Growth funds were hit harder than most in the recent bear market - they were, after all, stuffed to bursting with the sort of tech stocks hammered in the falling markets. But, says Christopher Salih, it seems growth may be enjoying something of a renaissance
Growth has been a dirty word in investment since the start of the bear market in 2000. Growth funds - often stuffed with technology stocks - saw some eye-watering losses and advisers and investors have avoided them ever since. In the UK nowadays there are few managers left who will admit to being pure growth, with many hiding behind the moniker of GARP (growth at a reasonable price). But there have been whisperings that some of the traditional 'growth' sectors are starting to look attractive again. Could growth be coming back into vogue? And are the terms 'growth' and 'value' still valid?
Managers who label themselves 'pragmatist' are currently reducing the value/recovery bias that they have held for much of the past five years in favour of growth stocks, as many feel that the market is beginning to favour more of the traditional growth stocks. There is obviously risk attached to this move - the income element of many traditional value stocks has provided a valuable cushion for many managers. How should advisers be evaluating growth funds?
Rob Burdett, director of multi-manager at Credit Suisse Asset Management, suggests that investors need to look at both the past and the future when choosing an investment: "I would suggest checking that the stocks held exhibit 'future' growth characteristics such as earnings and sales growth. Increases in analysts' estimates for the years ahead would also be a priority. But historic growth records are important too to prove such stocks are not recovery stocks in disguise. Such stocks still need to be priced sensibly of course."
Bambos Hambi, head of multi-manager at Gartmore, also believes past performance is a relevant indicator of future performance. He said: "Investors should look for a manager who will buy stock with above market return and secure earnings growth, both historically and in the future. From a sales side this is relevant too."
However, Hambi points out that advisers need to be very careful in terms of evaluating economic growth because things are not always as "rosy" as they seem. He says: "A good example of this is the Chinese economy which is growing 9% to 12% per annum and by 2050 they are expected to have the largest economy and stockmarket in the world. Yet at present, the Chinese stockmarket is at a six-year low. This shows that the quality of companies is low. From a macro view, economic growth is not correlating to the market."
There are now numerous types of growth funds. Richard Philbin, head of F&C's multi-manager team, divides growth funds into three specific categories. He says: "Firstly, there are growth funds comprised of some 30 to 45 stocks and are focused around pure stock picking. Secondly, there are diversified funds with some 75-150 stocks. These funds take little bets across the markets. There are also multi-cap funds which are very benchmark-aware." One of Philbin's favourite managers is Tim Russell, who runs the Cazenove Growth and Income Fund. Russell sets his stall out as a pragmatic manager.
When is the best time to invest in growth funds during the economic cycle? Some feel it is best to wait for the 'snowball to roll down the mountain' before investing, whereas others prefer to invest earlier because that is the best time to find anomalies. Richard Prew, fund manager for Axa UK Growth, is a believer in the latter, he says: "It is usually the best time to invest in a growth fund when growth is genuinely scarce, when interest rates are up and valuations are low - pretty much how the market is right now."
Hugh Sergeant, SGAM UK growth manager, also believes now is a good time in an economic cycle to invest in growth stocks, but for a different reason: "Now is a good time to invest as valuations are attractive and growth is reasonable."
But growth comes in many guises. Should advisers in fact be looking to smaller company funds or emerging markets for their growth opportunities? Many would argue that broader definition of growth funds incorporating these two sectors is more appropriate. Hambi believes that the arguments in favour of small cap are strong. He says: "Generally there are more opportunities in small companies. After all, elephants do not gallop. Naturally it is easier for small companies to double in size, but there is, of course, more risk as that company may well rely on one product. Marconi/British Telecom share price falling 45% in one day is a good example of this."
Hambi adds: "We added Roger Whiteoak's small-cap fund in December 2003 and it is up 60%, he is very much the best growth manager in our portfolio simply because he is the best at spotting anomalies in small cap."
Sergeant agrees that although it is best not to put all your eggs in one basket, a small-cap bias is definitely the way to go. "It is best to invest across the UK market and find anomalies in that market, but it is perhaps best to be overweight small cap because there are more opportunities, the stocks are less well-researched and there is a huge volume of stocks in that area. But we look to find opportunities across all market caps."
But what of emerging markets? Emerging markets have been a fertile source of new businesses and companies, and there are those who would argue that small-cap opportunities are limited in a mature economy like the UK.
Philbin feels that although these markets are more volatile than the UK market, they offer definite potential. He says: "Yes, China, Brazil and Russia have more volatility, but if you place your faith in one of those growing economies today, in 30 years it is probably going to be the best investment decision you could have made. Overseas investment is different, both politically and in terms of risk. For example, both China and Brazil have recently changed their economic currency and there is a chance to really capitalise."
Burdett also thinks that looking abroad can reap rewards. He adds that there are more traditional 'growth' funds in some of the foreign markets. He says: "Although there are options in the UK, I believe there is more choice overseas in markets such as the US and Japan where there seem to be more clearly defined growth styles."
A leap of faith
So, is the future for growth funds bright? There will always be stocks that offer 'surprising' growth, so theoretically the market should always present opportunities for growth managers. Philbin believes that those opportunities will always be crucial to boosting the market. He says: "The UK is a capitalist economy; there will always be opportunities to invest, 15 years ago there were no mobile phones. Look at the likes of Vodafone now. There are market opportunities and business in the long-term for investors and not just in technology stocks."
Prew is not as optimistic on the scale of success that growth in the UK will have: "Cyclically growth will continue to have a modest recovery from where we are now but it still remains a leap of faith to suggest that at some point it will overtake income funds."
Philbin is sure that the UK growth market will reach its previous heights despite the lingering legacy of the technology bubble. He says: "It was a pretty big bust. Take telecoms, they were £4 a share at their height but they are now only worth £1.30p and they were as low as 70p to 80p a share. Prior to the dotcom bust the FTSE 100 was 7,000, it will be difficult to get back to that. But greed will eventually overtake caution, there will always be investors involved too late or too early."
Hambi agrees that it will be greed that will propel the final recovery from the collapse in 2000. He says: "It may take time in terms of performance, but we are people and people are driven by fear and greed. Greed will eventually show its face again in the growth market."
Traditional UK growth funds will have their time in the sun again. When this will happen is difficult to predict, but most would argue that investors are not being asked to pay much for future growth prospects in the current market. As markets have stabilised over the past couple of years it could be time for growth funds to return to favour. 'Growth' is still a valid term, but no investor is going to buy a stock he believes is expensive. Investors should instead look at a wider view of growth incorporating smaller companies and, possibly, emerging markets as this is where much of the real growth is to be found.
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