Question

Suppose that over some time period, the HML portfolio had a total return of -6% and the SMB portfolio had a total return of -4%. During that same time period, there are four mutual fund managers whose funds all earned a 10% return. One manager runs a big value stock fund, one runs a small value stock fund, one runs a big growth stock fund, and one runs a small growth stock fund. Who was the most skilled manager during this time period and why?

Answer 1

The manager who runs a big value stock fund is the most skilled one.

Both growth and value are two fundamental approaches to stock investing that fund managers follow. Growth investing entails looking for companies that have a potential to grow faster than others. The optimism is reflected in the premium valuation commanded by the market price of such companies. A value investor, on the other hand, buys undervalued stocks that have a potential for appreciation, but are usually ignored by the investing community.

Typically, growth stocks have low dividend yields and above-average valuations as measured by price-to-earnings (P/E), market capitalisation-to-sales and price-to-book value ratios (P/B), reflecting the market's high expectations of superior growth. In contrast, value stocks usually have above-average dividend yields and low P/Es.

Growth and value investing are, however, not static concepts. When the value in a value stock is realised, it doesn't remain a value stock. Similarly, when growth stock stops growing or its share price falls substantially, it may have a lot of 'value' in it.