Australian fund managers with a value focused investment strategy are struggling to keep up with the index as the market continues its shift in favour of growth stocks.

While value shares have outperformed growth over the past ten years, growth shares have been in front for the past five, despite a value comeback in 2016 and the early part of 2017. Recent performance shows that growth has extended its lead even further, while the average return for value managers is in negative territory so far in 2018 (see chart below).

Calendar year returns for Australian growth and value equity fund managers (% p.a.)

Source: Lonsec

Includes value and growth style Australian equity fund managers rated by Lonsec Research

Value investors look for well-run businesses with solid company fundamentals that may be undervalued due to industry headwinds or temporary negative events. In contrast, growth investors look for businesses with high growth potential or earnings momentum, which can include smaller, scalable businesses or established market leaders.

The behaviour of value and growth shares over different periods, and the tendency for one or the other to outperform, underlines the importance of diversification, not just across markets and sectors, but across investment styles as well. For example, despite the five-year trend, value has outperformed growth significantly over a twenty-year period.

Value versus growth shares (growth of $10,000 to May 2018)

Source: Lonsec, Bloomberg

Despite the relatively lacklustre performance of Australian shares in 2018, growth companies have remained in favour and are currently the main drivers of market returns, among them consumer staples shares like A2 Milk Co (A2M) and Treasury Wine Estates (TWE), as well as some big names like CSL (CSL), Australia’s leading biotechnology business.

Growth shares have dominated through the end of 2017 and the first half of 2018

Source: Lonsec, Bloomberg

Meanwhile, value shares (represented by the MSCI Australia Value Index) have been weighed down by recent poor performance from financials and telecommunication shares, including the major banks which have come under pressure from the Royal Commission into Financial Services. The banks may become attractive propositions from a value perspective, but the question is how long it will take before they regain favour from the broader market.

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