Value, Growth or Quality

Difficult market environments often cause investors to rethink their investment strategy. Historically this may lead them to seek what they believe to be “safer” investments. For stocks, that traditionally has meant moving away from growth-oriented names toward those perceived as value.

Most investors define growth as stocks that have the potential to increase sales or earnings faster than the market. Value stocks, on the other hand, are believed to be trading below their fundamental—or intrinsic—value.

What does this mean for your portfolio?

The debate between value and growth heats up every so often, forcing investors to choose one side or the other. While over the last decade, growth investing was the place to be, more recently, value has posted strong returns in response to economic uncertainty before growth returned to favor. This is a typical short-term rotation that occurs. 

Source: S&P Capital IQ. Growth ETF is represented by the iShares Russell Top 200 Growth ETF. Value ETF is represented by the iShares Russell Top 200 Value ETF. Broad Market ETF is represented by the iShares Russell Top 200 ETF. Returns are dividend-adjusted pricing. Data from Jan. 2011 through May 2023.

But as long-term investors, we take a different approach altogether. We don't look at companies as value or growth. Instead, we seek Quality. What does Quality mean to us? We aim to identify qualitative business characteristics which we believe enable great performances across various economic environments, regardless of which style is in favor.

We believe Quality companies can...

1. raise prices.
2. generate positive cash flow.
3. garner customer loyalty.
4. maintain competitive advantages.
5. fuel organic growth without relying on external sources.

So instead of investing based on low multiples (value) or earnings expectations (growth), we look for companies that we believe can control their destinies and deliver returns to shareholders.

Historically, these companies typically perform relatively well in all economic environments. For example, as the graph below shows, a Quality factors-based index delivered excess returns over a broad market global index in periods with rising and falling inflation between December 1975 and October 2021. In addition, Quality has been strong during all periods over the last decade.¹

Source: MSCI.com. MSCI World “factor” indexes are rules-based indexes (as opposed to traditional market-cap-weighted indexes) that capture the returns of systematic factors that have historically earned a persistent premium over long periods of time. A factor can be thought of as any characteristic relating to a group of securities that is important in explaining their return and risk. Factor investing is the investment process that aims to harvest the risk premiums associated with each factor. MSCI currently identifies six equity risk premia factors: Enhanced Value, Equal Weighted, Minimum Volatility, High Yield, Quality, and Momentum. Left side chart: Monthly excess returns over the MSCI World Index from December 1975 to October 2021. Right side chart: 10-year annualized performance through May 30, 2023 is gross of fees.

When the market hands you lemons...

Despite our unique lens focusing on Quality companies, our strategies may—and do—underperform at various points in time, which should be no different than the performance of peer portfolios. That’s because no one style is always in favor. We understand that standing back as your portfolio loses value is never easy, and sometimes you are compelled to take action. Here are three strategies that seem sensible during a market decline—turning lemons into lemonade, if you will:

1. Diversify. Consider adding another strategy to your asset allocation. Including an asset class or investment that is uncorrelated—moves independently of other assets—to your portfolio may reduce your total risk.
2. Consider purchasing stocks. Depressed stock prices—especially when the decline is unrelated to the companies’ specific operations—can present opportunities to buy good companies at cheap prices.
3. Review asset allocation. This period may shed light on your ability—or willingness—to weather market drawdowns. You may want to review your portfolio's allocation and shift towards a more conservative one if market declines are too nerve-wracking.

Easing concerns

The rotation from growth into value—or vice versa—is not uncommon.² Despite the normalcy of shifts like this, it is still disconcerting to watch your portfolio fall if your style is out of favor. But it is also euphoric to watch it rise! 

We feel the key to staying steady throughout all market environments is to hold companies that you believe control their destinies. These companies will not outperform all the time—no company ever will. But we believe that they can grow faster than the market and drive strong returns for investors over the long term.

While volatility is hard to swallow, knowing that the market goes through bouts of ups and downs but tends to move higher over time—led by, in our view, Quality companies—can be comforting. In addition, recognizing that your wealth plan expects bouts of short-term volatility while driving toward your long-term goals should help settle your stomach.