Are Active Growth Strategies Poised for a Comeback?

This analyst blog is part of our coverage of the 2018 Morningstar Investment Conference.

It has been both a good and a bad time for large-growth funds. Of the nine Morningstar categories of diversified U.S. stock funds, large growth has been the best performer over the past three and five years through May 31, 2018, and the second-best (after small growth) over 10 years.

And yet investors have pulled nearly $300 billion from large-growth funds during the past decade. That's due in part to active large growth managers' collective failure to beat the Russell 1000 Growth Index. Indeed, actively managed large growth funds saw $372 billion in outflows over the period. But passive large growth funds have taken in a relatively paltry $78 billion over the past 10 years, as passive investors have overwhelmingly favored vehicles that track core indexes. Passive large blend funds took in a net $752 billion over the period, nearly 10 times as much.

Steve Wymer, portfolio manager of Fidelity Growth Company, said it's up to active large-growth managers to perform better. "Passive has beaten active, although not all active funds are equal."

His fund has handily surpassed the Russell 1000 Growth (as well as the fund's Russell 3000 Growth benchmark) over one, three, five, 10, and 15 years, primarily through savvy investments in tech and biotech stocks.

Holly Framsted, head of smart beta strategies at BlackRock, has seen one of her firm's large-growth charges succeed employing a different approach. IShares Edge MSCI USA Momentum Factor ETF, as its name implies, maintains exposure to stocks with strong stock price momentum, as measured over six and 12 months on a risk-adjusted basis (prior to the most recent month), and rebalances the portfolio twice a year. The ETF, launched in 2013, has thus far trounced the Russell 1000 Growth. Framsted equates price momentum with growth investing, noting that many successful active growth managers "often give you a large dose of momentum. Price momentum is one of the three factors S&P uses to construct its growth indexes." She says investors are flocking to passive vehicles in part due to what she called the structural advantages of ETFs

Although the ETF holds nearly $10 billion in assets and its portfolio turnover has exceeded 100% in each full calendar year thus far, Framsted said liquidity isn't a concern. "We’re trading large and midcap U.S. growth stocks, which are among the most liquid stocks in the world."

Fidelity Growth Company, meanwhile, has roughly $45 billion in assets, but is closed to new investors. Wymer stashes 35% of the fund's assets in its 10 largest holdings, but the fund also has an extended tail of tiny holdings (it owned 343 stocks in all at the end of April) that includes many mid- and small-cap stocks. A number of these are early stage biotech firms.

"We take a broad portfolio approach to that area due to drug development risk," he says.

When asked whether growth stocks can continue their recent run, Framsted was optimistic.

"The economic cycle is important; growth stocks tend to do well in the middle and late part of the cycle," she said. "We've seen a lot of momentum in growth. We also look at dispersion of performance and valuations, and we’re still very constructive on momentum versus value."

Wymer, on the other hand, sounded a more cautious note. He tends to take a five-year view on stocks and doesn't anticipate a repeat of the last five.

"I don't know how long the cycle will persist, though the majority of the world is growing now," he said. "The Russell 3000 Growth, my benchmark, has had returns in the high teens over the past five years. I expect that to be lower over the next five, including a dip and maybe a shock for the economy."