- Most investors limit their equity choices to growth and value stocks.
- That limited choice can leave a gap in certain economic environments.
- Consider adding quality stocks to your equity mix.
With hundreds of billions invested in both value and growth stocks, the popularity of these investment strategies is undeniable. And for good reason. Value and growth strategies tend to perform differently in different market and economic environments.
As a result, when they are combined in a portfolio, they can deliver valuable diversification benefits. Plus, by holding positions in both strategies, investors have the tools to express their views on the market, tilting more toward growth or value, depending on the market environment. As growth strategies are beginning to look rich versus historical fundamentals, is it time to take some growth chips off the table and tilt toward value?
Value and growth: only part of the spectrum
The issue with limiting your choice to stocks defined as value and growth is that, in the most general sense, both tend to work best in very specific environments.
Value stocks typically do well post-recession, when the economy is beginning to recover, while growth tends to perform well as an economic expansion gains steam. However, there are other phases in the economic cycle. Should investors consider investment styles beyond value and growth to better position themselves beyond just recoveries and expansions?
The economy actually experiences a gradient of cycles, including slowdowns and contractions. As a result, we believe investors should try to get more specific in portfolio construction beyond simply the broad categories of value and growth.
In our view, the growth category generally represents some stocks that are priced more expensively for good reason — and some that are not. When positioning growth in your portfolio, you can benefit by focusing on those aspects of growth that have been historically most rewarded: namely stocks with strong balance sheets and a robust earnings growth trend. That can help you more fully capitalize on economic trends that favor specific types of growth stocks.
An additional investment style
A question we hear from many clients today is whether this is the right time to scale back traditional growth positions in their portfolios and rotate more into value. But that may be the wrong way to look at it.
Is value necessarily the right place to turn? If we were entering an environment of economic recovery, then the answer might well be yes. If, however, you believe markets are heading toward a slowdown or contraction, value may not be the most timely investment strategy to deploy. Instead, you may want to position your portfolio in a way that is more resilient as the economy slows its pace.
A category of stocks we call quality investments can offer a protective middle ground between the typical value and growth dynamic. These are companies that generally exhibit more profitability, less leverage and stable earnings relative to their peers. This tends to make them more resilient at a time when earnings may have peaked or an economic cycle is maturing.
Here is an illustration of the typical behavior of a global business cycle and how we believe different investment styles best suit each phase of the cycle.
Value, growth and quality are long-term propositions
If you are an investor looking to make a change to your portfolio in the current environment, what we call “quality” stocks may offer an opportunity to build more resilience into your portfolio. However, while we believe altering portfolio allocations around the economic cycle can add value, timing the market is difficult even for the most experienced investor.
As such, quality stocks, like other strategies, including growth-oriented momentum stocks and value stocks, can play an important role in your portfolio throughout the full business cycle, giving it more effective exposure to diversified sources of returns.
Think beyond growth and value
In an economy where growth is slowing, quality companies can provide a defensive equity exposure by emphasizing stocks with strong balance sheets and stable earnings.
We believe incorporating quality can help add a new, protective dimension to existing investment styles. Both over the full business cycle and during economic periods of slowdown and contraction, we believe quality stocks capture an important source of diversification and return potential.
Regardless of your investment framework, the addition of quality can enhance the resilience of your investment portfolio, turning a two-dimensional decision into something more diversified and robust.
Holly Framsted, CFA, is the U.S. Head of Factor ETFs for BlackRock.