Could it be time to go for growth?

Where do you stand on the growth versus value debate? Investment companies that invest with a growth style have significantly outperformed their value-oriented counterparts over the past decade – delivering returns ten times higher on some measures. However, the value trusts have enjoyed a significant edge over the past two years of that period, as conditions in financial market have changed. So, will that trend continue?

Let’s start with the basics. Growth-oriented investors look to buy companies expected to grow at much faster rates over the medium to longer term. The best-known examples in the investment companies sector are several funds managed by Baillie Gifford; it runs vehicles such as Scottish Mortgage, which have invested heavily in technology stocks, often seen as classic growth plays.

By contrast, investors who prefer a value style look for companies where the share price currently appears to represent a bargain. Investment companies such as Fidelity Special Values that invest in this way have performed very well over the past two year or so.

The changing fortunes of value and growth funds largely reflect the shifting macroeconomic picture. Lower inflation and interest rates are good news for growth stocks, because investors don’t need so much return in the future to compensate for having to wait for it. By contrast, rising prices and borrowing costs reduce what investors are prepared to pay for those future returns, which is bad for growth stocks.  

Hence the move into value stocks in recent times. With inflation soaring and interest rates moving upwards – in the UK, there have been ten increases in the Bank of England’s base rate since February 2022 – growth stocks have plummeted. The value style has suddenly enjoyed a dramatic return to favour.

As always in investment, the question is what happens next. The fact that value stocks have been in the ascendancy is no guarantee they will continue to make ground – any more than growth stocks’ supremacy was ever a certainty.

The tricky thing here is that much depends on the direction of interest rates – and this is far from clear. There are plenty of economists who believe that the end of high inflation is now in sight and that rates will come down once again. The International Monetary Fund recently signalled that it expected rates to revert to the levels seen prior to the increases of the last year or so, at least once inflation is under control. That would mean a return to ultra-low rates.

However, there are also significant numbers of economists who think it’s too early to be optimistic. Inflation and interest rates will stay higher for longer, they believe, pointing to the stubbornly high levels of inflation seen in recent months.

That leaves investors in a pickle. Lower interest rates could well trigger a recovery for growth stocks – and a significant one given their recent travails – but when exactly will that happen?

There are no easy answers here. However, it’s worth pointing out that in the investment companies world, the shares of many growth-focused funds are currently trading at a significant discount to the value of the underlying assets. Scottish Mortgage shares, for example, currently trade at a 21.6% discount.

Such discounts reflect negative sentiment towards these funds in the current environment, but discounts could unwind quickly as the mood changes. Just the expectation of lower rates to come could provide a boost. Investment companies, in other words, could provide an early opportunity to benefit if and when growth stocks make a comeback.