Adam Levison, senior investment director, Oversight & Manager Search, Vanguard
Growth stocks have generally outperformed their value counterparts over the past decade1 following years of historically low interest rates and other accommodative monetary policy measures, such as quantitative easing.
The large-scale purchase of assets by central banks was designed to expand the money supply to boost economic activity and has favoured investing in more expensive stocks that promised earnings growth.
This was until November 2021, when a value rotation was triggered by rising interest rates as well as investors anticipating a recovery period in markets following the Covid-19 vaccine rollout and subsequent economic resurgence.
While macro-economic drivers have broadly led value stocks to outperform growth in recent months, for many global ESG funds, which are typically heavily invested in large-cap US technology stocks, a more sustained rotation towards value could prove to be challenging.
At Vanguard, our economists expect value to outperform by as much as the historical equity-risk premium over the next decade, mostly because of a decay in the overvaluation of growth stocks, not because the “fair value of value” has returned to historical norms.
With that in mind, what are the key considerations for advisers looking to incorporate sustainability into their centralised investment proposition?
Investment success, in our view, depends on four simple principles: goals, cost, balance and discipline. Good advice can be critical in helping investors to adhere to these principles. Once an adviser has created an investment plan to outline a client’s financial objectives, diversification across regions and sectors is one of the most powerful tools an adviser can use to create a balanced portfolio.
However, some advisers have asked if sustainability comes at a cost to portfolio diversification. At Vanguard, though, we know that balance matters to clients and that the same rules apply for active ESG strategies as they do for traditional active strategies; that by keeping costs low and taking a long-term approach, a balanced and broadly diversified portfolio can smooth returns and lower volatility over time2 by reducing exposure to risks associated with a particular region, company, sector or market segment.
The relative performance of a sector or region, for example, can vary greatly over time. However, owning a portfolio with exposure to some or all key market components ensures that an investor can participate in stronger performing areas while mitigating the impact of weaker ones.
Also, a portfolio that diversifies across sectors and regions is less vulnerable to the impact of significant swings in performance by any one segment. Consequently, investors participate in the entire market, which provides a good spread of investments across market cycles.
The Vanguard SustainableLife range of funds, managed by Wellington Investment Company, adheres to our four investment principles and can provide a core portfolio solution for investors who value sustainability. As multi-asset funds, they provide all-in-one portfolios of equities and bonds, which are highly diversified across geographies, sectors and investment styles.
The equity portfolios can hold 80-90 stocks with country exposures generally within +/- 15% of the index weight, and sector exposures generally +/- 10% of the index weight.
The equity portions of the funds are tilted towards stocks where the portfolio manager has identified what she believes to be undervalued opportunities and are conservatively managed in an effort to outperform the market with lower risk and a quality bias.
The fixed income portion comprises 400-500 investment-grade securities to help dampen the effects of market volatility. The fixed income portfolios’ exposure to countries will generally not exceed +/- 15% of the index weight. The portfolio manager does not generally concentrate assets in a single country that is not a major constituent in the benchmark – defined as countries that are less than 5% of the market value of the benchmark.
Overall, the portfolios are positioned to deliver returns through a combination of capital growth and income. The portfolio managers pursue opportunities presented by market inefficiencies to deliver a multi-dimensional and dynamic approach to incorporating ESG considerations.
In the months ahead, rising interest rates could leave high growth technology companies (and ESG funds tilted to the technology sector and other growth areas) particularly vulnerable as investors place less of a premium on future earnings. Against this backdrop, we believe that balance is an important consideration for clients looking to invest with personal objectives in mind and who want to prioritise sustainability.
1 MSCI Growth index versus MSCI Value index, 10 May 2012 to 10 May 2022. Source: Morningstar, as at 10 May 2022.
2 Source: Vanguard, Principles for investment success, 2022.
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