Impact of investment horizon on the performance of value versus growth styles and style allocation

Abstract

Most literature on time diversification focuses on the risks of stocks versus bonds. Little attention has been given to the impact of time horizon on the risks for value versus growth stocks. With the growing popularity of those two investment styles, it is in great need to analyze the time changing nature of risks for value versus growth styles. This article seeks to fill in the void. We study three downside risk measures: shortfall risk, expected loss and lower partial standard deviations (LPSDs), for value versus growth styles across different holding periods. We find that all the three risk measures decline when time horizon lengthens. The benefit of time diversification is greater for value stocks than for growth stocks. And value stocks outperform growth stocks in terms of both risks and returns in the long run. Does this mean that an investor should increase his/her investment in value stocks for longer investment horizons? We further explore the optimal mix of value and growth stocks across time horizons. Interestingly, even though value stocks dominate growth stocks in both risks and returns in the long run, adding growth stocks to value stocks is still beneficial. With rolling window analysis (when the returns are autocorrelated), the optimal weights for value stocks are approximately 50 per cent, 40–50 per cent and 30–40 per cent in order to minimize shortfall risk, expected loss and LPSDs, respectively, for an investment window of 1–15 years. With bootstrap analysis (return distributions are independent), the optimal weights for value stocks increase as time horizon lengthens. However, even for the 15-year window, the optimal portfolio still has about 30 per cent growth stocks. In other words, style diversification is still important even in the long run.