But there are a number of reasons the GMO managers don’t see value stocks’ fortunes tied to short durations, including the complicated dance among stocks’ total return, as well as the effect of rebalancing. When value stocks cycle in and out of the indexes, it adds to their total return while the same process hurts growth stocks, Inker writes:
“There are actually a number of different ways that companies enter or leave the value half of the S&P 500,” the report says. “A few of them cost value investors money, but the biggest effect is that when a value stock comes back into favor with investors and sees its valuation rise, it both outperforms and enters into the growth universe, which results in a positive impact on returns that does not impact the valuation of the remaining value group. In an average year, about 8% to 9% of the cheap half of the S&P 500 ‘graduates’ to the expensive half, so the impact of this mechanism really adds up.”
Growth stocks, on the other hand, suffer from rebalancing, and it actually detracts from their total return.
“As growth is the other side of the coin from value, it is not a surprise that the rebalancing effect is negative in that group, but just how negative is striking,” Inker writes. “As with value, there are multiple ways that growth stocks enter and leave the growth universe. The single biggest driver is the fact that a growth stock becoming a value stock tends to suffer a strongly negative return, but the other reasons for stocks entering and leaving the growth universe are also materially negative for returns.” For instance, growth stocks might leave the category because they are going through bankruptcy. A growth stock arriving in the index might come in at a too-high valuation. Acquisitions in growth stocks aren’t happening as often unless they are for cheap companies, the paper says.
“Given the drivers of return for value as an investment style, you could make the argument that value should have a slightly shorter duration than the overall stock market and growth stocks a slightly longer one,” Inker writes. “But the difference between them is small enough as to easily disappear in the noise of the market and cannot possibly explain the performance of value and growth stocks over the past few years.”
Morningstar wrote in January that large-cap value funds had suffered one of their worst years ever in 2020, lagging large-cap growth funds’ 34.8% return by 32 percentage points.