Thinking of riding the rotation to value stocks? There’s more than one approach.

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In a cyclical rotation, there are several ways to gain exposure to value. Here’s what investors should know.

The rotation from growth into value has been one of the leading stories in financial markets since the end of 2020. This trending topic connects to nearly every aspect of equities right now: which stocks will benefit from a cyclical recovery, the fate of flashy headline tech stocks, inflation fears and higher interest rates. But it’s critical for investors to make the distinction between value as a sector and value as a factor.

 

Value as a sector
A given sector within a benchmark can be classified as a growth sector or a value sector; a growth sector will have a higher-than-average earnings growth rate compared with other sectors or the economy in general. A sector like technology is considered growth because its future earnings are higher than, say, a financial sector. And in the current market, we’re seeing a rotation away from technology.

 

THE ROTATION TO VALUE

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Value as a factor
This simply means considering the stocks themselves, not necessarily the sector as a whole. Value factors look at companies sharing a fundamental metric like low price-to-earnings ratios. The approach can apply to a core or even a growth portfolio and is not necessarily connected to a value sector manager. 

 

Is it confusing to have the same terminology apply to both? Absolutely. But it does matter whether we get this terminology right because the value sector and the value factor are not always aligned. And if you’re going to make portfolio decisions based on a rotation, it certainly helps to know what you’re getting when you buy value. While sector and factor approaches have performed in a similar manner in the past year, don’t assume that adding value sector stocks to a portfolio will return the same result as adding value factor stocks — and vice versa.

 

 

Should the value rotation continue, the best way to harness that return is through value-oriented investment approaches. Both value sector and value factor approaches have strong links to active management, ranging from the value or contrarian approach of fundamental investors to the value factor that features prominently in quantitative portfolios.

 

It’s important not to abandon diversification. There are days when growth stocks perform very well and exposures to multiple sectors and styles can help balance a portfolio. At the same time, assuming the value rotation continues, investors will no longer benefit from concentrated exposures in a few headline technology names.

 

Bottom line
It’s a strong possibility that the stock market’s rotation to value will continue — at least in the near term. Investors can position their portfolios to take advantage of these opportunities but should keep in mind that there are different ways to identify value stocks: based on market sector or as a factor based on company fundamentals. Value sector and value factor don’t always perform the same way, so it’s important for advisors and their clients to work together and discuss what makes the most sense on a case-by-case basis. 


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