It seems easy enough. As an investor all you have to do is switch from growth to value at the right time and you can boost your returns, right? In practice, we doubt it. Yes, theoretically it is possible, but we believe the long-term trend of growth outperforming is so powerful that it has rendered value rallies to be extremely easy to miss because they have historically been:
• Very short lived • Concentrated
Daniel Chung, CFA CH I E F E X ECU T I V E O F F I C E R CH I E F I NV E S TMEN T O F F I C E R POR T FO L I O MANAG E R
To us, that makes value a short-term trade at best and growth an enduring investment. Our experience over more than half a century in this business makes us passionate advocates of the benefits of long-term growth investing.
The Power of Structural Forces In our view, it is important to recognize the larger trend of growth outperforming value. We believe this trend is driven by two structural forces. The first is the acceleration in the pace of innovation over time, which increasingly makes stocks that appear cheap into victims of change — i.e. value stocks into value traps. The second is the failure of accounting to keep up with the changing nature of the economy, which is rendering the key value factor used in benchmark style classification, price-to-book, outdated, as companies invest more in intangible assets that are missing from the balance sheet. Easy to Miss Within this long-term trend of growth outperforming value, which has lasted well over a decade, there have indeed been value rallies. The problem is that they are often quite brief. For example, around the Trump election in 2016, the Russell 3000 Value Index strung together five months of outperformance, rising 6% relative to the Russell 3000 Growth Index as investors priced in lower corporate tax rates which would benefit more domestically oriented companies like banks and retailers which are more prevalent in value indices. Not only was the duration of this rally relatively short, it was concentrated, with about half of it coming in the two weeks after the election. Similarly, after worries about the longevity of the European Union subsided in the spring of 2012, the Russell 3000 Value Index rallied over 8% relative to the
Brad Neuman, CFA S EN I OR V I C E PR E S I D EN T D I R ECTOR O F MA RK E T S T R AT EGY
Alger is committed to sustainability and is a signatory to the PRI.
growth benchmark through mid-2013. More than half of that move occurred in late 2012 and early 2013. After the Global Financial Crisis, the Russell 3000 Value Index rose over 4% relative to the Russell 3000 Growth Index in the summer of 2009, but most of the rally took place over only one month. More recently, value has rallied since efficacy data for the first Covid-19 vaccine was released by Pfizer in early November, but almost all the gains were concentrated in a day or two of trading such that if we measured from November 10, the day after the Pfizer press release, there has been no value outperformance. The key point is that these value rallies occurred within a structural downtrend of underperformance that has seen the Russell 3000 Value Index performance cut more than in half relative to the Russell 3000 Growth Index over the past 15 years (see Figure 1). Recovery vs. the Long Term What about the trade into value equities once the economy begins to re-open, potentially causing a significant rebound in certain cyclical stocks that may occur once a vaccine is widely available? It’s true that the energy, industrials, and financial sectors’ earnings per
share (EPS) estimates for 2021 are still below their peak levels, implying a further recovery to “normalized” earnings, while tech sector earnings have already eclipsed prior peaks. Our point, however, is that cyclical rebounds historically have been short lived and overshadowed by substantial secular growth over the long term. Moreover, we believe that over the long term, the fundamentals of many subsectors that are predominate in value indexes or value investing styles may have new challenges triggered by the Covid-19 crisis that may not simply subside once we “return to normal” as the health care crisis ends. For example, the success of remote employment for many companies may have driven a new paradigm for business travel and work, one that could result in weaker fundamentals for airlines, hotels, convention industries and the real estate market for commercial and office space in many cities. This weakening of fundamentals could potentially extend well past a general economic recovery that could occur during the next two years. These industries all have high fixed costs: they are classic examples of “value” and cyclical stocks that were overly reliant on high-end business travelers or office tenants for sustaining their business models. But what if business travel is a thing of the past? Are trade shows held in mass convention
Figure 1 Russell 3000 Value / Russell 3000 Growth
2006 2007 2008 2009 2010 2011
2012 2013 2014 2015 2016 2017
2018 2019 2020
