Equity markets have entered bear market territory, with the Russell 1000 Index down over -20 percent through the first half of the year. Several factors contributed to the market drawdown, including:
The combination of these pressures has created massive headwinds for the equity markets where “longer-duration” technology companies have traded off significantly, while deeper-value energy and commodity-linked stocks outperformed for much of the first half of the year. This has been especially impactful within the large cap growth asset class, as this sudden shift in market dynamics caused investors to sell many of the large cap growth stocks that had been the market leaders.
While growth-style investing is often looked at as one bucket of managers, there are actually several styles within the growth category. Using the eVestment U.S. large cap growth peer group universe managers as a good representation of subcategories within growth, they are:
To evaluate the large cap growth category, Segal Marco Advisors’ Alpha Research team started with this universe of manager data and performed a deep dive into the performance, upside/downside market capture and correlations between the three growth styles. We also reviewed the implications of investing actively versus passively within growth equities.
We started with the broad eVestment U.S. large cap growth peer group universes, managers, GARP, quality growth and high growth/momentum and then systematically evaluated the subcategories within the large growth category. We ranked the universe based on growth, value and quality factors relative to the Russell 1000 Growth Index over the trailing three years using style analytics tools.
We ranked all managers who reported their holdings to eVestment based on their exposure to growth, value and quality factors, with the top quintile (of an original peer group of 302, of which 205 reported holdings) for each style separated into GARP, quality growth, and high growth/momentum sub-peer groups. Those managers with the highest average exposure to growth and momentum metrics were labeled as high growth/momentum managers, while those with the highest average exposure to value metrics were labeled as GARP and those with the highest average exposure to quality metrics were labeled as quality growth. This created three distinct peer groups of 41 individual strategies in each group.
|MRQ||YTD||1 Year||3 Years|
|U.S. High Growth/Momentum||-22.17%||-31.13%||-24.97%||9.83%|
|U.S. Quality Growth||-18.12%||-26.27%||-17.36%||10.89%|
Russell 1000 Growth
The extreme shift in the market through June 30, 2022, created large dispersions among the three growth styles for the most recent quarter (MRQ), the year to date (YTD) and one year. Considering trailing YTD performance, the average active manager within our high growth/momentum peer group has negative excess returns relative to the Russell 1000 Growth Index of roughly 3.1 percentage points while the GARP peer group had positive excess returns relative to the Russell 1000 Growth of roughly 6.7 percentage points.
This style dynamic of GARP and quality growth managers outperforming high growth/momentum managers during conventional market downturns is consistent for two previous periods:
|October 2018–December 2018||January 2020–February 2020|
|U.S. High Growth/Momentum||-16.1%||-12.3%|
|U.S. Quality Growth||-13.8%||-15.3%|
|Russell 1000 Growth||-15.9%||-14.1%|
When looking back at drawdown periods, GARP and quality growth managers outperformed high growth/momentum during the fourth quarter of 2018, while performance was reversed during the initial COVID-19-spurred market dip in first quarter 2020.
Since every market downturn is not the same, it is important to understand the specific dynamics that have caused the declines. While the fourth quarter of 2018 appears similar to today, with the Federal Reserve raising interest rates and fears over slowing economic growth gaining traction, the first quarter of 2020 saw a rapid shutdown of the economy and investors fleeing into companies more integral to work-from-home and digital transition themes, effectively buoying returns within the high growth/momentum peer group.
Turmoil is bound to happen, and black swan events are, by definition, impossible to predict. Therefore, it is difficult to base allocation decisions on the anticipation of market events. Considering this more broadly, the general dynamic of GARP managers outperforming high growth during down markets can be observed through upside and downside market-capture ratios.
|1 Year Upside||1 Year Downside||3 Years Upside||3 Years Downside|
|U.S. High Growth/Momentum||78.59||105.75||92.35||101.15|
|U.S. Quality Growth||90.72||94.77||87.07||93.49|
When considering the chart above, the downside protection offered by GARP managers is clear, particularly over more recent style shifts. The valuation discipline employed by GARP managers provides intrinsic downside protection relative to the broader growth benchmark. The GARP peer group accomplishes this by sacrificing upside participation, while high growth/momentum managers, as the name suggests, use the momentum characteristic to participate on the upside.
Quality growth appears to be a middle ground over the long term, generating a more balanced upside/downside profile. The quality factor tends to be best realized in later-stage market decline, where investors tend to favor strong fundamental businesses when considering a recessionary environment.
To further demonstrate the difference in how each style generates outperformance, consider the excess return correlations for each of the peer groups versus the Russell 1000 Growth Index shown in the following two charts for the trailing five and 10 years.
|U.S. High Growth/Momentum||U.S. Quality Growth||U.S. GARP|
|U.S. High Growth/Momentum||1.00||-0.02||-0.25|
|U.S. Quality Growth||-0.02||1.00||0.85|
|U.S. High Growth/Momentum||U.S. Quality Growth||U.S. GARP|
|U.S. High Growth/Momentum||1.00||0.13||-0.14|
|U.S. Quality Growth||0.13||1.00||0.81|
The significant disparity in relative performance resulting from the difference in approach between GARP and high growth/momentum managers is clear in the above charts, with excess return correlations of -0.25 and -0.14 over the trailing five and 10 years, respectively.
The second significant takeaway is the relatively high correlation of excess returns between quality growth and GARP managers. These two styles had fairly correlated relative return profiles over the trailing five and 10 years, suggesting these two groupings are generating excess returns during similar environments. Excess return correlations can inform decisions of diversification between investment styles. Two managers with uncorrelated, or even slightly negatively correlated excess returns suggest different periods of outperformance. Splitting investment between managers which outperform the index during different periods will create a more balanced return profile, with each manager having the ability to buoy the portfolio’s relative returns during periods when the other manager struggles. In this context, pairing a high growth/momentum manager with a GARP manager in particular or quality growth manager has historically balanced relative return dynamics and created a more all-weather profile.
