In the growth-versus-value debate, it pays to look beneath the surface

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1 Insight In the growth-versus-value debate, By Patrick C. Foley The recently completed calendar year was characterized by a significant bifurcation within equity markets worldwide. Though U.S. benchmarks roughly flatlined, beneath that deceptively placid surface, many stocks were moving in different directions by unusually large magnitudes. That subterranean parting of the ways shows up clearly in the breakdown between the value and growth styles, and is also notable for what it reveals about the global economy. Of course, the growth and value segments of any equity market rarely move in absolute lockstep. Chart 1 displays the relative performance of the Russell 1000 Value Index versus the Russell 1000 Growth Index. Chart 1. Russell 1000 Value Index vs. Russell 1000 Growth Index (rolling 3-year periods) Chart is for illustrative purposes only. Past performance is no indicator of future results. Index returns are calculated on a rolling 3-year basis. INSIGHT-PRINT-GROWTH VS VALUE 1602 [16053] Page 1 of 5

2 Factors such as relative valuation, sector composition, interest rates, bond yields, inflation expectations, currency movements, and an economy s perceived position in its business cycle all play a role in determining which of the two major investment styles are more favorable. Often, however, outsized performance differentials between value and growth stocks can be traced to a notable story focused on a single sector or industry group. Déjà vu all over again... As we look at sector-level factors, let s review some history. Data for the respective Russell indices show the following sequence of trade-offs in style: In the aftermath of the savings-and-loan crisis, growth trounced value for three consecutive years in the late 1980s and early 1990s. Large-cap growth beat large-cap value by nearly 5,000 basis points from 1998 to 1999 as investors chased all manner of technology and telecom stocks (note that one basis point is one hundredth of a percentage point). Small-cap value shares subsequently outperformed small-cap growth by about 4,500 basis points in 2000 alone as the dot-com bubble deflated. However, from 2010 through 2014 a five-year period when the bulk of the current economic expansion occurred stylebased performance differentials were generally much tighter, especially among large-caps. Chart 2 illustrates the changes in style leadership over the course of these events. Chart 2. Russell 1000 Growth Index and Russell 1000 Value Index Chart is for illustrative purposes only. Past performance is no indicator of future results. The more or less synchronous returns of recent years vanished in Last year, the Russell 1000 Growth Index returned 5.67% while the Russell 1000 Value benchmark returned -3.83%, a 950-basis-point outperformance by large-cap growth. It was a similar story in domestic small-caps, and in international developed and emerging equity markets. Notably, value and growth in 2015 did not immediately arrive at the fork in the road. INSIGHT-PRINT-GROWTH VS VALUE 1602 [16053] Page 2 of 5

3 After tracking each other closely over the first six months, growth began to soundly outperform value in July amid indications that the Chinese economy was decelerating more than expected and that official data from that country were perhaps not to be trusted. With investors climbing a Chinese Wall of Worry, energy-related stocks a major component of the value sector began another sharp leg down. From July through December 2015, the S&P 500 Energy Index plunged by almost 20%, dragging value indices lower as well. Two major sectors within the S&P 500 Value Index energy and financials finished 2015 in the red (see Chart 3). Meanwhile, three main components of the S&P 500 Growth Index healthcare, consumer discretionary, and technology all ended in positive territory. Evidently, investors in 2015 were willing to pay a premium for top- or bottom-line growth. That has not always been the case. Chart 3. S&P 500 Index sector total returns in 2015 Chart is for illustrative purposes only. Past performance is no indicator of future results. Historically, value stocks have tended to outperform their growth counterparts when viewed over longer periods. For the calendar years 1979 through 2015, for instance, the Russell 1000 Value Index beat the Russell 1000 Growth Index by 100 basis points on an annualized basis. Most of that outperformance came after the dot-com bubble popped in 2000, sending presumably fast-growing technology stocks into free-fall and triggering the longest consecutive stretch seven calendar years of style-driven outperformance of the last three decades. Conversely, the largecap growth style beat large-cap value for three consecutive years twice over those 37 years, from 1989 through 1991 as noted earlier, and from 2009 through But aside from those three winning streaks, value-growth relative strength has generally flipped every one or two years. Of course, markets do not observe the Gregorian calendar, nor do stocks INSIGHT-PRINT-GROWTH VS VALUE 1602 [16053] Page 3 of 5

