Article: Active Equity Value Managers Require Style Benchmarks

Scott Treacy | December 17, 2020

From the beginning of the year through September 2020, the FTSE All-World Growth Index has outperformed the FTSE All-World Value index by 32.9%. Unfortunately, this has been the trend for the past decade, COVID-19 pandemic included. On an annualized basis, the 10-year trailing return difference by style is 7.6%. This puts good active value equity managers at a disadvantage because they are being evaluated against a broad-based benchmark, which includes high-flying growth stocks that they are unable to beat. To keep up with their peers, some value managers are veering outside their area of expertise in search of growth stocks. This introduces further risk into pension plan portfolios which are already trying to manage a volatile stock market. This can easily be avoided if pension plans provide the appropriate style index to their active equity managers. Given the large dispersion in performance by style across equity markets, now would be a good time to introduce style benchmarks to all-world, all-world ex. U.S., and emerging market active equity managers.

Our research team reviewed the active equity managers in the Investment Metrics Global Database. Included in the analysis were asset managers who had over $100M in tax-exempt assets (institutional investor focus), had up-to-date strategy assets and equity characteristics data, and had Global Investment Performance Standards (GIPS) compliant performance. We reviewed the gross returns for over 400 products across 121 firms reviewed in the all-world, non-U.S., and emerging markets active equity universes. There were 138 products in the all-world universe, 165 products in the all-world ex. U.S. universe, and 101 products in the emerging markets equity universe. We utilized the FTSE Global Equity Index Series (GEIS) and in particular, we used the FTSE All-World, FTSE All-World ex. U.S., Developed, Developed ex. U.S., and Emerging Markets indices and style indices (style methodology).

Over the trailing 3-year period, on an annualized basis, we are seeing double-digit differences in performance, with growth stocks outperforming value stocks. Even when evaluating the performance over a longer time period of 5 or 10 years, the annualized return differences is over 6%. In particular, the widest dispersion of returns occurred in indices that include U.S. stocks. This is not surprising because U.S. growth stocks have been on a tear over the past decade. Over the last 5 years, the Russell 1000 Growth index had an annualized return of 20.1% compared to the Russell 1000 Value index of -7.7%. The growth stocks driving those returns are coming from the technology sector, with the Russell 1000 Technology index returning 26.6% over the past 5 years.

In order to apply the appropriate benchmark to an active equity manager, we had to review each asset manager’s approach to stock selection and portfolio management. In addition to understanding each asset manager’s investment philosophy, we considered the portfolio’s price-to-earnings ratios, price-to-book ratios, dividend yield, and earnings per share growth figures. Each product was given an investment style (Growth, Value, and Core) as well as a sub-style to help differentiate each active manager’s investment approach.

The sub-styles for Growth were:

  • Earnings momentum (looks for companies with high and accelerating year-over-year earnings growth)
  • Consistent growth (looks for investments that have a long history of sales growth, good profitability, and predictable earnings)

The sub-styles for Value were:

  • Low price-to-earnings (looks for stocks that are trading at low price-to-earnings multiples)
  • Contrarian (looks for stocks that have experienced problems and are normally selling at a low price-to-book multiple)
  • Yield-focused (looks for stocks that are offering a high dividend yield and are selling at a discounted price)

The sub-styles for Core investors include:

  • Value bias (tilts their portfolios towards value)
  • Growth bias (tilts their portfolios towards growth)
  • Growth-at-a-reasonable price (looks for stocks with above average growth prospects that are selling at conservative valuations compared to other growth companies)
  • Style rotator (invests according to the style they believe will be favored in the relative short-term)

When using style benchmarks, the active value managers are outperforming, at a median level, the active growth managers by a substantial margin over the long term (5 years). Three groups performed extremely well: the all-world value managers have an active return of 2% over five years, compared to 0.3% for the all-world growth universe; the emerging market value peer group had an active return of 1.9%; and the growth universe active return was 0.4%. Interestingly, none of the growth universes had a median active return figure over 0.8%. Since this analysis was done using gross-of-fee returns, once you incorporate the management fee, it does not leave much room for an active return. However, when we reviewed the top 10 products with the highest active returns over 5 years against their style benchmark, 50% of the list were growth managers. This would suggest that the best-performing growth managers are disproportionately outperforming their growth peers. The asset managers that have been particularly impressive are Baillie Gifford and Jennison with multiple products on the top 10 list.

