Stay active: Seeking growth in a changing world
Year-to-date through the middle of September, U.S. growth stocks have posted outstanding results, with the Russell 1000 Growth Index gaining approximately 16%. In contrast, the Russell 1000 Value and S&P 500 Indices have returned close to 6% and 11%, respectively. To gain some insights on the current environment, and to better understand the opportunities and risks in the market, we recently spoke with Justin Kelly, CEO and CIO at Winslow Capital Management (“Winslow”) and Portfolio Manager for Mainstay Large Cap Growth Fund since 1999.
Large cap growth stocks leading in performance year-to-date
Source: Morningstar, as of 9/20/18. Past performance is not indicative of future results. It is not possible to invest directly in an index. Index definitions found at the end of this blog post.
The tax reform tailwind
One of the drivers of this year’s exceptional returns for large-cap growth stocks is tied to the benefits from tax reform. The most obvious benefit is the lower corporate tax rate. Less obvious is the huge Capex cycle that it has triggered. Case in point, the CEO of a leading global bank explained that the company is spending a lot of the benefits from tax reform on technological enhancements. This, in turn, has boosted the growth for a number of technology companies which, in some cases also saw their business fundamentals improve at the same time that their tax rates declined.
Valuations: More than meets the eye
Given the performance of large-cap growth companies, it’s reasonable to ask whether valuations have become expensive. The short answer is yes. And no. To be sure, some large-cap growth stocks are now expensive. But at the same time, other companies in the space offer attractive valuations. To get a better handle on this, consider the three ways Winslow classifies growth companies: dynamic growth, consistent growth and cyclical growth. Two years ago, dynamic growth companies were extremely cheap from a historical perspective. Today, many have become expensive. In contrast, consistent growth companies—those firms that can grow through various economic conditions—offer attractive relative valuations. Elsewhere, investor sentiment for certain cyclical growth companies has become challenged due to concerns over global trade wars and moderating growth overseas. Actively rotating among the three types of growth companies can be a prudent way to access the upside of the large-cap growth market, while paring a portfolio’s exposure to companies with unattractive valuations. This is an advantage active managers have relative to indexed strategies.
Types of growth stocks
|Dynamic Growth||Consistent Growth||Cyclical Growth|
|Companies in dynamic positions with superior competitive advantages generating revenue growth at/or above 10%||Companies with earnings-per-share (EPS) growth greater than the market and demonstrated acyclicality||Companies exposed to product, industry, regulatory or economic cyclicality with prospects for superior earnings growth in the forward 24 months|
Targeting the growth companies of tomorrow
A key theme we see playing out in the years to come is the journey companies are taking (or not taking) to transition from the analog world to the digital world. In our view, this is creating bigger winners and losers than at any point in history. That’s because the change mechanism to digital is happening at a much faster rate than, for example, the industrial revolution. There are obvious winners, such as certain companies in the technology space. There are also large companies outside the technology arena using data in the digital world to gain competitive advantages against smaller companies.
In contrast, a number of large multi-national consumer goods companies are on the wrong side of the digital transition and have lost their competitive advantages. In the past, many of these companies had a distribution advantage with physical stores. Today, they continue to lose market share to online retailers. And brand advertising that was previously so successful has become antiquated, as user reviews carry more weight with consumers. This leads to opportunities to invest in companies that we refer to as “staple replacements.” Many of these businesses are not owned by traditional large-cap growth managers, but they offer high quality franchises that are replacements for consumer staples. One such example: a payment company that should continue to reap the benefits as consumers increasingly utilize “digital wallets.”
The active advantages
Actively managed large-cap growth portfolios were challenged during the quantitative easing (“QE”) period. Over that period, investors favored higher dividend-paying stocks, as they offered attractive dividend yields in a low interest rate environment. Fast forward to today, it’s apparent that many of those companies have poor business models and weakening fundamentals. Not surprisingly, the percentage of active managers outperforming their benchmarks has risen.
