Data as of December 31, 2007Source: Fundata Canada Inc.

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Like the fashion industry, the mutual fund industry has its own styles. For example, within equity funds, there are value funds, growth funds and blend funds. Value funds invest in stocks with moderate revenue growth and low price to earnings multiples. Growth funds invest in stocks with high revenue growth and high price to earnings multiples. As one might suspect, value funds take the conservative route whereas growth funds take a more aggressive stance. Studies have shown that there are periods where value funds outperform growth funds and there are other periods where the opposite happens. In the long term, performance of value and growth funds is balanced out. In general, during economic downturns, value funds outperform growth funds and during periods of economic growth, growth funds outperform value funds. There are some years where the market cycle is not the only contributor to the investment style returns and 2007 was such a year.

In 2007, we saw economic expansion in Canadian and Global markets. If we look at the performance of the value and growth funds, we find that the value funds under performed growth funds in 2007. But economic cycle was not the only factor in explaining investment style returns.

To compare returns for growth and value investment styles, we looked at the performance of iShares CDN Growth Index Fund and iShares CDN Value Index Fund. The iShares CDN Growth Index Fund outperformed the iShares CDN Value Index by 16.41%. The iShares CDN  Growth Index Fund generated a one year return of 22.20 % in 2007 where the iShares CDN Value Index Fund produced a one year return of 5.79%.  One of the factors that affected performance of the value investing was the financial sector that was badly hit on a global scale by the US sub prime mortgage crisis.  As it can be seen on the graph, the monthly returns for value style were slightly above growth style returns until the summer of 2007. At that time sub prime mortgage crisis started spreading its tentacles and the value style returns fell much below the growth style returns.

Data as of December 31, 2007

Source: Fundata Canada Inc.

In 2008, many people are placing a high probability on a recession in US due to the credit crisis. Some people suspect that the US is already in a recession. If a recession is already underway or is going to occur soon, one should expect the growth stocks to start under-performing value stocks. It follows then, that growth mutual funds would underperform the value funds.  Of course, past performance does not guarantee future outcomes, but investors can choose to time their investments and investment style to take advantage of the change in the market cycle.

Olga Peram is Director of Analytics at Fundata Canada Inc, a leading source of Canadian mutual fund information. For more information, please visit www.fundata.com.

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