Value vs Growth Investing: Why Do Different Investors Have Different Styles? via Ben Graham Centre

Henrik Cronqvist, Stephan Siegel, and Frank Yuy

This draft: December 14, 2013

Abstract

We find that several factors explain an investor’s style, in the sense of the value versus growth orientation of the investor’s stock portfolio. First, an investor’s style has a biological basis {a preference for value versus growth stocks is partially ingrained in an investor already from birth. Second, investors who a priori are expected to take more finnancial risk (e.g., men and wealthier individuals) have a preference for growth, not value, which may be surprising if the value premium reflects risk. Finally, an investor’s style is explained by life course theory in that experiences, both earlier and later in life, are related to investment style. Investors with adverse macroeconomic experiences (e.g., growing up during the Great Depression or entering the job market during an economic downturn) and those who grew up in a lower status socioeconomic rearing environment have a stronger value orientation several decades later in their lives. Our research contributes a new perspective to the long-standing value/growth debate in finance.

I think Warren [Buffett] captured the idea himself in his 1964 article “The Superinvestors of Graham and Doddsville” and in it he talks about { value investing is like an inoculation { you either get it right away, or you never get it. And I think it’s just true. I actually think there’s just a gene for this stuff, whether it’s a value investing gene or a contrarian gene. – Seth Klarman, in an interview with Charlie Rose, 2011.

Value versus Growth Investing: Why Do Different Investors Have Different Styles? – Introduction

The concepts of “value” and “growth” investing have a long history in financial economics. Today, there exist some 2,050 value funds and 3,200 growth funds catering to investors with preferences for these investment styles.1 For more than two decades, Morningstar has provided a Value-Growth Score to help investors choose a fund with their preferred style. Fidelity, the world’s largest provider of employer-sponsored retirement plans such as 401(k) plans, prominently features a description of value and growth funds on their Learning Center website.2 There are best-selling books about both value and growth strategies, and countless business magazine articles boast recommendations about the “Best Value Funds” and/or the “Best Growth Funds.” Wall Street professionals are educated about value and growth investing already in business school, with many MBA programs today offering, e.g., Value Investing courses. Most importantly from the perspective of academic research, one of the most debated issues in the past several decades is the differential returns of investments in value versus growth stock portfolios { the value premium debate (e.g., De Bondt and Thaler (1985), Fama and French (1992, 1993, 1996), Lakonishok, Shleifer, and Vishny (1994), and Daniel and Titman (1997)).3

Despite all this attention to value and growth investing, very little research has attempted to explain the determinants of an individual’s investment style. That is, why are some investors value oriented, while others are growth oriented? In this paper, we argue that differences in investment styles across individuals, in principle, may stem from either of two non-mutually exclusive sources.

First, these differences may be biological, in the sense that a genetic predisposition results in a preference for a specific investment style. In recent years, individual characteristics of first-order importance for portfolio choice, e.g., the propensity to take financial risk, have indeed been shown to be partly explained by an individual’s genetic composition (e.g., Cesarini et al. (2009), Barnea, Cronqvist, and Siegel (2010) and Cesarini et al. (2010)). As a result, we hypothesize that an individual’s investment style has a biological basis, i.e., a preference for value versus growth stocks is partially ingrained in an investor from birth.

Second, based on life course theory, an approach to research in social psychology,4 which has recently made its way into finance research (e.g., Oyer (2006, 2008), Kaustia and Knupfer (2008), Malmendier and Nagel (2011, 2013), and Schoar and Zuo (2013)), we hypothesize that an individual’s specific life experiences affect behaviors, including the individual’s investment style, later in life. We consider several potentially relevant, and likely exogenous, life experiences of individuals. More specifically, we analyze whether experiencing an adverse and significant macroeconomic event, e.g., growing up during the Great Depression, affects an individual’s value versus growth orientation. We also examine the impressionable years during an individual’s life course, e.g., the economic conditions when an individual entered the job market for the first time. Finally, we also examine the socioeconomic status of the rearing environment in which the individual grew up.

Value Investing Growth Investing

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