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Portfolio Construction Insights
Volatile Times Call for a Balanced Approach
Key Insights
- Given the many challenges investors are facing in today’s unsettled market, a balanced equity allocation of growth, value, and core may be appropriate.
- Financial professionals have significant overweight allocations to growth versus value even after value’s recent outperformance.
- Growth/value performance cycles have tended to last for several years, but style regime changes can be abrupt, particularly during extreme market environments.
- Our analysis suggests that a balanced, diversified approach to investment style historically has improved returns, efficiency, and consistency versus investing just in U.S. large-cap blend.
Market volatility surged again in early 2022
Markets entered 2022 on a cautiously optimistic note as concerns about the COVID-19 pandemic receded and investors refocused on the potential for a global economic recovery to gain momentum. However, markets—can change quickly. In addition to the extraordinary toll in human suffering, Russia’s military incursion into Ukraine has roiled the word’s energy markets and further disrupted already strained global supply chains. All of this has combined to dampen economic growth expectations and fueled market volatility even as the Federal Reserve (Fed) has signalled that it will continue to raise interest rates in 2022 to combat persistently high inflation.
Against this markedly unsettled backdrop, it may be time to take a careful look at how your equity portfolios are positioned and consider adopting a more balanced approach to growth, value, and core style allocations. Research conducted by the T. Rowe Price Portfolio Construction Solutions team suggests that a balanced approach to investment style allocations has helped to improve investment returns, efficiency, and consistency.
Growth/value performance reversals can be swift and sharp
As shown in Figure 1, the relative returns for large-cap U.S. growth stocks versus their value counterparts since April 1993 reveal some interesting characteristics of historical growth/value performance cycles.
- Performance cycles tended to persist for several years...
T. Rowe Price’s U.S. equity team looked at growth and value equity returns from June 1926 through December 2020. On average, value performance cycles lasted approximately 64 months, while growth cycles lasted about 45 months. At 173 months through December 2021. On average, value performance cycles lasted approximately 64 months, while growth cycles lasted about 45 months.
- ...and performance differentials have been insignificant at times.
From April 2009 through July 2014, for example, the performance of growth and value stocks was roughly equal despite a challenging backdrop that included the European sovereign debt crisis, U.S. federal debt downgrade, and extreme volatility in energy markets.
- However, style regime changes have been abrupt and steep in extreme conditions.
When the “dot com” bubble burst over twenty years ago, value stocks outperformed growth by more than 45% in the nine‑month period from July 2000 through March 2001. And today’s unsettled environment certainly appears extreme.
Growth/value performance cycles have tended to vary in duration and intensity.
(Fig. 1) Total Return: Russell 1000 Growth Index versus Russell 1000 Value Index, April 1993 through December 2021.
As of December 31, 2021
Past performance is not a reliable indicator of future performance.
Index performance is for illustrative purposes only and is not indicative of any specific investment. investors cannot invest directly in an index.
Sources: T. Rowe Price analysis using data from FactSet Research Systems, Inc; Russell Investment Group. Please see Additional Disclosures for more information.
Over the near term, the only certainty may be more uncertainty
Equity markets have been on a wild ride in the opening months of 2022 amid concerns about geopolitics, inflation, and monetary policy. Value stocks fell modestly through the end of February, but growth stocks fell even more despite being viewed as more defensive in volatile, risk-off environments. While cyclically oriented value stocks have fared better, it’s notable that almost all of the positive contribution came from the energy sector.
So what should investors expect in coming months? On one hand, the conflict in Ukraine continues to unfold and is likely to exacerbate energy shortages and to challenge global supply chains. At the same time, the impact of last year’s fiscal stimulus may be waning, and the Fed is expected to tighten monetary policy in the face of inflationary pressures. On the other hand, corporate balance sheets appear reasonably healthy and consumer savings rates are elevated. Coupled with pent-up demand resulting from the COVID pandemic, renewed spending on capital expenditures and consumer goods/services offers economic support.
Our Asset Allocation Committee continues a modest overweight to value over growth in multi-asset portfolios, but they have moved toward a more neutral allocation amid conflicting signals on the economy and markets. More cyclical value stocks could benefit from slowing but still-positive economic growth and strong consumer fundamentals. Growth stock valuations have receded from their recent highs but valuations remain elevated relative to value and could be challenged as the Fed raises interest rates over the course of the year.
Financial professionals continued to favor growth over value by a wide margin.
(Fig. 2) Growth minus value allocations, 2019 through 2021
Sources: T. Rowe Price Client Investment Platform (CIP); Morningstar Direct.
Based on moderate-risk model allocations and underlying fund exposures as of 12/31/2021. The sample includes 1,159 total models.
Consider a balanced approach to unsettled markets
Proprietary data from our Portfolio Construction Solutions team reveal that many model portfolios used by financial professionals have maintained an overweight to growth stocks at the expense of value over recent years.
As shown in Figure 2, growth allocations were 16 percentage points above value at the end of 2020 versus a seven-point tilt in 2019. Even as performance momentum favored value stocks in 2021, we didn’t see a commensurate adjustment in financial professionals’ portfolios as the tilt toward growth fell only two percentage points to 14% for the year.
