Despite the fact that domestic value equities have outperformed domestic growth equities over the last decade, a study of mutual fund performance finds value funds have had a more difficult time bettering their benchmarks than growth funds.
The report, by SEI Investments, Oaks, Pa., shows just 20% of large-capitalization value funds beat the Russell 1000 Value index, while 55% of large-cap growth funds beat the Russell 1000 Growth index for the five-year period ended Dec. 31, 2000. The Russell 1000 Value returned a compound annualized 16.9% over the five-year period ended Dec. 31, 2000, while the Russell 1,000 Growth returned 18.1% for that time period.
The spread also was wide on the small-cap side - 39% of small-cap value funds beat their benchmark, compared with 89% of small-cap growth funds. Over that five-year period the Russell 2000 Value index posted an annualized return of 12.6% while the Russell 2000 Growth index returned 7.1%.
The study also found there was little or no outperformance for value funds over their style benchmarks in the 10-year period ended Dec. 31, 2000. Top-quartile performing large-cap value funds lagged the Russell benchmark by 70 basis points for the 10-year period while top-quartile small-cap value funds beat the Russell 2000 Value Index by just 10 basis points.
On the growth side, the spread was wider. Top-quartile large-cap growth funds beat the benchmark by two percentage points while top-quartile performing small-cap growth funds beat the Russell 1000 Growth index by 6.3 percentage points. The Russell 2000 Growth Index returned an annualized 17.3% for the 10-year period ended, slightly below the Russell 2000 Value index which returned 17.4%. The Russell 2000 Growth returned 12.8% for the period, trailing the Russell 2000 Value's annualized return of 17.6%.
While value had another strong year in 2001, the numbers really don't change much when looked at through the end of the first quarter of 2002. Boston-based mutual fund data tracker Kanon Bloch Carre found 58% of large-cap growth funds beat the Russell 1000 Growth index for the five year period ended March 31, 2002, while just 25% of large-cap value funds beat the Russell 1000 Value index in the same period.
The trend pretty much holds true in the separate account world, too. Roughly three-quarters of the large-cap growth managed accounts in the Pensions & Investments' Performance Evaluation Report universe beat the Russell 1000 Growth index, which returned 7.59% for the five-year period ended March 31, 2002. Only about half of the large-cap value separate accounts in the PIPER universe beat the Russell 1000 Value index, which returned 11.5% for the five-year period ended March 31. Close to 90% of small-cap growth portfolios in the PIPER universe beat the Russell 2000 Growth index, which returned 4.7% for the five-year period ended March 31, while about 60% of small-cap value separate accounts in the PIPER universe beat the Russell 2000 Value index's return of 13.3%.
Lori Heinel, director, investment strategies group at SEI Investments, said one of the reasons fewer value funds beat their benchmark has to do with the pond they fish in, or don't fish in enough. Traditionally, the value stocks that have performed the best over time have been "deep value" stocks, she said, those that make up the bottom 20% of the universe from a valuation perspective. But in the latter part of the 1990s, when many of these stocks took a beating, many value fund managers lost their tolerance for them and as a result, had less exposure to the opportunity in this part of the market.
Also, said Ms. Heinel, many value managers added more growth-type stocks to their portfolios in the late 1990s because stocks in the value area were so battered. As a result, when the market turned in 2000, many value managers were caught in the middle, and performance suffered.
Jeff Nipp, director of manager research at Watson Wyatt Worldwide, Atlanta, said the findings are consistent with what he has seen in examining the growth and value universes. Part of the reason, he said, relates to the different approach taken by managers on opposite sides of the style table. "There's a different mindset for growth and value managers," said Mr. Nipp
Typically, value managers aren't comfortable with heavy weightings in a particular sector, even if that sector is red hot, said Mr. Nipp. "Even if they like the fundamentals, they'll tend to underweight it," he said, or establish a limit on how much they can put into a sector. Value managers take this approach, he said, because they typically are more concerned with limiting volatility and having broader sector diversification. Growth managers, on the other hand, have no problem loading up on a hot sector, such as technology, which drove the market in the late 1990s and produced high returns for many managers.
Not as concerned
Because value managers often are more focused on controlling volatility and having diversified portfolios, they aren't as concerned with simply beating the benchmark, said Mr. Nipp. That's why he's not surprised to see fewer value funds beating the benchmark than growth funds.
Much wider performance swings in the growth universe might also help tip the scales toward growth funds in terms of beating the benchmark, said Don Cassidy, senior analyst at Lipper Inc., Denver. "The range of results for value funds is narrower than the range of results for growth funds," said Mr. Cassidy. So when the growth market is hot, like it was in 1998 and 1999, there is much higher upside return potential for growth funds as evidenced by the number of triple-digit returns. On the other hand, when the value market is strong, it does not yield the same type of outperformance over the benchmark for value funds.
The SEI study also found there wasn't a sturdy correlation between tracking error and alpha. In each of the four asset classes, SEI ranked managers by tracking error and found that high tracking error resulted in excess returns in only one of the four asset classes, large-cap growth.
In the small-cap universe, funds with the highest tracking error did not produce the most excess alpha. Small-cap growth funds in the top quartile in terms of tracking error generated excess returns of 6.8% while second and third quartile funds produced alpha of 7.4% and 8.1% respectively.
In the small-cap value universe, funds with top quartile tracking error generated -1.8% alpha while second-quartile funds produced excess returns of 0.3%. "There's a perception among many investor that you have to take on risk to get returns," said Ms. Heinel. "But if you buy a fund that's risky in hopes that the manager is going to add additional return, then you're playing a sucker's bet because there's no relationship between having a manager that's risky and having a long-term potential for outperformance."