Author Details

Abhishek Gupta

Abhishek Gupta
Executive Director, MSCI Research

Guillermo Cano

Guillermo Cano
Executive Director, MSCI Research

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What Really Drove Value and Growth Fund Performance?

  • Value and growth style indexes can potentially be more relevant benchmarks than market-cap indexes to evaluate performance of value and growth managers, regardless of how much factor exposure they deliver.
  • As we switched the benchmark from market-cap to style indexes, contributions from industries and style factors were significantly reduced and manager skill became more apparent.
  • A “true” benchmark may help asset managers better demonstrate skills and provide asset owners and consultants a more robust tool for fund evaluation.

As growth funds, generally, have significantly outperformed value funds over the past decade, many investors and researchers have compared the performance characteristics and skills of value and growth managers while evaluating them against market-cap indexes. In a recent blog post, however, we demonstrated that value and growth managers’ performance may be more appropriately captured by value and growth style indexes. To build on that theme, in this post, we use the funds’ “true” benchmarks to uncover what drove that performance. We found in our analysis that as we switched the benchmarks from market-cap to style indexes, contributions from industries and style factors were significantly reduced and manager skill became more apparent.

We conducted our analysis on U.S. equity value and growth mutual fund managers found by searching for keywords “value” and “growth,” respectively, in fund names. For the period of study, December 2012 to February 2021, our sample included 145 U.S. value funds and 195 U.S. growth funds, on average. To overcome the limitations of the traditional style box, which discriminates among value and growth managers only by size, and to provide further granularity on fund characteristics, we used MSCI FaCS to assess factor exposures of the MSCI USA, MSCI USA Value and MSCI USA Growth Indexes and the value and growth funds. We used this assessment to sort the funds into quintiles based on their exposures to value and growth, respectively.

 

Value and Growth Funds Are Not Homogeneous

Value and Growth Managers’ Active Risk Was Lower when Aligned with Style Indexes

Value and Growth Managers’ Active Risk Was Lower when Aligned with Style Indexes

Value and Growth Managers’ Active Risk Was Lower when Aligned with Style Indexes

Average MSCI FaCS exposures from December 2012 to February 2021.

 

We observed wide dispersion in the target-factor exposure of value and growth funds — and the funds had exposures to other style factors in varying amounts. Managers in quintile 1 (Q1)  are those with the lowest exposures and similar to the MSCI USA Index (mostly factor-neutral), Q3 managers are those closest to the style benchmarks and Q5 managers are those with the highest target-factor exposures.

 

Assessing Active Risk

We then reviewed the performance characteristics of value and growth funds, starting with asking how much active risk (i.e., volatility of excess returns) these funds really took? When we switched the benchmark from market-cap to style indexes, active risk diminished, on aggregate, as well as  each of the underlying sources – industry, style factor and stock – specific – for Q3 and Q5 managers across both value and growth funds. This observation emphasizes that style indexes were more reflective of the managers’ investment styles. In contrast, active risk for Q1 growth and value managers increased when we switched to style indexes. While this seemed logical given their MSCI USA Index-like factor exposures, from here on, we focused our analysis on Q3 and Q5 managers only.

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Value and Growth Managers’ Active Risk Was Lower when Aligned with Style Indexes

Value and Growth Managers’ Active Risk Was Lower when Aligned with Style Indexes

Data from December 2012 to February 2021.

 

Assessing Active Returns

Overall active returns increased for value managers and decreased for growth managers when we switched the benchmark from the MSCI USA Index to the corresponding style indexes. Looking deeper, however, we found that industry bets, which appeared to have dragged on the performance of value managers while profiting growth managers, saw their contributions significantly neutralized when compared to style indexes. Additionally, (as shown in the lower panel of the exhibit below) the negative momentum exposure impacted value managers’ performance, but that bias was corrected using style indexes. Q3 growth managers had most of their style-return contributions neutralized and Q5 growth managers had a scaled – down effect from growth and momentum.

Most striking, for our purposes, were the shifts around a manager’s stock-picking skills, often demonstrated through “stock-specific” bets (as shown in the upper panel of the exhibit below). When we compared performance against style benchmarks, these were less negative for value managers, generally – and positive for Q3 managers. On the other hand, it deteriorated for growth managers, save Q5 growth managers who still added positive return.

 

Fund Managers’ Active Return and Style Contributions: Market-Cap vs. Style Benchmarks

Fund Managers’ Active Return and Style Contributions: Market-Cap vs. Style Benchmarks

Data from December 2012 to February 2021.

But which active bets contributed the most to fund performance? For illustrative purposes, we used the data for Q3 value managers to answer this question. The exhibit below shows the active return contribution from style factors, industry and stockspecific sources across three categories of active bets: underweights (active weight less than -5 basis points), overweights (active weight greater than 5 basis points) and neutral (all others).

 

Which Active Bets Paid Off?

Which Active Bets Paid Off?

Active returns from December 2012 to February 2021.

Together, the underweight and overweight categories represented 10% of the securities and more than 75% of the active weight in Q3 value funds. A small number of high active-weight positions were primary drivers of performance whereas a large number of holdings in the neutral category contributed little. More specifically, on switching the benchmark from market-cap to style indexes, contribution from the over- and underweights to industries improved, as did avoiding or underweighting individual stocks (observed in the sharp divergence from the stock-specific component).

Over the past decade, growth managers, on average, have outperformed value managers, but that is not entirely reflective of their skillsets, as managers report and investors compare performance. Switching from market-cap to value and growth style benchmarks allowed for a truer accounting of manager bets and other drivers of portfolio performance. In doing so, fund managers can more appropriately demonstrate their skills, and asset owners and consultants can perform more robust due diligence.

 

 

Further Reading

Are Growth and Value Indexes Still in Style?

Did Value-Factor Exposure Deliver for Value Funds?

MSCI FaCS Methodology

Regulation