For the first time in a long time, investors are talking about “growth” versus “value” investing, and that’s not a good thing. Well, actually, it is a good thing, but the reasons why they are talking about it are not a good thing.
On the plus side, it’s important for retirement savers to understand the different uses (and abuses) of growth versus value investing (see “How a Fiduciary Should Explain ‘Growth’ and ‘Value’ Investing Styles,” FiduciaryNews.com, April 11, 2017). Unfortunately, what’s prompting this discussion is a short-term performance aberration that shows all that is wrong with SEC mandated performance reporting requirements.
Several years ago the SEC began requiring mutual funds to report calendar year performance on a one-year, five-year, ten-year, since inception basis. They thought this was a good idea because, prior to that, mutual funds were permitted to report on a fiscal year basis (just like all other publicly traded companies).
It was therefore difficult to compare mutual funds with different fiscal years since they reported on different performance periods. Getting all funds aligned on the same reporting period (in this case, calendar year), avoided this apples-to-oranges performance comparison.
Unfortunately, it failed to resolve the awful “snapshot-in-time” anomaly. Don’t know what that is? Well, if you recall what happened on December 31, 2011, you’ll know what the snapshot-in-time anomaly is.
As of January 1, 2013, five-year performance reporting dropped the very bad year of 2008 from the books. In 2008, the Russell 3000 lost more than 37% (by comparison, the S&P 500 was down 38.5% that year). For the five years ending December 31, 2012, the Russell 3000 had an average annual return of only 2.04%.
On the other hand the five-year average annual return for the same index as of December 31, 2013 was a whopping 18.71%. That’s the power of dropping 2008 from your reporting period. That’s the power of the Snapshot-in-Time Anomaly.
That’s also why you should be wary of putting too much stock (pun intended) in singular reporting periods, especially short ones.
What’s got everyone all aflutter about growth stocks was the first quarter numbers. For the first time in a long time, growth stocks outpaced value stocks in a dramatic fashion.
According to Morningstar, in the first quarter of 2017 the average growth beat the average value fund by 4-5%. The Russell 3000 growth index blew past the Russell 3000 value index by 5.64%. Those are big numbers for a year, let alone a quarter.
This leads the typical investor to ask, “Shouldn’t I be investing in growth stocks (or an index fund, since they tend to mimic growth returns) instead of value stocks?”
This is a reasonable question for someone who only pays intermittent attention to the markets. For professionals, however, the challenge is to successfully explain the snapshot-in-time anomaly to those asking this naïve question.
The best way to accomplish this task is by showing a graph of rolling five-year returns, since that at least reframes the question into a long-term investing question. Still, the cynical client might say, “Why are you trying to hide the quarterly return date from me?”
No need to hide it. Here are those numbers.
In the 265 rolling quarters since January 1995, the Russell 3000 Value index beat the Russell 3000 Growth index 133 times (that 50.19%). The Russell 3000 Growth index has only match the success it had in the first quarter 2017 against the Russell 3000 Value index eight times before (the most recent time being the three months ending November 2010).
Furthermore, the worst quarter for growth was 4% worse than value and the best quarter for growth was 1% worse than value. So, value had a lower downside and a higher upside. As you might expect, then, value had a higher median return than growth.
Growth will have its day (or quarter) every so often, as the Snapshot-in-Time Anomaly proves. For the long haul, though, as the rolling return analysis suggests, value has stronger numbers.