The challenge for Australian fund managers is that pure style differentiation is hard to achieve in a risk-controlled portfolio. Many managers who claim to be value or growth are actually incorporating stocks outside their respective (style) universes.
Style investing evolved throughout the 1960s, offering investors two distinct advantages over traditional core approaches. Firstly, the categorisation of the share market into value/growth enabled better screening of stocks. Secondly, the establishment ofstyle buckets enabled investors to better compare the performance of style-oriented managers with their peers.
The challenge in Australia is that the share market is shallow, both numerically and by market capitalisation. The top 10 stocks in the Australian market account for 43 per cent of the index, compared to 19 per cent for the US S&P500. This presents challenges for fund managers in creating style-differentiated portfolios.
To examine the problem of style within the Australian market, let’s examine the S&P Citigroup style index for Australia (S&P/ASX 300) and the US (S&P500). Citigroup divides the universe into four style buckets – growth (pure), value (pure), decline at reasonable prices (DARP) and growth at reasonable prices (GARP). Growth is defined as those stocks with share price growth, sales-per-share growth and internal growth rates above market average. Value are those companies with price-book values, price-to-sales, price-to-cash-flow, and dividend yield that are above market average. DARP are stocks that possess both value and growth characteristics but are weighted towards value. Typically these stocks were classified as growth, but have suffered large declines. Similarly GARP stocks possess growth and value characteristics, but are weighted towards growth. These stocks have attractive valuation metrics (priceto- book ratios) yet are growing faster than peer companies.
The sectors in aggregate are roughly evenly split across the S&P/ASX 300 index – (pure) value (29 per cent), DARP (21 per cent), (p re) growth (28 per ent) and GARP (22 per cent). A comparison of the sector/style breakdown of the Australian benchmark with the S&P500 is provided in the graph. The aggregate number of stocks in each category is provided. The graph shows style buckets are not evenly distributed within sectors. This presents a challenge for investors seeking to construct a risk controlled portfolio without large sector tilts. There is less scope (numerically) in the Australian market to select stocks that meet both the style and investment objectives of the manager. For example, in the utilities sector, dominated by (pure) value characteristics, there is only one stock classified as growth whereas in the US there are seven. This gives US managers greater scope to select companies that meet their style bias.
In the year to July 31, 2006, resources (+41 per cent) significantly outperformed Industrials (+13.5 per cent). Since (pure) growth and GARP stocks have a disproportionate weight in the energy and materials sectors in aggregate (74 per cent), which represents 21.5 per cent of the S&P/ ASX300, this presents a challenge to value managers. Casual observation would expect the dispersion of returns between value and growth median managers to be significant given respective sector returns and weights. Yet dispersion between value and growth managers in Australia is low, suggesting style drift is significant.
The implications for investors are profound. Constructing (pure) value or (pure) growth portfolios are hard unless managers, and by default investors, are prepared to accept significant sectoral tilts. Even when managers adopt GARP and DARP styles to offset the lack of (pure) growth/value, these tilts are hard to avoid. The challenge for advisers in constructing composite portfolios, or selecting multi-manager portfolios, is ensuring the composite portfolio is free from unintended sector and style tilts. Constant and diligent monitoring of manager portfolios is required to ensure investors are not left adrift, and blown by the seasonal tides of growth or value.
