- Despite market conditions that favored growth over value in recent years, our analysis did not find, on average, that growth managers performed better than their value counterparts relative to appropriate style benchmarks.
- During the study period, U.S. and international growth and value funds outperformed benchmark style indexes with lower tracking error than versus market-cap indexes (with the sole exception of U.S. growth funds).
- Aligning investment style with benchmarks gave managers a more consistent basis for measuring performance, and asset owners and consultants a more relevant performance benchmark to use in their fund-selection process.
Value and growth investing as we know them have been around for decades. Value investors look for securities whose prices appear low compared to their intrinsic value, while growth investors focus on identifying securities whose prices they believe will be driven by outsized sales and earnings growth. Consequently, value and growth indexes were created in the 1980s as finer tools than market-cap indexes to measure the performance of these two distinct investing styles. More than 30 years later, are they still a relevant choice?
As shown below, growth indexes outperformed and value indexes underperformed market-cap indexes starting in around 2007. But how did growth and value funds perform? And what can that tell us about whether market-cap benchmarks are appropriate for style-based investments?
Value and Growth Funds Relative to Market-Cap and Style Benchmarks
To determine whether growth and value funds were better aligned with market-cap or style indexes, we compare performance, tracking error and factor exposures among funds. We selected U.S. and international1 funds from the Lipper database with value exposures of greater than +0.20 and, separately, those with growth exposures greater than +0.20. To measure these exposures, we used MSCI FaCS™ on Funds, which aggregates stock holdings at the fund level and calculates exposures across different factor groups including growth and value.2 Then, each of the funds within the growth and value fund groups (U.S. growth, U.S. value, international growth and international value) was equally weighted on a quarterly basis from March 2011 through December 2020.3 We calculated the trailing performance of the funds over different time periods and compared them against both their respective market-cap and style benchmarks.
Relative Performance of Growth and Value Indexes
As we can see in the exhibit above, growth funds outperformed and value funds underperformed market-cap indexes across all periods (the pattern referenced earlier). By contrast, each group of funds outperformed their corresponding style benchmarks during those same time periods (except for U.S. growth funds, which outperformed only for the one-year period).
Further, all funds showed reduced tracking error when compared to their corresponding style, rather than to market-cap benchmarks, as shown in the chart below. Lower tracking error suggests greater alignment between a manager’s investment strategy and the benchmark, and may help determine which type of benchmark is appropriate. The reduction in tracking error for value funds was smaller. Does this mean that value managers were taking additional bets beyond value that resulted in weaker alignment with the value benchmark? We investigate this further in the context of U.S. value funds by examining certain historical absolute factor exposures.
Growth and Value Funds Had Lower Tracking Error Against Style Benchmarks
US Value Funds’ Performance Drivers
The chart below shows absolute value- and growth-factor exposure for our set of U.S. value funds and the MSCI USA Value Index. From March 2011 through December 2020, both were similarly exposed to the value factor. The MSCI USA Value Index, however, had a much more negative exposure to the growth factor. The higher exposure to growth (average of +0.21) of the U.S. value funds may have contributed to the higher tracking error.
Growth Exposure of Value-Fund Managers
To further investigate, we examined which sectors contributed the most to the U.S. value funds’ active return. From March 2011 to December 2020, we see that these funds were overweight sectors usually considered growth-oriented (information technology, consumer discretionary and communication services) and underweight sectors usually considered value-oriented (utilities, consumer staples and energy). The net return contribution from these underweight and overweight sectors was approximately 14% on a cumulative basis.
Value Managers Overexposed to Traditional Growth Sectors
| US Value Funds vs MSCI USA Value Index | ||
| Sector | Active Ret Contrib | Avg Active Wgt |
| Information Technology | 19.1% | 3.4% |
| Cons Discretionary | 13.4% | 4.6% |
| Comm Services | 7.7% | 0.4% |
| Utilities | -8.3% | -3.1% |
| Consumer Staples | -8.3% | -3.8% |
| Energy | -9.3% | -2.0% |
With evidence of this growth bias in hand, we set out to see whether this played a part in the higher tracking error. To do so, we reselected U.S. value funds with a value exposure of greater than +0.20, but added the condition that they have growth exposure of less than -0.20. We call these “pure” U.S. value funds to denote that they have minimal-to-negative exposure to the growth factor.
Over the period of analysis, the tracking error for these “pure” funds was 40 basis points lower (at 2.8%) than that of the original set of value funds. And not only on a total basis. The different components of tracking error — i.e., active-risk contribution from risk factors and industry- and stock-specific components — were all reduced.
‘Pure’ US Value Funds Tracked Their Style Benchmark More Closely
Informed Investors Never Go Out of Style
Over the past decade, we saw that, on average, growth funds outperformed, while value funds underperformed, their market-cap benchmarks. Comparing our analysis set of growth and value funds to growth and value style indexes, however, we found outperformance from managers of both styles. What’s more, by comparing tracking error between market-cap and style indexes, we found that style indexes were more appropriate benchmarks for growth and value funds. In addition, while value and growth managers tend to show tilts toward their target styles, this tilt varies across managers and across time. A better understanding of these exposures can shed further light on their impact on the performance of these funds.
1Lipper defines international funds as funds investing in developed markets excluding the U.S.
2MSCI FaCS calculates exposures across eight factor groups: growth, value, volatility, yield, quality, momentum, size and liquidity. We consider factor exposures of +/- 0.20 standard deviations as meaningful since they are likely to be intentional. Please refer to: Bonne, G., Roisenberg, L., Subramanian, R.A., and Melas, D. 2018. “MSCI FaCS Methodology.”
3In our dataset, the average number of U.S. value and growth funds was around 240 each and the average number of international value and growth funds was around 40 each.