Value funds or growth funds? Who shines in a booming economy?
As the major Western economies throw off the shackles of the pandemic, economic growth is accelerating, with Gross Domestic Product (GDP) predictions upgraded several times already this year for many countries. Will this rising tide lift all boats, or will certain styles of mutual funds offer the potential for better returns this year?
As economists and market watchers have noted, economic growth seems set to expand considerably thanks to several positive trends: vaccinations are well underway; reopening is proceeding across North America; pent-up demand is strong; and household savings are high. But it is these very circumstances that may allow some companies and sectors to outperform over others. Inevitably, there will be winners and relative losers as the economy shifts from lockdown mode to more typical conditions.
Value or growth?
Many mutual fund managers are characterized as having an investment style, often using a “value” or a “growth” filter to assess potential stocks. Depending on the approach, the opportunities in the post-lockdown economy may look very different.
Value-focussed fund managers seek out quality firms whose market price does not accurately reflect their intrinsic value. Essentially, the value style means buying stocks that are regarded as being “on sale.”
They pay close attention to a company’s financial information, such as debt levels, price/earnings (p/e) ratio, price/book value ratio and dividend yields to determine whether its stock is overpriced, underpriced, or fairly valued.
Value stocks tend to do well at the beginning of an economic cycle, which many market watchers believe is where we are now, and value managers will be looking for those relative underperformers that are ready to excel. Indeed, in the U.S., earnings sectors that often lead in value stocks, such as financial services, energy and materials, have seen large increases in the first half of this year.1 The flow of money into growth funds has followed.2
Growth fund managers, on the other hand, seek out companies whose earnings they think will grow faster than others in their industry or the overall market. They look for firms that have high earnings growth rates, a high return on equity, high profit margins and low dividend yields.
As the economy accelerates, growth managers will continue to see opportunities in companies that are riding a wave of growth and can expect continued high levels of profitability as consumers and businesses begin spending with gusto. Technology stocks, for instance, are classic growth stocks. Many of these have done well during the pandemic. The big question for money managers is this: is that outperformance set to go on or is a pull back likely?
For the individual investor, considering the approaches that professional fund managers use offers a way to understand equity markets and investment performance better. But the most important approach is to adhere to the foundations of a diversified portfolio matched with your individual risk profile and investment goals. If you’d like to better understand the role of value and growth fund styles in your investments, a portfolio review may be in order.
1 MarketWatch. Value stocks are so in favor they’ve become momentum stocks. March 27, 2021. https://www.marketwatch.com/story/value-stocks-are-so-in-favor-theyve-become-momentum-stocks-11616084864
2 MarketWatch. Value stocks are making a comeback. Don’t get left behind, these analysts say. March 22, 2021. https://www.marketwatch.com/story/value-stocks-are-making-a-comeback-dont-get-left-behind-these-analysts-say-11615828690