Turning to a discussion of active versus passive investing, it is important to keep in mind the uniqueness of recent market activity relative to historical norms. Recent years have been marked by rapid, extreme market swings, with strong growth markets in the latter part of 2020 and throughout 2021 bookended on either side by sudden market drops during the first quarter of 2020 and the first half of 2022. This caused relative performance to whipsaw significantly.
Although the rapidity of market downturns can be expected to increase relative to history given the increased access to and velocity of information, the last several years were marked by a low-probability event in the COVID-19 pandemic. Prior to 2020, markets experienced a period of extremely low volatility, with just 9 percent of months generating a VIX above 22.6. It seems likely that markets remain volatile while macro influences continue to drive headlines. Longer term, however, it appears likely that a middle ground between these two recent periods will occur, and very unlikely that volatility will become irrelevant to the extent it was between 2010–2019. However, if there is an eventual alleviation in some of the macro factors affecting markets, volatility may subside to an extent. The following chart considers manager performance purely through the lens of volatility.
|U.S. High Growth/Momentum||-0.89%||2.19%|
|U.S. Quality Growth||-0.78%||1.99%|
|Russell 1000 Growth||-0.89%||2.19%|
Active GARP and quality growth managers tend to outperform the index during periods marked by heightened volatility. This dynamic is reversed during periods of low volatility as confidence rises and investors seek higher returns by investing in longer duration growth companies, boosting returns within active high growth/momentum strategies.
Much of the difficulty in recent years for active management can be attributed to market returns being dictated by a select few tech giants, making the environment for active managers difficult given restrictions on position sizes and active weights. Those same names led the index down during the first half of the year, creating a much more conducive environment for active outperformance. Market breadth is key for active managers, and it has been narrower than historical norms in the period leading up to 2022.
Macro factors have also had an outsized impact on market returns, with heightened inflation dominating economic headlines. Inflation and rising rates as central banks combat inflation may have a direct impact on company profitability and valuations. Active managers can position their portfolios to weather company-level impacts, such as inflation, by pivoting to companies with greater pricing power and those that are able to generate present-day cash flows. Prior to today, the most recent period when inflation consistently topped the Federal Reserve’s 2 percent annual goal were the years leading up to the Great Financial Crisis (GFC) in 2008: between 2004 and 2007. The average manager within each growth peer group outperformed the Russell 1000 Growth Index during the period of heightened inflation leading up to the GFC. The average GARP manager returned 10.7 percent, the average quality growth manager returned 9.9 percent and the average high growth manager returned 11.2 percent, all outpacing the Russell 1000 Growth Index return of 8.1 percent.
The chart below includes the performance of the average manager in each peer group relative to the Russell 1000 Growth Index in rolling three- and five-year periods over the past 20 years, proving a more robust dataset of longer-term periods.
|Rolling 3 Year||Rolling 5 Year|
|Recommended Large Cap Growth||83%||88%|
The data for the chart above looks at the trailing 20 years, which likely skews the data slightly, particularly considering growth was rebounding significantly in 2002 following the bursting of the tech bubble, a difficult environment for GARP and quality managers given their focus on downside protection. The average current Segal Marco Advisors recommended manager has outperformed the Russell 1000 Growth in 88 percent of rolling five-year periods over the trailing 20 years, confirming that managers who undertake sufficient due diligence tend to provide positive excess returns over longer periods.
Finally, it should be noted that performance is not the only consideration and passive investments are a lower-fee option. The median commingled fund fee within the eVestment U.S. Large Cap Growth Peer Group is 55 basis points, while passive Russell 1000 Growth vehicles are typically offered for below 10 basis points.
There is a clear difference in performance profile among the three distinct growth styles we have reviewed. As market conditions change and evolve, it is important for investors to understand the implications of the growth style they are allocated to, as well as the performance dynamics that style typically exhibits.
When considering which style to invest in, those with the ability to allocate to multiple managers within the large cap growth space should consider splitting allocations between GARP or quality growth and high growth/momentum managers to take advantage of the uncorrelated nature of excess returns provided by the different styles. Investors should also maintain a robust rebalancing program to ensure this benefit is not deteriorated following prolonged periods of outperformance by one style.
Additionally, the active vs. passive debate is not a one or the other question. Although creating a balanced active profile between high growth/momentum and quality growth or GARP offers investors the potential benefits of each investment style relative to the index, investors leaning towards allocating passively can look to split their large cap growth exposure between a passive instrument and a high conviction active manager, while enacting a disciplined rebalancing program. This provides diversification between active and passive styles, should the current market continue to be conducive to active management, while keeping costs down and lowering overall tracking error relative to a pure active allocation. A style decision can be made with the active allocation as well. Given the concentration and natural higher growth tilt of the benchmark investors looking to reduce their risk or upsize weightings in higher-quality companies can pair the passive investment with a GARP or quality growth manager, respectively.
It is always important to speak with your investment consultant prior to completing any allocation decisions to ensure proper fit and implementation given the uniqueness of each investor’s circumstance.
The information and opinions herein provided by third parties have been obtained from sources believed to be reliable, but accuracy and completeness cannot be guaranteed. This article and the data and analysis herein is intended for general education only and not as investment advice. It is not intended for use as a basis for investment decisions, nor should it be construed as advice designed to meet the needs of any particular investor. On all matters involving legal interpretations and regulatory issues, investors should consult legal counsel.
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