Last month I started a series on the anomalies to the efficient market theory which can create opportunities for outperformance. I discussed the opportunity presented when almost no one has valuable information and so the anomaly is not arbitraged away. This month I would like to discuss two other opportunities, Value stocks and Growth stocks.

There is extensive and conflicting evidence on Growth and Value stocks being anomalies to the efficient market theory. I have spent a great deal of time unwinding the mystery and have come to the conclusion that when the data is handled properly both growth and value are anomalies and can produce above average returns. Since the market (usually an index of some type) is usually divided into Growth and Value segments, how can the parts outperform the whole?

The market is not easily divided into Growth and Value segments. Some securities have such poor data that you cannot tell where they belong. Other securities have such poor growth and value criteria they do not belong in either camp. Some have good criteria in both Growth and Value and are excluded from one portfolio to avoid duplication. Some have very good criteria only because they are recovering from a dismal past. Some portfolio managers, thinking more of marketing than performance, insist that all securities in the starting index be represented in the two Growth and Value sub-indexes.

All these factors combine to limit the usefulness of Growth and Value indexing. We have found that growth and value portfolios that are unconstrained from the above issues are more likely to outperform the market. Finally, we believe that individual securities that score high in both the Growth AND Value portfolios will attract attention from both Growth and Value investors. Hopefully this added attention will be observed as increased capital appreciation. These are the securities from which we select for the Growth and Value factors of our investment strategy.

The Lesson… I was told in my first year of my MBA program “Honesty is the best policy: Perhaps not the most profitable, but the best.” It applies here. Honest research, not marketing, is the best policy for serving clients.

Sincerely,

Katz Family Financial