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Benefits and Pensions MonitorManager Style Report: Differentiating Growth And Value Lack Of Breadth The distinction between styles has since become more mixed both in Canada and the U.S. Today, you will frequently see similar holdings in both growth and value manager portfolios. In Canadian equity funds — names such as Alcan, Manulife, Petro Canada, and TD Bank — have been found in the top 10 holdings of differing style managers as recently as June 2007. One could suggest this also points to the lack of breadth in the Canadian market. Finding distinctly value or growth securities becomes increasingly challenging when your country represents just four per cent of the world’s market cap and the economy is dominated by three sectors – financials, energy, and materials. As of June, the Barra style indexes for Canada have sizeable weightings in all three sectors for both value and growth. If a stock is in a growth industry and is susceptible to all the global pressures of that industry, but is trading at a discount to its peers, does that mean it’s a growth stock or a value stock? Monitoring The Portfolio In order to evaluate a portfolio for style factors, plan sponsors have two methods of analysis they can employ – holdings-based analysis or returns-based analysis. Holdings-based analysis requires looking at the characteristics of each individual holding in the portfolio. There are no absolute standards on the measures you should use for this analysis, but some are more accepted and common than others. Perhaps the most common valuation statistic is the price-to-book ratio. It is also common to all the major index providers in creating their style indices. A favourite among value managers seeking bargains, it can also give investors an initial view on the makeup of their portfolio. Since book value is the net worth of a company (or assets minus debt), it provides an idea of the minimum value a company should receive if it is liquidated. The price-to-book ratio gives you an indication of how the company is currently priced relative to its liquidation value. At a basic level, a value stock would be trading at low multiples and a growth stock at higher multiples. Other popular statistics used to evaluate companies include dividend yield, price-to-earnings ratio, projected P/E ratio, price-to-sales, trailing earnings growth, and forecasted earnings growth. Different managers will place varying levels of emphasis on the statistics they deem important even within their style category. Return-based analysis is the more simple to perform, requiring less data inputs as you need only the historical returns of the portfolio and the style indexes you want to compare to. Then, it is a matter of regressing the fund returns versus the style benchmarks and analyzing the correlation. Though the holdings-based and returns-based analysis can provide similar results over the long run, return based cannot detect potential short-term changes in style, since it’s dependent on trends. Holdings-based analysis can better spot a sudden shift in style by looking at the actual securities, as well as better forecast the style going forward. Difficulties In Benchmarking The U.S. has the most established market for style benchmarking, where there are three notable providers – Russell, S&P, and Wilshire. All three have their own techniques to separate their respective broad market indexes into style categories with surprisingly similar results in total returns to their counterparts. However, constituents can be quite different. Issues can be raised with each of these providers. For example, there are overlapping securities in the Russell and S&P indices, where the same security can appear in both value and growth at different weights. Breadth of coverage becomes another issue as securities from the broad market index that don’t fit either style category are not included effectively shrinking the opportunity set for a style manager. Rebalancing is another important variable, as each index provider rebalances its styles indexes at least once a year. Securities that were once labeled growth can potentially be switched over to the value index and vice versa at rebalance. To further complicate matters, the different providers of style indexes all use their own custom approach in creating their growth and value benchmarks. Demonstrating the difficulty of slicing the Canadian market into style categories, the most notable style indexes in Canada, the Barra Canada Growth and Value indices, are not used as a benchmark by any of the well-known institutional Canadian equity funds. Included in that list of funds are self-proclaimed growth and value managers. Going Forward Recent market activity has served to remind us that equity markets can be quite volatile and move very unexpectedly. In a prolonged bull market, it is easy to be complacent. Plans need to be ready ahead of market shocks, instead of simply reacting afterward. There is strong evidence that there are diversification benefits to having style offset managers. This has been demonstrated historically with the massive swing of growth to value in 2000. As we have seen over the past few years, markets evolve and the lines between growth and value are now blurred. Plan sponsors can’t assume that offsetting style managers will have the same diversification advantages as in the past. Constant monitoring needs to be performed to ensure that the goals of diversification and reduced volatility are being met. And if your growth and value managers are both buying similar securities, there’s a good chance that those goals are not being achieved.
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Lawrence Lim is a senior 