Modern management demands something more sophisticated than the traditional division between value and growth, however those terms might be defined
Are you a value investor or a growth investor? It sounds such a simple question that you may imagine you will have no difficulty answering. But before you do so, pause for a moment and ask yourself precisely what is meant by value investment and growth investment.
Are you someone who does not look for value when investing your own or your client's cash? On the other hand, would you deliberately choose to invest in a company that did not at least show some prospects of growth? In both cases, the answer is almost certainly no, so where does that leave you, a value/growth investor perhaps?
The problem is that while growth and value investing are widely used labels, exactly what they stand for is by no means clear. There is no universally accepted definition for either in the investment textbooks. Often growth and value are used as convenient labels with which to describe funds, fund managers or even whole management groups.
The most common starting point for the definition of a growth investment, and the one that is to be found on many websites aimed at US private investors, is an investment in a company that will produce above-average growth. In theory, strong growth will translate into rising share prices, even if little or none of the profits come back to investors as dividends.
The criterion is future growth, which is a not a completely objective yardstick. In the late 1990s, technology, media and telecom shares thrived on the expectation that companies in the sector would deliver superior growth in the new millennium. That faith proved to be misplaced and growth was the last thing many investors saw. It may seem hard to believe now but back in 1999, BT was a growth stock selling on a P/E ratio of more than 40.
Value is no less difficult to pin down. A simplistic approach is simply to say that a value stock is anything that is not a growth stock. On the growth definition considered above, this means a company that falls into the value category is expected to grow at or below the average growth rate ' not the most appealing prospect.
A different approach might be to say that value stocks have P/E ratios at or below the market average and growth stocks are what are left over. This approach has its appeal because it avoids a company falling into both categories but it is undoubtedly arbitrary, especially at the margins. It also begs the question of why a company cannot simultaneously demonstrate growth and value characteristics.
In the US, the Russell 3000, 2000 and 1000 series of indices have value and growth versions, based on price-to-book ratios and probability weighted forecast earnings growth. These indices eschew the black-or-white approach: about 70% of the parent index constituents are classified as either pure growth or value, with the other 30% weighted proportionately to both growth and value. For example, a stock might be weighted 20% growth and 80% value.
In the UK, value and growth shares are often divided by yield. So, for example, the FTSE series includes an FTSE 350 Higher Yield and FTSE 350 Lower Yield, splitting in two the combined constituents of the FTSE 100 and FTSE 250. These are often used as value/growth proxies.
The yield division is not without its drawbacks, however. A company that cuts or suspends dividends because of poor profitability or a need for capital retention can move across to the supposed growth sector. The FTSE also runs value and growth versions of the FTSE 350 operating with the same underlying methodology as the Russell indices, but these are not widely used.
Whichever way you choose to define value, for the past couple of years, it has been the place to be. For example, between the start of 2000 and the beginning of 2002, the FTSE 350 Higher Yield Index managed to achieve a positive return of 1% while its Lower Yield counterpart fell by 41.8%.
In the US, the Russell 3000 Value Index has beaten its Growth counterpart over one, three, five and 10 years to 28 February 2002. Some academic research, such as that recently undertaken by two professors at the London Business School (LBS) also tends to find in favour of value investing over the long term. However, as LBS researchers say, it should not be assumed that history will repeat itself.
Go back to the final months of 1999 and you would have found only a handful of brave (or foolish) investment managers claiming to be value investors. Those that remained true to the value fold lost clients because they missed out on the technology, media and telecoms boom. Since then, the remaining clients have also avoided the high tech bust.
The switch back from growth to value that has taken place over the past two years should not be overly surprising. Any manager who rigidly adheres to one investment approach is likely to be right at some time, like a stopped clock.
Value has proven the correct choice in the past couple of years but that is by no means justification for saying it will always be right, any more than the success of growth in the late 1990s meant the final demise of value investment. In the past, value has generally performed well when economic conditions have been tough, while growth has been superior when conditions are rosier.
From an investor's viewpoint, particularly the retail investor, what matters is the overall return a manager delivers rather than how it is achieved. Growth from an income fund is no less valuable than capital gains from a growth fund.
At New Star, our approach is to refuse to place ourselves in either the growth or value camp. There are three main reasons for our agnosticism either strategy has delivered the goods all the time, as recent history shows only too well. Investment management groups that nail themselves to one style have sometimes paid a high price for their principles ' and so too have their clients. There is an argument that the one style house is not performing a full investment management role if it rules out opportunities on simplistic growth/value grounds.
A modern approach to investment management demands something more sophisticated than the crude value/growth division, however defined. Few businesses today are operating the same business processes as they were, say, 10 years ago, a fact that applies as much to investment management as to television manufacture.
In a low inflation, low return environment we can expect to have to think differently. For example, in the UK, dividend growth has stalled over the past two years and a growing number of companies are revising their dividend strategies. If this trend continues, it will call into question a value investment approach driven by yield.
flexibility is the key
We want to give maximum flexibility to our investment managers. The New Star philosophy is to let the managers manage their funds. New Star funds do not rely upon the ubiquitous management team, which suddenly emerges from the shadows when a named manager departs.
We believe in selecting the best fund managers available, keeping them incentivised through direct stock holdings and, within defined limits, leaving them to make their own investment decisions. What we look for are good managers not growth or value managers.
For instance, Richard Pease, manager of the European Growth Fund, would classify himself as a GARP (growth at reasonable price) investor, if forced to choose one camp.
He has always been reluctant to buy shares with P/E ratios of much over 20. On the other hand, Alan Miller, manager of New Star's UK Growth Fund, has been happy to invest in stocks with P/E ratios over 15 in circumstances where the company is either producing phenomenal growth, or is trading at a substantial discount to its tangible assets.
So are you a value investor or a growth investor? Or do you subscribe to our view that first and foremost, you are an investor who wants to achieve investment returns whichever way the stock market wind is blowing?
While value and growth are widely used labels, exactly what they stand for is unclear.
In the UK, value and growth shares are often divided by yield.
Growth from an income fund is no less valuable than capital gains from a growth fund.
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