Going forward, we believe active managers with the resources to conduct extensive research and micro economic analytics will be advantaged given the increase in return dispersion in the marketplace. In addition, we feel identifying companies with superior growth trends that have pricing power to deliver sustainable earnings growth will be increasingly important in the year to come.
Since the Federal Reserve began paring quantitative easing and raising interest rates, active large growth managers have outperformed, driven by security selection and sector allocation.
Source: Morningstar, as of 6/30/18. Active Large Growth managers defined as 232 non-Indexed Funds/non-ETF institutional funds with a 3-year tracking error > 4.0%. Peer performance is net of fees. Past performance is not indicative of future results. It is not possible to invest in an index. Alpha measures a fund’s risk-adjusted performance and is expressed as an annualized percentage. Index definitions can be found at the end of this blog post.
Opinions expressed are current opinions as of the date appearing in this material only. The information and opinions contained herein are for general information use only. New York Life Investments does not guarantee their accuracy or completeness, nor does New York Life Investments assume any liability for any loss that may result from the reliance by any person upon any such information or opinions. Such information and opinions are subject to change without notice, and are not intended as an offer or solicitation with respect to the purchase or sales of any security or as personalized investment advice. There can be no guarantee that any projection, forecast, or opinion in these materials will be realized. Past performance is no guarantee of future results.
All investments are subject to market risk, including possible loss of principal. There is no assurance that the investment objectives mentioned will be met. Diversification cannot assure a profit or protect against loss in a declining market.
Index performance is shown for illustrative purposes only and does not predict or depict the performance of the Funds. Indices are unmanaged, include the reinvestment of dividends, and cannot be purchased directly by investors. Past performance does not guarantee future results.
Large-cap growth stocks are measured by the Russell 1000 Growth Index.
Active investing is an investment strategy involving ongoing buying and selling actions by the investor. Active investors purchase investments and continuously monitor their activity to exploit profitable conditions. Active management typically charges higher fees. Investing in smaller companies involves special risks, including higher volatility and lower liquidity. There is no assurance that the investment objectives mentioned will be met.
Capital expenditures (CapEx) are funds used by a company to acquire or upgrade physical assets such as property, industrial buildings or equipment. It is often used to undertake new projects or investments by the firm.
Earnings-per-share (EPS) is the portion of a company’s profit allocated to each outstanding share of common stock.
Large cap (sometimes “big cap”) refers to a company with a market capitalization value of more than $5 billion. Large cap is a shortened version of the term “large market capitalization.” Market capitalization is calculated by multiplying the number of a company’s shares outstanding by its stock price per share. The dollar amounts used for the classifications “large cap,” mid cap” or “small cap” are only approximations that change over time.
Quantitative easing is an unconventional monetary policy in which a central bank purchases government securities or other securities from the market in order to lower interest rates and increase the money supply.
Russell 1000 Growth Index refers to a composite that includes large and mid-cap companies located in the United States that also exhibit a growth probability. Russell 1000 Growth Index refers to a composite that includes large and mid-cap companies located in the United States that also exhibit a value probability. Both are subsets of the Russell 1000 Index.
Russell 1000 Value Index measures the performance of the large-cap value segment of the U.S. equity universe. It includes those Russell 1000 Index companies with lower price-to-book ratios and lower expected growth values.
The S&P 500 Index is an unmanaged index and is widely regarded as the standard for measuring large-cap U.S. stock-market performance. Index results assume the reinvestment of all capital gain and dividend distributions. An investment cannot be made directly into an index.
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New York Life Investment Management LLC engages the services of federally registered advisors. Winslow Capital Management, LLC is unaffiliated with New York Life Investments. New York Life Investments® is a registered service mark and name under which New York Life Investment Management LLC does business. New York Life Investments, an indirect subsidiary of New York Life Insurance Company, New York, NY 10010, provides investment advisory products and services. Securities distributed by NYLIFE Distributors LLC, 30 Hudson Street, Jersey City, New Jersey 07302.