Value versus growth investments: state of the market
A fundamental decision many SMSF investors need to make is finding the right balance between growth and value assets in their portfolio.
Both have their role, but many investors will find they have a bias towards one or the other, depending on what’s happening in the market and their own situation.
What are growth assets?
Pete Pennicott, a director and financial adviser with financial advice firm Pekada, explains growth shares are entities that have future earnings potential.
“They are priced at a premium to the market as these businesses are expected to outpace the market average over time. Because of this they don’t appear cheap based on traditional metrics such as price-to-earnings ratios. Given the high-growth nature of these businesses, they are less likely to pay a dividend as the profits are reinvested back into future growth plans,” he says.
What are value asset?
In contrast value investments are considered to be trading at a discount to their true value. “Value assets are typically more mature businesses, with lower prices in relation to quantitative factors such as earnings, sales and assets. Often, but not always, they are more likely to pay a dividend,” Pennicott explains.
He notes that often an asset will display both growth and value qualities. “Investments don’t always fit nicely into one or the other of these categories,” he says.
Why invest in growth assets?
As for why an SMSF investor may wish to invest in a growth asset at this stage in the market cycle, he says one reason is because these investments generally have a very long investment horizon.
“What we’re seeing is that traditional markets continue to be disrupted. This creates opportunities for those growth-style businesses to take on market share and continue to deliver outsized returns,” Pennicott says.
In terms of why a client may be less inclined to invest in growth shares, he says if an SMSF investor only has a shorter investment horizon, say less than three to five years, and a requirement for consistent income, then there is the threat that growth businesses will expose the investor’s capital to too much risk.
“In these circumstances, there is the potential for the portfolio not to have the required level of cushioning that a dividend yield provides,” he says.
Why invest in value assets?
When it comes to the argument for investing in value assets, Pennicott says one of the benefits is that they deliver sustainable investment returns and consistent income. “For a retiree client, or someone requiring regular income, these businesses are generally more predictable and have reliable cash flows. But investors should always be wary of the ‘value trap’, where a low price isn’t value at all and the share is cheap for a reason.”
This reason may include structural faults with the business or systemic problems with the sector.
A blended approach
Some investors will prefer an allocation in their portfolio that is more biased to growth assets, while others will prefer to invest mainly in value assets. The path investors take will depend on their risk appetite and time to retirement, among other things.
However, Pennicott says a balanced approach is often the way to go.
“Both value- and growth-style shares deserve their place in a portfolio, and there's no crystal ball to indicate whether value or growth investments will perform better in the short-term or the long-term,” says Pennicott.
“Ideally, investors should have a portfolio mainly made up of good value, growth businesses. But it’s important to weigh up how long your investment horizon is and what your portfolio needs. If you require more income, then typically you will be more heavily weighted towards a value-style investment portfolio,” says Pennicott.
“If you are younger, and you do not require as much income, and you're going to be invested in the market for a longer time, it may make sense to align your investments with businesses that are going to continue to grow over the long-term,” he advises.
Overall it’s essential to ensure the assets in the portfolio meet the investment goals and objectives of the fund and its members, no matter whether they are growth or value investments.