The battles of styles: which global equity fund should you invest in for 2021?

Style investing is an approach investors use to frame their investment decisions based on a particular macroeconomic environment. Broadly speaking, there are three distinct types of styles available for retail investors to express; Growth, Value and Blended (an equal mix of growth & value exposure).

These styles may be broken down further into greater granularity according to the various market capitalisation categories of small, mid, and large caps. Style investing has entered the limelight over the recent weeks given the major moves in equity markets over the recent quarters as one distinct group of stocks have clearly outperformed the other.

Tech & Thematic global equity funds dominated… until recently

The strongest performing funds in 2020 were growth-centric strategies as investors flocked towards them in the wake of a poor investment and economic outlook. Tech-centric and thematic funds’ underlying strategies buy into companies with secular growth prospects.

The reason why Growth was seen was the anti-fragile investment of choice was because these opportunities allowed for greater certainty in a time of great uncertainty – nearer term economic and market gyrations were unlikely to have a major impact on their underlying structural growth drivers. Resultantly, growth stocks have been a significant driver of equity markets for much of 2020.

Fast forward today, however, the goal posts have shifted. Growth-centric stocks are now shunned as the world becomes more optimistic about stronger economic growth in the year or two ahead. The heavy sell-off over the past two weeks is a testament of how a change in growth and inflation narrative can quickly unwind some of the crowded positioning accumulated in growth stocks over the past year.

Table 1: Tables are turning for value & blended global equity strategies as they outperform over the recent weeks

Chart 1: Global equity funds with growth characteristics (higher P/E ratios) experienced sharper drawdowns in 2021 thus far

Value making a comeback: temporary or something actually durable?

If the global economic shutdown was the biggest reason why value & cyclical stocks were most negatively impacted in 2020, then it would be natural to assume that an economic reopening would be highly bullish for these beaten down stocks.

Value stocks displayed nerves of steel during this market correction with its unyielding performance. According to the MSCI AC World Value Index, it outperformed its growth counterpart by 4% since the start of the year (as of 7 March 2021).

Delving deeper at a sector level, Energy, Materials, Financials & certain Industrials were pretty much left unscathed given that the sell-off was largely contained within the growth-led indices (Technology, Consumer Discretionary, Disruptive Innovation, Digital Economy).

For instance, in the US, while the NASDAQ 100 Index has now corrected 14% from peak to trough (February 16^th to March 5^th), the Dow Jones Index (an index with greater exposure towards value & cyclical stocks) made new highs just yesterday (as of 9 March 2021). Such similar dynamics may also be observed in other major markets; Europe equity indices, who has a higher proportion of companies within cyclical industries, also appear to be similarly unfazed by the sell-off.

Chart 2: Cyclical and value oriented sectors (Energy, Financials, Materials) outperform as market participants flock towards reflationary havens

Speed is not of the essence when it comes to treasury yields

A display of fireworks on the downside for tech stocks over the past weeks show this tug of war dynamic clearly as growth does not do well whenever the rate of change (also known as delta) in growth or inflation expectations accelerates at a pace that is unexpected by market participants.

This is because it also corresponds to a greater delta in treasury yields which can be unnerving for growth stocks given their sensitivity to changes its equity risk premium (see: Growth opportunities are growing scarcer. Thematic investing can help alleviate that problem). Overall, an accelerating equity risk premium is unfavourable for growth stocks’ due to their high valuation multiples.

The Value vs Growth equity ratio showcases this clearly. A lower ratio over time suggests chronic underperformance. Despite Growth investing being the favoured investment style over the last decade, the ratio temporarily bucks the longer term structural downtrend, indicating investors’ preference for value and cyclical stocks over growth. This outperformance also occurred during 2013 & 2016 when the global economy was similarly undergoing a reflationary environment.

Overall, we believe the delta of treasury yields is a bigger factor contributing to volatility for growth stocks than the absolute yield level. Moving forward, should economic expectations continue to rerate, funds with value & cyclical tilts may continue outperforming the broader equity benchmark.

Chart 3: Value outperformance coincides with periods of reflation

With rising yields, do you stop investing for growth?

However, investors would be remiss to dismiss growth stocks entirely. Over the medium to long term, certain segments of growth equities remain an attractive proposition, especially after a washout in sentiment and valuations.

In the article Inflation risk on the horizon? Strategies for rising inflation, we suggested that reflation and not runaway inflation remains our base case scenario at this juncture. The recent panic selling of growth stocks as a whole is therefore likely to be transient and not a structural change in trend. Therefore, being selective on the type of growth companies to invest in is key here.

Rotation from value to growth is inherently a positive nod towards the overall economy. We believe that large cap growth stocks, as opposed to small to mid-cap hyper growth companies, are better positioned to weather a gradual rise in government bond yields.

Their more diversified revenue base, and greater earnings sensitivity towards to changes to real growth in economy, should see them outperform their less capitalised growth peers. What are the odds of companies like Microsoft, Apple, Amazon and Tencent not participating in a global cyclical recovery and see their earnings outlook improve?

Historically, rising yields have also not been necessarily bearish for equities as seen from the example below:

Chart 4: Gradual rising yields are good for equities especially if backed by improving economic and corporate fundamentals

Take the Middle Path

There are numerous global equity funds available to retail investors on the platform, each with their own unique investment process and style biases. As we have set the tone for the current market environment, a blended style approach may be the most ideal way to navigate the next few quarters.

The reason why is because timing the rotation is something difficult for a retail investor to do. Such trading activities are often suited more for institutional investors who have a greater arsenal of tools and flexibility at their disposal.

Furthermore, market narratives tend to ebb and flow from one end to another, and thus, it would probably be easier from an execution point of view, that augmenting your current portfolio to include value-oriented strategies is perhaps one way to reduce overall volatility for your equity exposure.

Many of our past recommended funds as well as fund features highlighted previously for global equity funds are growth-oriented strategies. Therefore we hope to provide some guidance in terms of product selection for blended and value oriented strategies as more of such value rotations may occur over this year.

We believe an agnostic approach to style investing could serve investors well by (1) reducing equity volatility or underperformance resultant from the macro environment, and (2) ensuring investors have a well-rounded exposure to a fast recovering global economy.

There are many ways to do this. If you have already invested in our past recommended or featured global equity funds, such as the Threadneedle (Lux) Global Focus AU Acc USD, United Global Quality Growth Fund Acc USD or Nikko AM Shenton Global Opportunities SGD, what you can do is to partially switch out, or introduce new monies and allocate some of these towards value oriented strategies like Natixis Harris Associates Global Equity RA SGD (also offered under the CPF-IS scheme).

Alternatively, one could also go for blended equity strategies such as Neuberger Berman Systematic Global Equity A Acc USD, a strategy that does not have a rooted style bias.

Conclusion

At the end of day, we can only perceive where the winds of change are blowing towards. Anticipating when the direction may change will likely prove be a futile attempt. More data and policy certainty is needed to truly ascertain whether the classical Benjamin Graham style of value investing is here to stay. In the meantime, taking the middle path of moderation when it comes to picking investment style is the most ideal way of reducing uncertainty stemming from unforeseen market outcomes.