The long feud between growth and value equity investors can end. Both concepts are increasingly unhelpful with the shift from active investment to passive portfolios.
As a result of this transition, growth and value are now broken approaches that have the potential to create significant and unnecessary risk for many investors. All-or-nothing methods of index construction create portfolios with dramatic over/under weights in volatile sectors. Single stock weightings can be double more broadly based indexes. Instead of helping investors diversify via traditional “style boxes,” growth and value now herd them into tightly fenced pens.
Growth and value investing came of age during the mutual fund-driven rise of active management in the 1980s and 1990s. As a way for portfolio managers to differentiate and explain their investment styles, they were — and still are — very useful labels. However, as passive indexes — hard-coded rule sets with largely binary stock selection parameters — they have their problems. For example, growth/value classifications create dramatic and potentially risky sector concentrations versus broader market averages.
The S&P 500 Growth Index has a 41.3% weighting to technology. The Russell 1000 Growth Index carries similar exposure, at 39%. At the average of the two, this represents a 60% overweight versus the S&P 500’s 25% exposure to technology stocks. The S&P 500 Value Index carries only a 7.1% weighting to technology, and instead overweights financials at 25.7%. For the Russell 1000 Value Index, the current weightings are 9.1% technology and 27% financials. The S&P 500 Index has a 15% weighting in financials, so both value indexes show notably incremental concentration. And, of course, technology is essentially a trace element in the S&P 500 Value portfolio.
Growth or value funds also push investors to take noticeably more single-stock risk than broader market averages.
About 27% of the S&P 500 Growth Index is invested in five companies: Apple, Microsoft, Amazon, Facebook and Alphabet. That is almost double their collective weightings in the S&P 500, or 14.3% of total. The story with the Russell 1000 Growth Index is similar, with a 24.7% weight in these names. On the value side, single stock concentration is actually similar to the S&P 500, with a 13.7% weighting to JPMorgan, Berkshire Hathaway, Exxon Mobil, Bank of America and Johnson & Johnson combined. Still, at a 3.6% weighting in the S&P 500 Value Index, JPMorgan’s influence is almost double what it is in the S&P 500, just to pick one example.
Simply using U.S. small-cap measures such as the Russell 2000 Value or Growth indexes gets rid of the single stock overweight issue, but does little to ameliorate the sector concentration issue.