Investment style is one of the key decisions an investor needs to make when picking a fund, and style is particularly prominent in the US market. During the past nine years, which coincide with the bull market witnessed in the US, growth stocks have been the standout.
Divergences in returns between the two investment styles have particularly augmented over the past three years and more dramatically during the 2017 period. Indeed, large-cap growth stocks beat their value counterparts by more than 16% as measured by the Russell 1000 Growth and Value indexes.
While growth opportunities can be found in many sectors, recent years have seen most of the investment ideas spring from technology. The industry’s potential to disrupt traditional industries has created a rich fishing ground for growth managers, making it the strongest secular growth story in the market.
As of March 2018, the average fund’s exposure to the information technology sector within the large-cap growth category has increased by more than 35% over a three-year period. Across the open- and closed-ended funds carrying a Morningstar Analyst Rating with a growth tilt, the average growth rate was higher, standing at 41% during the same time frame.
It is also worth noting that many large-cap high-growth managers took their technology bet to a historical high in absolute and relative terms in 2017 as the sector rallied strongly, leading the overall US equity market. Medalist funds – those with a Gold, Silver or Bronze rating – have the highest exposure to the information technology sector, which was reached during the fourth quarter.
Gold-rated PGIM Jennison US Growth had the highest allocation to the sector, accounting for just more than half of its overall assets. The Morningstar Global Risk Model shows that it is also the offering with the highest sensitivity to the technology sector, scoring 0.56 on a scale ranging from 0 to 1. Higher scores indicate higher levels of sensitivity to individual sectors.
A Basket of Stocks Hard to Ignore
Looking at the medalists, particularly those exhibiting a tilt to high-growth, we observe that a group of stocks, namely, Facebook (FB), Amazon (AMZN), Apple (AAPL), Microsoft (MSFT) and Alphabet (GOOGL) features in all portfolios, making up about 25% of the overall assets at the end of the first quarter of 2018. These stocks led the sector and the market in 2017 and were again at the heart this year. Interestingly, Amazon is the largest holding in each of these funds as well as being an overweighting relative to the Russell 1000 Growth Index benchmark.
Valuations and Prospects
As technology stocks rallied strongly, especially in 2017, the S&P 500 Information Technology Index’s P/E ratio expanded, reaching a record high of 31.4 in February 2018 from 22.1 back in January 2017. Because of this expansion, the technology sector is now the most expensive sector after REITs.
Several large-cap high-growth managers whom we spoke to recently started taking profits in January 2018, and subsequent months saw further reductions to reduce valuation risk. For example, PGIM Jennison US Growth’s management team had reduced the fund’s stake in Facebook early in the year on the back of its strong performance in 2017 and expectations of slower, though still solid earnings growth.
The increasing regulatory scrutiny has taken a toll on Facebook and other high-flying technology stocks recently, wiping significant value of their market shares. This stumble has not changed the long-term view of many managers on the sector and the big tech stocks. Franklin US Opportunities’ management team, for example, cut the fund’s holding in Facebook, as in its view the upside is limited. It has also taken profits from its stake in Amazon, which performed strongly; yet this remained a sizeable position at the end of March, accounting for 7.3% of assets, as the managers’ long-term view remained very positive.
Other growth managers, especially those exhibiting a high growth tilt, also continue to view the sector as a powerful force to gain access to growth opportunities. For instance, Gold-rated PGIM Jennison US Growth and Bronze-rated Franklin US Opportunities’ exposure to the technology sector accounted for about 47% of assets at the end of March 2018, a testament of the managers’ long-term positive view on the sector.
Beyond Technology
Another long-term story where managers see potential for significant growth is healthcare. Within our rated universe, Grant Bowers, manager of Bronze-rated Franklin US Opportunities, believes that innovation in biologic therapies such as immunocology are creating strong investment opportunities in the space. Additionally, we note that in contrast to technology stocks, valuations for the healthcare sector are lower.
Indeed, the S&P 500 Healthcare Index’s P/E ratio is currently trading at 15.3 times earnings, a level not seen since February 2013, a discount to the S&P 500 benchmark relative to a historical premium. As of March 2018, the average exposure to healthcare observed across our medalists within the large-cap growth category was 16.5%, which is lower than levels seen three years ago.
Growth funds that have a high sensitivity to both secular growth themes are well-poised to lead the pack. Within our medalists, Gold-rated T. Rowe Price US Blue Chip, Bronze-rated T. Rowe Price US Large Cap Growth Equity, and Silver-rated Loomis Salyes US Equity Leaders funds are strongly taking advantage of the growth opportunities in both technology and healthcare sectors. However, in the latter sector, managers have tended in recent periods to avoids stocks with a binary outcome and in many cases have reined in their exposure to biotechnology companies.
