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The value/growth discussion is important when considering how to invest in U.S. stock mutual funds, non-U.S. stock mutual funds, and ETFs inasmuch as one of the primary distinctions between mutual funds and ETFs is whether they are categorized as growth or value. (The “blend” category is a mix of both growth and value).
In recent years a growth tilt has been advantageous in all three “cap” categories (large, mid, and small). In 2023, the five-year small cap value premium eclipsed the five-year growth premium for the first time since 2016.
The term value suggests that the investor is buying stock that is relatively less expensive, as opposed to stock that is relatively more expensive. The stock of a company that is classified as a “value stock” typically has a lower price-to-earnings ratio, which simply means that the stock currently has a lower price per share relative to the company’s earnings per share. Think of it as investing in a home that needs repair versus putting more money down for the glitzy house on the hill. Very simply, value stocks are those that are currently priced more attractively.
Growth stocks are just the opposite. They have higher price-to-earnings ratios; thus, an investor who purchases a growth stock is paying a higher price per share because he or she believes the stock price might go even higher. Clearly, value and growth are relative measures. In fact, evaluating a stock’s price (in value versus growth terms) is much like trying to determine if the price of a home you’re interested in buying is priced “right”. Rather than wax philosophical, let’s now dive into the results for actual value and growth US stock market indexes and mutual fund category averages.
Does It Make a Difference?
As shown in Table 1, the 34-year annualized return for growth-oriented large-cap U.S. stock was 10.66% (which represents the average of the Russell 1000 Growth Index and the Morningstar Large Growth Category Average for actual mutual funds). Value-oriented large-cap U.S. stock in this study (Russell 1000 Value Index and the Morningstar Large Value Category Average) had a 34-year average annualized return of 9.49% over the period from 1990–2023. Over the entire 34-year period there was a 117 basis point growth “premium” over and above large cap value. However, large cap value US stock produced a 9.49% average return with 28% less volatility relative to large cap growth stocks (as measured by standard deviation).
The 34-year average annualized return of two midcap value measures (Russell Midcap Value Index and the Morningstar Midcap Value Category Average) was 10.64% which was slightly lower than the 10.77% average return of the combined midcap growth measures (Russell Midcap Growth Index and Morningstar Midcap Growth Category Average). On a risk-adjusted basis, midcap value has been superior to midcap growth because it has produced a similar return but with 23% less volatility.
Over the entire 34-year period small cap value demonstrated an advantage relative to small cap growth US stocks. The 34-year return for small value was 10.41% compared to a return of 9.44% for small cap growth—or a 97 basis point “value premium”.
Table 1 also includes (for comparison purposes) the performance of the S&P 500 Index (large cap US stock), 90-day Treasury Bills (cash), and the Bloomberg US Aggregate Bond Index (bonds).
1 Average of Russell 1000 Growth Index and Morningstar Large Growth Category Average
2 Average of Russell 1000 Value Index and Morningstar Large Value Category Average
3 Average of Russell Midcap Growth Index and Morningstar Midcap Growth Category Average
4 Average of Russell Midcap Value Index and Morningstar Midcap Value Category Average
5 Average of Russell 2000 Growth Index and Morningstar Small Growth Category Average
6 Average of Russell 2000 Value Index and Morningstar Small Value Category Average
The annual returns in Table 1 reflect performance from one point-in-time (January 1, 1990) to another point-in-time (December 31, 2023). Clearly, many investors won’t invest for that length of time, so it’s useful to examine performance in shorter time frames. Table 2 shows the performance (or return) “premium” for value and growth over rolling five-year periods from 1990-2023. The term “premium” simply means superior performance.
The premium (whether growth or value) for each five-year period is shown in basis points (bps). As a reminder, there are 100 bps in each 1% of return. Said differently, a return of 10% is 100 basis points higher than a return of 9%. For instance, over the five-year period from 1992 to 1996, large-cap value U.S. equity demonstrated a premium of 260 bps over large-cap growth U.S. equity. Among midcap U.S. equities during the same period, there was a value premium of 238 bps. Among small caps, the five-year value premium from 1992 to 1996 was 515 bps.
