Growth versus Value Investing: Which is better?
Ken French and Eugene Fama provided ground breaking research in the world of modern portfolio management that has been the bedrock for how the industry develops and manages a portfolio. What I find unique about Fama and French is that the goal for their initial study and those continued by other academics was simple, to “explain market returns”. Their initial study was what propelled them to the forefront of the discussion of value versus growth debate. That debate continues to this day.
Fama and French’s attempt was based on a pure and humble question. It wasn’t “how can we beat the market, or provide alpha consistently in a given portfolio”. In fact their assumption is that you can’t do that. Their research was focused on how to achieve market returns on a risk adjusted basis and what components explain those returns consistently. It was bent towards a curiosity, much like a scientist with nature, using observation to explain what is going on and how things truly work. Fama & French wanted to study the nature of returns, with all its facets, and distill down a more concise and thoughtful understanding of what provided meaningful evidences of return. From that, create efficient portfolios that reflect those elements of consistent return based on the expected risk return relationship of the portfolio. For a portfolio manager or advisor the result of this discussion and research helps us better allocate our clients wealth towards those areas evidenced in providing consistent returns. These essential ingredients are “factors” of return.
Whether it be the beta, size, value etc., they wanted to determine which of these factors best indicated and contributed to a higher return more consistently over a long period of time. Eventually, Fama & French developed what is now known as the three factor model. This model collectively explains 95% of the variability of expected market returns. Size, Market Risk, and Value are those main factors of return determined by Fama and French.
The debate continues as to whether growth stocks outperform value over a long period of time. Based on the research of Bank of America Merrill Lynch, value stocks outperformed growth stocks by almost 5% over a 90 year period (http://www.fool.com/
Since the initial publishing by Fama and French, there have been additional factors introduced that can explain returns. Two new factors are, momentum and profitability/quality. “Momentum is the rate of increase in a stock’s price over a given period of time. Stocks that have “gone up a lot” in the last year are said to have substantial positive momentum, while stocks that have declined, have negative momentum.” Profitability or Quality is found in stocks with a high operating profitability perform better. So not only does the debate continue but also the search for factors that can attribute returns for a portfolio.
As an investment advisor I think that it is important to recognize the research of the past and ongoing in order to contribute to the debate. Moreover, being able to intelligently speak about this topic and understand the concepts are important regardless if you agree with them. What I believe is that both strategies are helpful when building and managing a portfolio. I would agree with a more passive or indexed approach, tilting the allocations towards those particular factors of return all while recognizing the need for broad diversification.
McDonald, Ph.D. Michael, Momentum: What Do We Know About This Investment Strategy (June 2015)