facilities now dinosaurs? Also, what if oversized corporate offices in expensive locations potentially become out of fashion for corporations as a symbol for expressing their status versus creating a more flexible, happier, remote and distributed office (suburban) workforce? We believe trends and fundamental changes in e-commerce, digital business and consumer behavior is why, over the past 15 years, earnings per share for the Russell 3000 Growth Index has more than doubled relative to the Russell 3000 Value Index (see Figure 2). Given the stock market is a “weighing machine” over the long term, as Warren Buffett’s teacher Ben Graham said, it is no surprise that investors have rewarded growth stocks with superior performance. Have Your Cake and Eat it Too Too often, we hear investors referencing value stocks when they really mean cyclical stocks that can benefit from a potential economic recovery and expansion. At Alger, we believe we can potentially have our growth cake and eat the recovery too by investing in high-quality, market share gaining companies whose end markets could recover with widely available vaccines. Examples of these types of companies could include travel and leisure stocks such as Booking.com, Uber and Planet Fitness or restaurant stocks
like Shake Shack or Wingstop, retailers such as Nike, Louis Vuitton Moët Hennessy, or Ollie’s Bargain Outlet, or even certain commercial real estate companies like CoStar and energy companies like Core Laboratories. We believe that by pursuing such opportunities, we may not have to sacrifice quality and long-term growth potential when anticipating a rebound in depressed areas of the economy. Conclusion We believe the lesson is to beware of the powerful structural forces that have driven the underperformance of value and the outperformance of growth stocks over the long term because they are still very much intact. Value may be a trade at certain points in the cycle, but in our view, real wealth is built over time through investing in winning growth stocks. At Alger, we believe we can potentially have our growth cake and eat the recovery too by investing in high-quality, market share gaining companies whose end markets could recover with widely available vaccines.
Figure 2 EPS Growth
Brad Neuman, CFA Senior Vice President Director of Market Strategy
Daniel C. Chung, CFA Chief Executive Officer Chief Investment Officer Portfolio Manager
15 Years Ended December 2020
Russell 3000 Growth
Russell 3000 Value
The views expressed are the views of Fred Alger Management, LLC (FAM) and its affiliates as of December 2020. These views are subject to change at any time and may not represent the views of all portfolio management teams. These views should not be interpreted as a guarantee of the future performance of the markets, any security or any funds managed by FAM. These views are not meant to provide investment advice and should not be considered a recommendation to purchase or sell securities. The Russell 3000 Growth Index is constructed to provide a comprehensive, unbiased and stable barometer of the broad growth market. The index is completely reconstituted annually to ensure new and growing equities are included and that the represented companies continue to reflect growth characteristics. The Russell 3000 Value Index measures the performance of the broad value segment of the US equity value universe. It includes those Russell 3000 companies with lower price-to-book ratios and lower forecasted growth values. The Russell 3000 Value Index is constructed to provide a comprehensive, unbiased and stable barometer of the broad value market. The index is completely reconstituted annually to ensure new and growing equities are included and that the represented companies continue to reflect value characteristics. Investors cannot invest directly in any index. Index performance does not reflect deductions for taxes. Frank Russell Company (“Russell”) is the source and owner of the trademarks, service marks and copyrights related to the Russell Indexes. Russell® is a trademark of Frank Russell Company. Neither Russell nor its licensors accept any liability for any errors or omissions in the Russell Indexes and/or Russell ratings or underlying data and no party may rely on any Russell Indexes and/or Russell ratings and/or underlying data contained in this communication. No further distribution of Russell Data is permitted without Russell’s express written consent. Russell does not promote, sponsor or endorse the content of this communication. Earnings per share represents the total amount of a companies earnings divided the number of outstanding shares. The price-to-book ratio is the ratio of a company’s market price to its book value. Risk Disclosure: Investing in the stock market involves risks, including the potential loss of principal. Growth stocks may be more volatile than other stocks as their prices tend to be higher in relation to their companies earnings and may be more sensitive to their companies’ earnings and may be more sensitive to market, political, and economic developments. Technology and healthcare companies may be significantly affected by competition, innovation, regulation, and product obsolescence, and may be more volatile than the securities of other companies. Past performance is not indicative of future performance. 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The following positions represented the noted percentages of Alger assets under management as of 9/30/2020: Pfizer, 0.01%; Booking.com, 0.26%; Uber, 0.10%; Planet Fitness, 0.17%; Shake Shack, 0.50%; Wingstop, 0.65%; Nike, 0.71%; Louis Vuitton Moët Hennessy, 0.35%; Ollie’s Bargain Outlet, 0.28%; CoStar, 0.45%; and Core Laboratories 0.6%.
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