A debate between different styles of investing is not new to
the financial world. There are various 'experts' from different
schools of thought with strong arguments poised in favor of their
beliefs as far as investment styles are concerned. Whether
undervalued stocks have the potential to deliver high returns
(value style)
or overvalued stocks make for a good momentum play
(growth style)
or a combination of both flavors in a portfolio is a winner
(blend style)
has been and will be a never ending discussion.
Nevertheless, while there are pros and cons associated with
each investing style, it is also true that the same strategy or
style doesn't work for different market conditions. Having said
this, a look at the best performing
investment style
this fiscal year is prudent especially as we near the conclusion
of yet another economically action packed year. (see
3 Emerging Market ETFs Protected from Global
Events
)
The methodology adopted was selecting nine
ETFs
, each ETF representing a particular investment style and a
market capitalization bucket (i.e. large, mid or small). To
compute the results we have assumed that an investor allocated
capital uniformly across the entire spectrum of market
capitalization, thereby focusing solely on the investment style
and eliminating any market capitalization bias. (read
Mid Cap ETF Investing 101
)
The portfolio returns and risk is computed assuming that the
investor allocates equally across the three types of ETF for any
particular style. In other words, the weight allocated to each
ETF across a particular style is
33.33%
.
The following table summarizes the results obtained for each
style box.
Table: 1
|
Capitalization
|
Large Cap
|
Mid Cap
|
Small Cap
|
Overall Portfolio
|
Rank
|
|
Growth
|
IVW
|
IWP
|
VBK
|
|
|
|
Risk
|
12.13%
|
14.94%
|
16.92%
|
14.21%
|
|
|
Return
|
10.85%
|
11.55%
|
13.18%
|
11.86%
|
|
|
Return per unit risk
|
|
|
|
0.83
|
2
|
|
|
|
|
|
|
|
|
Value
|
IVE
|
IWS
|
VBR
|
|
|
|
Risk
|
13.45%
|
13.72%
|
15.24%
|
13.73%
|
|
|
Return
|
12.23%
|
13.42%
|
13.79%
|
13.15%
|
|
|
Return per unit Risk
|
|
|
|
0.96
|
1
|
|
|
|
|
|
|
|
|
Blend
|
SPY
|
IJH
|
IWM
|
|
|
|
Risk
|
12.56%
|
15.25%
|
16.47%
|
14.25%
|
|
|
Return
|
11.45%
|
13.52%
|
9.86%
|
11.69%
|
|
|
Return per unit Risk
|
|
|
|
0.74
|
3
|
Note: Returns are computed on year-till-date
basis.
Not surprisingly, the volatility tends to increase towards the
small cap ETFs. Of course, this is quite expected as mid and
small caps are more volatile than their large cap counterparts.
This is especially true considering the volatility that we have
witnessed over the past twelve months, first over the Eurozone
issues and now over the impending fiscal cliff. However, the
small caps have fared better in terms of absolute returns. (see
more in the
Zacks ETF Center
)
Instead of concentrating on absolute performance, our exercise
focuses on risk-adjusted performance. In other words, it takes
into consideration the reward reaped by an investor for bearing
up with the volatility of the investing style chosen by
him/her.
The table summarizes the trailing performance of each style on
the basis of their risk-adjusted returns. In order to compute
this, the portfolio returns and risk were calculated, and the
return was divided by the risk obtained. Based on this score the
various styles were ranked.
As we can see, the value ETF portfolio has performed better,
both in terms of absolute portfolio returns as well as risk
adjusted returns, than its growth and blend counterparts, having
a return per unit of risk score of 0.96. Compared to this, the
growth portfolio has a score of 0.83 while the blend portfolio
got a score of 0.74.
Also, the value ETF portfolio has exhibited less volatility
than the growth and blend portfolios as indicated by lower
portfolio volatility (read
SPDR Files for Low Volatility ETFs
).
Growth investing is basically a momentum play; this makes it a
great strategy in a trending market (i.e. a market characterized
by a prolonged up or downtrend). This is because stocks in the
growth ETF portfolio harness their momentum in earnings to create
a positive bias in the market which results in rocketing share
prices. However, this only works when the broader market
sentiments have a predetermined direction.
However, in the last 12 months the markets have seen movement
in a quarterly up-down-up-down trend making it virtually
impossible to predict a trend, at least this was the case for a
good period of time this fiscal (read
What Do Quarterly Trends Reveal about ETFs in
Q4?
). However, this doesn't mean that growth stocks underperform
during such markets.
However it does mean that they exhibit a higher degree of
volatility especially compared to value stocks. This is the
primary reason why growth stocks have a lower risk adjusted
return performance, although in terms of absolute returns there
seems to be hardly any difference between the three styles.
On the other hand, value stocks are not very susceptible to
the trending markets unlike their growth counterparts. They give
the market ample time to find and realize the potential of these
companies with hidden value. This makes them less susceptible to
the broader market conditions. This also results in a lower
realized volatility as indicated by the figures in the table.
Therefore in a volatile market these make for great picks for
highest risk adjusted returns. (see
ETFs in a QE3 World
)
Nevertheless, each investing style has its own advantages and
disadvantages and it entirely depends on the individual
investor's risk-return profile as to which style is best suited
for him/her. However, with 2013 poised to be yet another action
packed year ahead of the fiscal cliff one might think that in
order to seek investments with higher risk-adjusted returns,
value ETFs might well be the place to be.
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ISHARS-SP500 VL (IVE): ETF Research Reports
ISHARS-SP500 GR (IVW): ETF Research Reports
ISHARS-RS M GR (IWP): ETF Research Reports
ISHARS-RS M VL (IWS): ETF Research Reports
VIPERS-SC GRWTH (VBK): ETF Research Reports
VIPERS-SC VALUE (VBR): ETF Research Reports
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