The Solution: Build More Inflation-Resilient Exposures
We think the style-balanced strategy’s stronger showing stems from a more effective balance between growth and value exposure as well as less stock concentration—an issue with the passive market-cap-weighted strategy.
The cap-weighted portfolio’s –0.66 value score (Display, center) signals its heavy growth exposure, making it much more susceptible to the underperformance typical in a high-inflation environment. In contrast, the style-balanced future-resources portfolio’s value score is close to zero, indicating no significant tilt to either growth or value—an attribute that drove its relative success–especially in rising-rate environments.
Also, the passive cap-weighted portfolio had 50% of its holdings concentrated in just five stocks, making it highly vulnerable to the fates of a very small cohort (Display, right). In contrast, the style-balanced portfolio was much more diversified in terms of stock weightings, with less than 5% of its holdings in the top five.
Note that style-balanced construction would require more trading and rebalancing than a simple cap-weighted approach. That’s the key to keeping the growth-value profile balanced by reducing exposure to stocks that have become expensive and increasing exposure to those that cheapen. But our simulation indicates the required trading activity would be in line with normal trading patterns of the average active stock portfolio.
The Big Picture
The style-balanced future-resources portfolio doesn’t win all the time. It may well trail the cap-weighted approach when yields fall sharply. But as we see it, future-resources investing is a marathon, not a sprint. That’s why we think applying style-based factors to construction can produce a diversified inflation-protection allocation that may provide a cushion for when inflation and yields rise while offering exposure to an important secular theme.
We think future-resources companies have a key role to play in the path to decarbonization. But given current inflation pressures, it’s important to embrace these growth-oriented companies thoughtfully rather than in a passive approach that carries sizable risks. Getting the calculus right can provide investors with yet another inflation-fighting tool in a real-return strategy.