Using Morningstar investment category averages, Figure 3 shows the potential benefits of investment style diversification within a U.S. large-cap equity allocation. The analysis compares long-term performance characteristics of three Morningstar U.S. large-cap category averages with two hypothetical blended allocations. The analysis shows that relative to a standalone allocation to U.S. large-cap blend, an equally-weighted blend of all three styles exhibited better returns, more efficient performance, and improved long-term return consistency.
With growth overweights still prevalent amid elevated uncertainty over geopolitics, inflation, interest rates, and moderating economic growth, now may be a good time for financial professionals to reassess equity style allocations in model portfolios and consider shifting to a more neutral position.
Style diversification has improved portfolio performance, efficiency, and consistency.
(Fig. 3) Impact of portfolio diversification across Morningstar style categories.
25-Year Performance
December 31, 1996, through December 31, 2021
Past performance is not a reliable indicator of future performance.
Source: Morningstar Direct. Calculation benchmark: Morningstar U.S. Large Blend category average. Rolling success rates calculated using 1-month moving windows. Hypothetical blended allocations rebalanced monthly. The hypothetical Large Blend (50%)/Large Growth (50%) portfolio illustrates equal allocations to U.S. Large Blend and U.S. Large Growth Morningstar categories within an allocation to U.S. large-cap stocks. The hypothetical Large Blend (33%)/Large Growth (33%)/Large Value (33%) illustrates allocations to U.S. Large Blend, U.S. Large Growth, and U.S. Large Value Morningstar categories within an allocation to U.S. large-cap stocks.
The performance shown is hypothetical for illustrative purposes only and does not represent the performance of a specific investment product or portfolio. Performance does not reflect the expenses associated with the management of an actual portfolio and is not a guarantee of future results. Illustration assumes reinvestment of income and no transaction costs or taxes. Morningstar category average performance is calculated net of fees and the underlying allocations are rebalanced monthly. Dividends and capital gains distributions are reinvested monthly. Actual results may differ significantly from those shown above.
Our expertise could enhance your portfolios
If you’re looking to adopt a more balanced approach to equity styles in your client portfolios, we can help. Built on the same foundation that supports our world-class Multi-Asset Division, our integrated suite of Portfolio Construction Solutions is designed to help you improve investment outcomes and position your practice for success. Contact your T. Rowe Price representative to learn more.
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Additional Disclosures
Financial data and analytics provider FactSet. Copyright © 2022 FactSet. All Rights Reserved.
© 2022 Morningstar, Inc. All rights reserved. The information contained herein: (1) is proprietary to Morningstar and/or its content providers; (2) may not be copied or distributed; and (3) is not warranted to be accurate, complete, or timely. Neither Morningstar nor its content providers are responsible for any damages or losses arising from any use of this information. Past performance is no guarantee of future results.
London Stock Exchange Group plc and its group undertakings (collectively, the “LSE Group”). © LSE Group 2022. “Russell” and “Russell Investment Group” are trademarks of the relevant LSE Group companies and is/are used by any other LSE Group company under license. All rights in the FTSE Russell indexes or data vest in the relevant LSE Group company that owns the index or the data. Neither LSE Group nor its licensors accept any liability for any errors or omissions in the indexes or data, and no party may rely on any indexes or data contained in this communication. No further distribution of data from the LSE Group is permitted without the relevant LSE Group company’s express written consent. The LSE Group does not promote, sponsor, or endorse the content of this communication. The LSE Group is not responsible for the formatting or configuration of this material or for any inaccuracy in T. Rowe Price Associates’ presentation thereof.
Important Information
Sharpe Ratio: An investment measurement that is used to calculate the average return beyond the risk-free rate of volatility per unit.
Standard Deviation: Indicates the volatility of a portfolio’s total returns as measured against its mean performance.
Risks: Investing involves risk, including loss of principal. Diversification neither assures a profit nor eliminates the risk of experiencing investment losses.
Value investing is subject to the risk that the market will not recognize a security’s intrinsic value for a long time or that a stock judged to be undervalued may actually be appropriately priced. Value and growth investing styles may fall out of favor, which may result in periods of underperformance.
This material is provided for general and educational purposes only and not intended to provide legal, tax, or investment advice. This material does not provide recommendations concerning investments, investment strategies, or account types; it is not individualized to the needs of any specific investor and not intended to suggest any particular investment action is appropriate for you, nor is it intended to serve as the primary basis for investment decision-making. T. Rowe Price group of companies, including T. Rowe Price Associates, Inc., and/or its affiliates, receive revenue from T. Rowe Price investment products and services.
The views contained herein are those of authors as of March 2022 and are subject to change without notice; these views may differ from those of other T. Rowe Price associates.
Past performance cannot guarantee future results. All charts and tables are shown for illustrative purposes only.
Portfolio construction services discussed are available only to financial professionals and not to the retail public.
T. Rowe Price Investment Services, Inc., distributor, T. Rowe Price funds. T. Rowe Price Associates, Inc., investment adviser, T. Rowe Price Separately Managed Accounts. T. Rowe Price Associates, Inc. and T. Rowe Price Investment Services, Inc. are affiliated companies.
© 2022 T. Rowe Price. All Rights Reserved. T. ROWE PRICE, INVEST WITH CONFIDENCE, and the Bighorn Sheep design are, collectively and/or apart, trademarks of T. Rowe Price Group, Inc.
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