4 and sectors know which style buckets they belong to. In addition, index creators now allow for cross-pollination, with some stocks given significant allocations in both value and growth benchmarks. When faced with such potential sources of ambiguity, it s tempting to turn back to our sector-level analysis. Let s look again at energy, for instance. With oil prices having fallen below $30 a barrel in early 2016, and with Iran s 500,000 barrel-a-day output set to hit the market, it is reasonable to wonder if the bad news for the energy sector and perhaps for value stocks generally isn t already baked into market valuations. Put another way: Can we soon expect the onset of a mean reversion cycle that could benefit value stocks in the short run? I am not prepared to make that call. What I will say is that investors and their financial advisors would do well to keep in mind that growth s run of outperformance may well be stretched thin, that mean reversion tends to recur, and that over long periods of time the value style has historically tended to outperform growth. If you re an investor who strongly believes in mean reversion and is keen on making a tactical shift toward value, one way to take action quite simply is through passive vehicles like index funds and exchange-traded funds (ETFs). After all, passive strategies can be great on the way up, allowing investors to capture market beta when all is going well. For investors concerned about downside protection, conventional wisdom says actively managed strategies may make sense for managing volatility. Active managers may take a less-simplified view of style, focusing on company fundamentals and managing various risk exposures within a portfolio. An active manager s view of style in fact may be much more nuanced than simply considering stocks on a price-to-earnings basis. At a later date, we ll explore the passive-versus-active discussion a bit further, highlighting its implications for style investing. But for now, it s worth noting the current performance gap between the styles, and considering the mean reversion effect. The views expressed represent the Manager s assessment of the market environment as of February 2016 and should not be considered a recommendation to buy, hold, or sell any security, and should not be relied on as research or investment advice. Views are subject to change without notice and may not reflect the Manager s views. Carefully consider the Funds investment objectives, risk factors, charges, and expenses before investing. This and other information can be found in the Funds prospectuses and summary prospectuses, which may be obtained by visiting our fund literature page or calling Investors should read the prospectus and the summary prospectus carefully before investing. IMPORTANT RISK CONSIDERATIONS Investing involves risk, including the possible loss of principal. Past performance does not guarantee future results. The Russell 1000 Growth Index measures the performance of the large-cap growth segment of the U.S. equity universe. It includes those Russell 1000 companies with higher price-to-book ratios and higher forecasted growth values. The Russell 1000 Value Index measures the performance of the large-cap value segment of the U.S. equity universe. It includes those Russell 1000 companies with lower price-to-book ratios and lower forecasted growth values. The S&P 500 Index measures the performance of 500 mostly large-cap stocks weighted by market value, and is often used to represent performance of the U.S. stock market. The S&P 500 Energy Index comprises those companies included in the S&P 500 that are classified as members of the GICS energy sector. The S&P 500 Growth Index is a subset of the S&P 500 Index and consists of those stocks in the S&P 500 that exhibit strong growth characteristics as measured by three factors: sales growth, the ratio of earnings change to price, and momentum. INSIGHT-PRINT-GROWTH VS VALUE 1602 [16053] Page 4 of 5

5 The S&P 500 Value Index is a subset of the S&P 500 Index and consists of those stocks in the S&P 500 that exhibit strong value characteristics as measured by three factors: the ratios of book value, earnings, and sales to price. Index performance returns do not reflect any management fees, transaction costs, or expenses. Indices are unmanaged and one cannot invest directly in an index. Russell Investment Group is the source and owner of the trademarks, service marks, and copyrights related to the Russell Indexes. Russell is a trademark of Russell Investment Group. All third-party marks cited are the property of their respective owners. As referred to in this material, the concept of mean reversion has to do with the tendency of equity prices to generally move back to their long-term averages Delaware Management Holdings, Inc. [15545] INSIGHT-PRINT-GROWTH VS VALUE 1602 [16053] Page 5 of 5

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