The prolonged outperformance of growth stocks compared to value stocks has led some active value managers to venture into the growth stock arena in order to keep up with the broad peer group. We cannot blame them since all active managers in the all-world, all-world ex. U.S., and emerging markets universes are being compared to a broad benchmark like the FTSE All-World index. For pension plans, this increases equity risk because active value managers with expertise in picking value stocks are wading into waters they are not accustomed to, which can lead to mistakes. We regressed the all-world universe with 5-year monthly returns against the FTSE Developed Growth, FTSE Developed Value, FTSE Emerging Growth, and the FTSE Emerging Value indices to see what value managers are drifting towards growth. Additionally, on the y-axis of our graph, we plotted each product’s 5-year return rank against the all-world universe. Not surprisingly, those value managers that correlate more closely with the value indices ended up in the fourth quartile against peers based on 5-year returns. Some of the value products we have seen drift towards growth over the past 5 years are MFS’s Global Value, Lazard’s Global Discounted Assets, Independent Franchise’s Global Franchise, and Acadian’s Global Equity portfolio. Their 5-year return rank is much better compared to their value peers, but their returns also correlate more closely with their growth peers.

Instead of making value managers with excellent stock selection capabilities venture into areas they are unfamiliar with, it would be more effective to give them a value benchmark. Subsequently , you can pair them with a growth manager who has exceptional stock selection abilities and provide them with a growth benchmark. Remember, the FTSE All-World index has 3,974 stocks and it is very difficult for active managers to have a good understanding of each stock in the index in order to take advantage of mispricing opportunities that change on a daily basis. Allowing active managers within each style to select the best opportunities in their area of expertise will provide you with a portfolio that has an increased probability of outperforming the broad-based benchmark. This will ultimately increase the plan asset level above what an index would provide.

As an example, we created two active-manager-paired portfolios to compare with the FTSE All-World index over 5 years. We paired active growth and value managers that complement one another and weighted the developed equity portion of the portfolio at 42.5% each and the emerging markets equity portion of the portfolio at 7.5% each. The first pairing included First Eagle’s Global Value, Morgan Stanley’s Global Opportunities, Baillie Gifford’s Emerging Markets Leading Companies, and Causeway’s Emerging Markets portfolios. This portfolio outperformed the index by 4.8% over the trailing 5 years on an annualized basis. For a hypothetical $125M equity allocation for a pension plan, this active return would equate to an additional $49.9M over 5 years in plan assets over what an index would offer.

The second portfolio paired Artisan’s Global Value, Jennison’s Global Opportunities, Mondrian’s Emerging Markets, and Sands Capital’s Emerging Markets Growth portfolios. This provided an active return of 3.5% over 5 years on an annualized basis. Based on the aforementioned $125M equity allocation, this portfolio would provide an additional $35.6M over 5 years in plan assets over what an index would offer. Pension plan investment analysts who spend some time on the equity manager selection process can reap enormous benefits for plan participants.

In closing, even during this difficult period for value stocks, there are active value managers providing good active returns over their style benchmark and now may be the time to provide these active managers with an appropriate benchmark. Pension plans that are giving broad-based benchmarks in all-world, all-world ex. U.S., and emerging market equities to their active managers are introducing added risk to their portfolios. More importantly, it does not provide the investment analysts with an appropriate assessment of how their active managers are performing. Allowing the active managers to pick stocks within their area of expertise provides the best probability of the pension plan portfolio outperforming the FTSE All-World index.


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