Which Way Do We Look at Performance: Growth vs. Value in 2005

Chart of the Week for January 20-26, 2006

Growth Funds came back in 2005, edging out value funds by just over half a percent according to Morningstar. This is the first time in five years that growth funds have outperformed value funds. Historically, growth funds look for companies with high earnings growth, while value funds generally focus on stocks of undervalued companies.

Growth has beaten out value among large growth and value funds (as defined by Morningstar) in 2005. But, comparisons between the Russell 1000 Value and the Russell 1000 Growth indices illustrate that value stocks outperformed growth by almost 2 percentage points. This might create confusion with investors, as one set of numbers shows growth as the stronger performer, while the other shows value. Why does this happen? The answer is two fold.

Looking at the indexes, growth outperformed value in the last three quarters of 2005 but still wasn't able to overcome a negative first quarter return in the yearly number. The other idea to understand is the definition of a “peer category” and an “index.” A peer category is used to group actual funds based on objective to gauge relative performance. An index is used as a tool to represent a certain style, and the characteristics of its component stocks bear some commonality. Even though a mutual fund is placed in a particular peer category, fund managers may invest in companies that fall outside of the category. An index, is in a sense, more “pure.” Growth fund managers may have had help outside of growth to overcome a negative first quarter. As a result, performance of the Large Growth fund peer category was not as affected by the performance of growth stocks in the first quarter as the Russell 1000 Growth index, and was able to outperform the Large Value Category for the year.

If growth continues to perform as well as it did during the last three quarters of 2005, investment managers and individual investors may see growth funds make a strong return in 2006. Nevertheless, the age old mantra is to stay diversified.

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