------------------------

Don't Get Massacred !

Gudovac1941

Sep 29 09:01 AM

[User 35345:]

You lost me at:

"An investor who timed that transition perfectly"

Sep 29 09:20 AM

[Ichabod:]

Mr Hougan:

Please proofread your article. You say that for BOTH periods in question, "value" outperformed "growth" and "broad" indices. Yet you conclude that the most profitable tactic would have been to switch between growth and value last March.

Huh????

Sep 29 11:38 AM

[Ron Rowland:]

You are correct that correlation does not measure return. The correlation between a straight line moving up at the rate of 30% per year has a perfect correlation of 1 with a straight line moving up at the rate of 2% per year.

Sep 29 01:11 PM

[Living4Divi...:]

I agree with you DVK -

The author has no basis for saying that growth stocks have stronger fundamentals. The only thing they are strong in is their past and predicted growth rates.

Still, I am glad that the author countered the argument that "Growth and Value Styles are dead"

On Sep 29 07:52 AM David Van Knapp wrote:

> Growth stocks have less risk and stronger fundamentals than value
> stocks? I thought it was the other way around. I'd love to have the
> author come back and explain what he means, or cite to a source for
> more information about the inherent riskiness of growth and value
> stocks.
> with lower P/B values and called them "value."

Sep 29 03:48 PM

[sasoros:]

I think the author means that growth stocks have less risk at the OPERATING level.......which at a thumbsuck is probably true..

Sep 30 12:35 PM