ETF Strategies to Balance Growth and Value Portfolio Exposure

As exchange traded fund investors look at the current state of the market, they should also consider the outlook through the lens of value and growth mandates.

In the recent webcast, The Great Debate: Growth vs. Value, John D. Linehan, Portfolio Manager, T. Rowe Price; and Caleb Fritz, Portfolio Specialist, U.S. Equity, T. Rowe Price, highlighted the ongoing strength in the growth style relative to value, with the current growth cycle at 170 months, compared to its historical average of 55 months. The current growth cycle is especially unusual in magnitude with the return differential between growth and value at its widest on a historical basis.

The strategists argued that investors may be overlooking valuation as a key factor for long-term excess return. Regardless of valuation metrics, cheap stocks typically outperform the market. Looking at data back from 1956, cheap stocks outperformed 80% of the time, with a median excess return of 2.99%.

In the current growth cycle, we have witnessed a number of factors that supported this disparity between the two styles. Specifically, the strategists pointed out that innovation has been widespread, which has disrupted sectors that are overly represented in value. Higher financials and energy weights, along with lower tech and communications services weights, have been a headwind for value. Value investing typically does best when there is strong economic growth, but growth since the Great Financial Crisis has been slow. Additionally, compared to growth stocks, value stocks are typically shorter duration assets and, as such, typically perform better when interest rates are higher.

Meanwhile, the growth cycle has been backed by strong fundamentals. For example, since 2007, Russell 1000 Growth companies showed 53% sales per share growth, 164% free cash flow growth and 113% earnings per share growth. On the other hand, Russell 1000 Value companies exhibited 53% sales per share growth, 38% free cash flow growth and 6% earnings per share growth.

Widespread innovation has been a key driver of this growth trend. For instance, the internet and the cloud have developed image classification, language processing, e-commerce tagging, digital personal assistance and product recommendations. Other areas of innovation include health care, media, energy, automation and more.

However, the strategists have warned of signs of excess, with growth valuations becoming further disconnected from value. Forward price-to-earnings ratios over the next 12 months in the Russell 1000 Growth Index was at 30x, compared to 17x for the Russell 1000 Value Index. The EV/EBITDA premium fo the Russell 1000 Growth versus Value was at 52%, its highest level since the dot-com bubble era. Meanwhile, the combined weight of the 5 largest S&P 500 components was at 23%, compared to 18% at the height of the dot-com boom.

Looking ahead, the strategists argued that style diversification leads to better risk-adjusted returns. Consequently, investors should better balance fundamentals against valuations to create a more diversified investment portfolio.

At T. Rowe Price, investors can look to four actively managed ETF strategies based on time-tested investment strategies, including the T. Rowe Price Blue Chip Growth ETF (TCHP), T. Rowe Price Dividend Growth ETF (TDVG), T. Rowe Price Equity Income ETF (TEQI), and T. Rowe Price Growth Stock ETF (TGRW).

The T. Rowe Price Blue Chip Growth ETF seeks to provide long-term capital growth by investing in common stocks of large and medium-sized blue-chip companies that have the potential for above-average earnings growth and are well established.

The T. Rowe Price Dividend Growth ETF seeks dividend income and long-term capital growth by investing the majority of its assets in the common stocks of dividend-paying companies expected to increase their dividends over time.

The T. Rowe Price Equity Income ETF seeks a high level of dividend income and long-term capital growth by investing most of its assets in common stocks, with an emphasis on large-capitalization stocks that have a strong track record of paying dividends or that are believed to be undervalued.

Lastly, the T. Rowe Price Growth Stock ETF seeks long-term capital growth and invests in companies that have one or more of the following: superior growth in earnings and cash flow, ability to sustain earnings momentum even during economic slowdowns, occupation of a lucrative niche in the economy, and ability to expand even during times of slow economic growth.

Financial advisors who are interested in learning more about growth and value strategies can watch the webcast here on demand.