The S&P 500 index, represented by the iShares Core S&P 500 ETF (IVV), consists of the 500 largest stocks in the U.S. and broadly reflects the sectors and businesses within the U.S. economy. These stocks exhibit different characteristics, often referred to as "styles." The two primary styles are "growth" and "value," with a combination of the two known as "blend." Growth stocks typically have higher price/earnings ratios, justified by their larger expected earnings growth rates. In contrast, value stocks usually have lower growth rates but more stable earnings.
Over the past decade, growth stocks have significantly outperformed value stocks. Growth stocks, as represented by the iShares S&P 500 Growth ETF (IVW), returned +14.76%, while value stocks, represented by the iShares S&P 500 Value ETF (IVE), returned +9.17%. The broader S&P 500 (IVV) returned +12.82% during this period. Much of the recent outperformance in growth has been driven by mega-cap tech companies like Nvidia, Microsoft, Apple, and others.
How does D&A manage this relationship within the context of client goals and risk profiles? There are several ways to capture the excess returns from the growth style, including buying individual stocks, active mutual funds, or passive ETFs. At D&A, we generally favor passive ETFs as a way to gain diversified exposure to this style.
Some active mutual funds have performed exceptionally well in the growth space. For example, the T. Rowe Price Blue Chip Growth Fund (TBCIX) achieved a 1-year price return of +31.45%, slightly outperforming the passive growth ETF (IVW), which returned +29.93% (see chart below). During the same period, the value style continued to lag growth, with a +17.76% return, and the core S&P 500 (IVV) returned +24.09%.
So, why doesn’t D&A exclusively invest in the T. Rowe Price Blue Chip Growth Fund? The answer lies in risk management. Upon closer examination, this mutual fund excels in up markets, with an upside capture of 106%, similar to the growth ETF. However, it has a concerning downside capture of 128% compared to the growth ETF's 117%, and a maximum drawdown of -39.61% compared to -30.49% for the growth ETF. In essence, when the market rises, this mutual fund provides 106% of the index's return, but when the market falls, it captures 128% of the loss. While this could balance out over time, the higher short-term volatility doesn't seem like a favorable tradeoff for clients with anything less than a very long-term investment horizon.
At D&A, we start almost every client portfolio with a core holding in the S&P 500 passive ETF. By its nature, the S&P 500 includes exposure to the growth style. We then assess the client's risk profile and allocate an appropriate portion to a growth style ETF to overweight growth in client accounts. Additionally, most client portfolios already include an allocation to a passive ETF targeting the momentum factor, which in today's market is also overweight in growth. As a result, most client portfolios have a double overallocation to the growth style.