David A. Koenig, CFA, FRM, Investment Strategist
The most challenging multiple-choice exams start with a deceptively simple question followed by several possible answers. Each answer has merit, and none is actually wrong, so the trick is to choose the one that is most comprehensive and offers something the others lack.
It’s the same with modern investing. Investors and portfolio managers weigh the advantages of value versus growth and wonder whether the current trend toward factor investing is a better bet than sticking with such traditional styles. Yet with investment strategies, as with multiple-choice questions, sometimes the correct answer is "all of the above."
The evolution of indexing
Russell Investments introduced the industry’s first growth and value indexes in 1987, not long after establishing a series of U.S. size-based indexes. Since then, the Russell style indexes have been widely adopted as the industry standard for measuring growth and value market segments, benchmarking active managers, and serving as the basis for passive investment vehicles.¹ Together, the Russell style and size indexes became a basis for the well-known style box, and for decades they have shaped how investors build their portfolios.
Index use has grown dramatically since those early days as investors have embraced it as a standard method for viewing the market. Yet we’re now finding a new and contemporary use for this traditional tool. Investors are using style indexing not only to track performance and measure results by looking back, but also to create outcome-oriented investment strategies by looking forward.
Today, a wide range of new indexes also focuses on individual factors such as low volatility, quality, momentum, and several others. Some experts claim that factor investing could replace investing based on traditional styles such as growth and value, while others have dismissed factor investing as a passing phase that is likely to disappoint investors.
Meanwhile, investors are trying to understand these strategies, asking whether the current trend toward factor investing has made traditional styles irrelevant, and wondering how they can use either style or factor investing to improve their portfolios.
Styles vs factors and growth vs value
Style indexes are designed to represent broad market segments and to be symmetrical, dividing a complete market segment into complementary components so that, together, they comprise the whole segment. As an example, the Russell 1000® Growth Index plus the Russell 1000® Value Index equal their parent index: the Russell 1000® Index.
Source: Morningstar Direct
Historically, value has significantly outperformed growth over the long term, leading some investors to believe that an all-value portfolio is the smart investment and that growth stocks can potentially be ignored. Style leadership is cyclical, however, and there have been several extended periods—the technology boom of the 1990s is a good example—when growth has outperformed value. In addition, most investors don’t experience a 20- or 30-year return. Instead, the return they do get is highly dependent upon when they enter and exit the market.
Factor indexes are specifically designed to provide a more focused exposure to a specific factor—momentum, low volatility, and so on—essentially to enable investors to make a more focused bet using an investable product on the performance of the target factor. Factor indexes also typically weight securities by exposure to the target factor rather than by market capitalization. And because consistent factor exposure is a primary goal, factor indexes tend to have higher turnover and typically are rebalanced more frequently than market cap–weighted indexes such as style indexes for value and growth.
Strategic investing in a multi-factor world
When faced with the choice between growth and value, and between styles and factors, one strategic approach for investors to consider takes its cue from the multiple-choice exam discussed earlier. Choose "all of the above."
Diversifying between both growth and value styles offers investors an opportunity to strategically or tactically tilt the portfolio toward a particular style, such as a 60/40 tilt toward value. Using such a blended portfolio diversified across value and growth styles ensures that investors have exposure to whichever style is performing well at any given point while also ensuring that they have adequate exposure to its counterpart when the leadership cycle changes.
In addition, having separate allocations in growth and value styles will help enable investors to adjust their portfolio efficiently as the market shifts and their views evolve. Historically, this type of style diversification can help deliver more consistent returns over time, which is especially important for a core investment portfolio.
Conversely, factor indexes are much more focused tools that can be used, along with traditional style indexes, to actively tailor portfolios based on views of the market, business cycles or other economic conditions. Factor indexes, for example, can be used strategically to make precise portfolio adjustments in seeking to achieve return enhancement, risk reduction or greater diversification. Investors also can use them to make dynamic adjustments over time.
By combining both growth and value investments along with specific factors that are consistent with their investment beliefs and market views, investors can potentially build a “best-of-all-worlds” approach into their portfolios.
Note: David Koenig has produced a PDF paper on this topic, with all due respect to fans of rock-and-roll music: Value & Growth: The Beatles and The Stones.
¹Russell Indexes 2013 Annual Benchmark Survey, December 2013
The information, analyses and opinions set forth herein are intended to serve as general information only and should not be relied upon by any individual or entity as advice or recommendations specific to that individual entity. Anyone using this material should consult with their own attorney, accountant, financial or tax adviser or consultants on whom they rely for investment advice specific to their own circumstances.
This material is proprietary and may not be reproduced, transferred, or distributed in any form without prior written permission from Russell Investments. It is delivered on an "as is" basis without warranty.
The Russell 1000® Growth Index measures the performance of the large-cap growth segment of the U.S. equity universe. It includes those Russell 1000 companies with higher price-to-book ratios and higher forecasted growth values.
The Russell 1000® Value Index measures the performance of the large-cap value segment of the U.S. equity universe. It includes those Russell 1000 companies with lower price-to-book ratios and lower expected growth values.
The Russell 1000® Index measures the performance of the large-cap segment of the U.S. equity universe. It is a subset of the Russell 3000® Index and includes approximately 1000 of the largest securities based on a combination of their market cap and current index membership. The Russell 1000 represents approximately 92% of the U.S. market.
Russell Investments is the owner of the trademarks, service marks, and copyrights related to its respective indexes
Indexes and/or benchmarks are unmanaged and cannot be invested in directly. Returns represent past performance, are not a guarantee of future performance, and are not indicative of any specific investment.
Diversification does not assure a profit and does not protect against loss in declining markets.
Copyright © 2016 Russell Investments Group, LLC. All rights reserved. This material is proprietary and may not be reproduced, transferred, or distributed in any form without prior written permission from Russell Investments. It is delivered on an “as is” basis without warranty.
First used: August 2014