Reasons to consider adding value to your portfolio today
Now, let’s turn to why we believe it may be a good time to consider adding value exposure to your portfolio. First, there is concentration risk, sector risk, and factor risk in passive indices today that investors may not be aware of. Investors often think that they are reducing risk by investing passively in the market but we believe that they are potentially taking significant unintended risks with a passive U.S. large cap allocation. Figure 1 shows the rising weight in the S&P 500 made up of the top 7 stocks. Over the last 10 years, the weight of these holdings has tripled, from approximately 7% to 20+%, which creates more idiosyncratic stock risk potential going forward. Also, the index’s sector concentration risk has increased. Over the last 30 years, the Information Technology sector has been by far the most volatile sector with an average standard deviation of 24%, vs 13.6% for the overall index and this sector weight has grown to over 1/3rd of the index.
We believe by passively investing, investors are taking on unintended concentration risk in growth exposure.
Another reason to consider value today is based on an assessment of valuation spreads. Valuation spreads are a measure of dispersion between the cheapest and most expensive stocks. As you can see from Figure 2, spreads are at historic extremes today. Historically, when spreads are wide and then narrow, value outperforms as prices converge. Regardless of value measure or which manager we speak with, valuation spreads are at extremes not witnessed before, at least not since the TMT bubble.
A common question is: are value stocks cheap for a reason? In Figure 3 we plot the return on equity (ROE) of value and growth companies over time. You can see that ROEs of growth companies have been consistently higher, and investors have bid up those superior fundamentals with higher prices. However, ROEs have just started to converge between growth and value companies. It is still early, but often with markets, it is the rate of change that matters the most. With this convergence of fundamentals and ROEs between value and growth companies, price and return convergence could soon follow, resulting in outsized returns from value going forward
Because wide spreads are typically associated with future subsequent outperformance for value, we believe now may be a good time for investors to add value to their portfolio.
Legal Notices & Disclosures
The views expressed herein are those of Harbor Capital Advisors, Inc. investment professionals at the time the comments were made. They may not be reflective of their current opinions, are subject to change without prior notice, and should not be considered investment advice. The information provided in this presentation is for informational purposes only.
The information provided in this presentation should not be considered as a recommendation to purchase or sell a particular security. The weightings, holdings, industries, sectors, and countries mentioned may change at any time and may not represent current or future investments.
Past performance is no guarantee of future results.
The information shown relates to the past. Past performance is not a guide to the future. The value of an investment can go down as well as up. Investing involves risks including loss of principal.
The Russell 1000® Growth Index is an unmanaged index generally representative of the U.S. market for larger capitalization growth stocks. This unmanaged index does not reflect fees and expenses and are not available for direct investment. The Russell 1000® Growth Index and Russell® are trademarks of Frank Russell Company.
The Russell 1000® Value Index is an unmanaged index generally representative of the U.S. market for larger capitalization value stocks. This unmanaged index does not reflect fees and expenses and is not available for direct investment. The Russell 1000® Value Index and Russell® are trademarks of Frank Russell Company.