While it is important to have a consistent investment style, we believe that tactically slanting the portfolio towards a certain style can improve portfolio returns.
No style outperforms all the time. In fact there can be prolonged periods when one style does better than the other. These last few years is a good example. Since equity markets came out of the global financial crisis, the performance of value stocks have lagged growth stocks. This does not mean that fund managers should switch between value and growth without any regard for the core competence of the company or the investment objective of the fund. However, there may be opportunities to tactically tilt the fund towards one style or another to capture superior returns.
How do we determine if one style will do better than the other? We won’t know unless we look at the underlying companies. Value style outperforms growth style when value companies outperform growth companies. It is only by comparing the valuation and fundamentals of value and growth stocks are we able to determine if value stocks will outperform growth stocks. We will use the Australian market as an example to illustrate this.
The chart below shows that Australian value stocks are expected to have slightly positive absolute returns for the next few years. Valuation is at fair values and fundamentals are mildly positive. The Composite Valuation Band is derived from the best combination of Price to Earnings, Price to Sales, Price to Cash Flow, Price to Book and Dividend Yield models in explaining the share price. You could read more in in our Market Absolute Performance Page.
However, when we compare with growth stocks, we find that value stocks in Australia historically traded at a PE discount of 11% and now the discount is even greater than 11%. However, while valuation is cheap, earnings growth is poorer than growth companies as indicated by the downward sloping red line. Therefore, value stocks are likely to underperform growth stocks over a 2 to 3 year time horizon although a short-term closing of valuation gap may be possible.
Bottom-up analysis of the two styles have been very effective in explaining which style will outperform. Make style tilts with more certainty by relying on bottom-up company data!
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