As shown at the bottom of Table 2, large-cap value has demonstrated a performance premium 40% of the time relative to large growth—suggesting that a growth tilt makes more sense when investing in large cap US stock (at least over the past 34 years).
The average five-year large cap value premium was 384 bps during those five-year periods in which there was a value premium. Conversely, large-cap growth outperformed large-cap value 60% of the time (over rolling 5-year periods) by an average of 423 bps. The large cap growth premium in the 5-year period from 2017-2021 was 1,266 bps. Then, in the next 5-year period (2018-2022) the large growth “premium” shrunk dramatically to 297 bps. In the most recent 5-year period from 2019 to 2023 the large cap growth premium increased to 664 bps—largely driven by the performance of a handful of mega cap stocks (Apple, Microsoft, Nvidia, etc.).
Among midcap US equity, value outperformed growth 40% of the time by an average of 404 bps (over five-year periods). When midcap growth outperformed midcap value (60% of the time), the margin of victory averaged 304 bps.
Among small-cap U.S. equity, value beat growth 53% of the time by an average of 435 basis points (again, over five-year periods). However, when small-cap growth outperformed (47% of the time), the difference can be large. For example, during the five-year period of 1995–1999, small-cap growth beat small-cap value by 808 bps. Overall, however, when small growth outperforms small-cap value over 5-year periods the average margin of victory has been 328 bps.
Among small cap stock we observe a value premium in both frequency and in magnitude (magnitude measured in bps). The opposite is true among large cap stock where we see a growth premium—both in frequency and magnitude. Among midcap US stocks, there has been a growth premium over rolling 5-year periods over the past 3+ decades in terms of frequency, but not in terms of magnitude.
Historically we clearly observe seasons of growth as the winner and then seasons where value dominates. The late 1990’s and into the mid-2000’s was a “season” in which value was clearly superior (at least when measured over five-year rolling periods). The five-year period from 2005-2009 was the beginning of a season in which a growth tilt gained favor. We might call it the growth-oriented “post 2008” recovery. This is most clearly evident among large cap US equity, and to a lesser extent among midcap and smallcap US stocks. In the most recent 5-year period US small cap value stocks produced a premium of 63 basis points relative to US small cap growth stocks.
It is not possible to accurately predict when growth will outperform value or vice versa. Thus, it makes sense to have exposure to both growth and value in the large cap and mid cap equity portions of your portfolio. When it comes to small cap, a modest and persistent value tilt has historically been advantageous.
Those familiar with the Morningstar Style Box (shown below) might consider the following “tilts” in the US equity portion of their portfolio based on the analysis of growth/value performance since 1990. Accomplishing the asset allocation shown below would require six separate mutual funds and/or ETFs. For instance, if a person was investing a total of $100 in large cap US stock, they would invest $40 in a large cap value fund and $60 in a large cap growth fund. Likewise in midcap funds. In small cap funds the amounts would be reversed with $60 going into the small cap value fund and $40 into a small cap growth fund.
Alternatively, an investor may look at Table 2 and conclude that it’s time for value to make a comeback—similar to the results in the top half of the table. With that perspective a distinct value tilt would be in order. But, it would be based on the notion that the pendulum—favoring growth since 2009—is due to swing back in favor of value stocks.
In either case, the course of action will be similar: have exposure to both growth and value stocks!
1 Average of Russell 1000 Growth Index and Morningstar Large Growth Category Average
2 Average of Russell 1000 Value Index and Morningstar Large Value Category Average
3 Average of Russell Midcap Growth Index and Morningstar Midcap Growth Category Average
4 Average of Russell Midcap Value Index and Morningstar Midcap Value Category Average
5 Average of Russell 2000 Growth Index and Morningstar Small Growth Category Average
6 Average of Russell 2000 Value Index and Morningstar Small Value Category Average