The big losers, said the report, were the growth-oriented managers who were unwilling or unable to adjust their investment style.
But given that value stocks have suffered periods of underperformance, such as when growth stocks were in the ascendancy during the 1990s, the report examined the long-term performance of value versus growth stocks.
Using a record of dividends on UK stocks, LBS/ABN Amro studied the value-growth premium over the 105 year period from 1900 onward, comparing the long-run performance of the UK equity market with the performance of high and low-yield indices.
An investment of £1 (e1.42) in the growth index at the start of 1900 would have grown in nominal terms to £2963 by the end of 2004, equivalent to an annualised return of 7.9 per cent. The same investment in the market as a whole would have generated £14,988, equivalent to an annualised return of 9.6 per cent.
However, the same initial investment applied to the value index would have generated £69,208, equivalent to an annual return of 11.2 per cent.
In light of these findings, shouldn’t investors simply sack their growth managers and stuff their equity portfolios with value stocks?
On the contrary, Professor Paul Marsh of LBS urges caution. The key question, he says, is how long value stocks will continue to outperform growth stocks. It could be said that after five years in the relative doldrums, growth stocks are ripe for a bounce-back.
In that case, the investor might think it prudent to hold a style-neutral equity portfolio. Or one could just as easily argue that value stocks will continue to outperform growth stocks over the next 30 years.
On the other hand, Professor Marsh warns that trying to “call styles” is a dangerous game and investors are best advised to maintain a well-diversified portfolio of domestic and international equities and bonds.
Value stocks are not the only consistent, long-term outperformers. Small-cap stocks in the UK have realised a substantial premium over the last 50 years, according to the year book. To show the size effect on investment returns, the performance of the Hoare Govett Smaller Companies (HGSC) index, which comprises the lowest tenth by value of the UK equity market, was compared with the ABN Amro/LBS All Equity index and the ABN Amro/LBS MicroCap index, which tracks the bottom 1 per cent of the UK market.
An investment of £1 in the UK equity market at the start of 1955 would, with dividends reinvested, have grown to £549 by end-2004, equal to an annual return of 13.4 per cent. The same investment in the HGSC would have generated £1821, equivalent to a return of 16.2 per cent a year. But an investment in micro-caps would have yielded a remarkable £9834, more than five times as much as an investment in the HGSC and equivalent to a return of 20.2 per cent. Again, the apparent good news carries a health warning for investors who might conclude that the road to riches is paved with small-cap portfolios.
LBS points out that only since 1999 have the smallest companies provided the highest returns. As with value stocks, the important question is how long the present situation will last.
So the advice from Professor Marsh is the same: spread your money around a number of different asset classes and geographical markets. It is only common sense, really. But for this observer, the head-long rush into hedge funds highlights the ease with which sentiment-driven investors forget the harsh lessons of past herd-like behaviour.
Henry Smith, editor, henry.smith@ft.com
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