It has been a brutal year for growth investing. The average growth-focused mutual fund is down by more than 30% in 2022 as of June 13, according to fund tracker Morningstar.
Yet growth stocks could well be worth buying now. The growth-stock universe is priced at about a 20% discount to estimates of fair value by Morningstar analysts. But that doesn’t mean stocks can’t get cheaper. In today’s volatile markets, investors should remain wary of super-aggressive funds like ARK Innovation (ticker: ARKK), which was up 152% in 2020 and is down more than 50% in 2022.
For investors who can’t stomach gut-wrenching volatility, a more cautious approach toward growth is warranted. One way to find lower-risk growth funds is to look at their volatility stats.
A fund like MFS Massachusetts Investors Growth (MIGFX) could fit the bill. It has a standard deviation—a volatility measure—of 17.8%, while the average fund in Morningstar’s Large Growth category sits at 20.9%. The MFS fund’s beta—a measure of market sensitivity—is 0.96, indicating if the market rises or falls 10%, it rises and falls 9.6%. The average large-growth fund rises and falls 5% more than the market with a beta of 1.05. By comparison, ARK Innovation has a 1.73 beta and a 43% standard deviation—way more volatile. The MFS fund is down 21.8% in 2022, besting 90% of its peers, which average minus 30%.
Yet volatility stats are all in the rearview mirror. It’s important to understand why a fund has been less volatile, and whether its risk profile is sustainable. That requires digging into the manager’s strategy. “We focus on owning high-quality, durable [earnings] growth compounders that we believe will have relatively resilient fundamentals even through challenging times,” Jeff Constantino, Massachusetts Investors Growth’s co-manager, tells Barron’s. “This leads us to favor companies with strong sustainable competitive advantages, or wide economic moats, typically with high profit margins, [product] pricing power, strong balance sheets, and significant cash-flow generation.”
Growth Funds With Less Volatility
These funds will help you get back into growth stocks while losing less if we see more downside.
|Fund / Ticker||YTD Return||Beta||Standard Deviation|
|Calvert Equity / CSIEX||-23.6%||0.90||17.4%|
|Capital Advisors Growth / CIAOX||-19.9||0.90||16.7|
|Franklin LibertyQ US Equity / FLQL||-17.9||0.93||17.1|
|Janus Henderson Enterprise / JAENX||-20.3||1.05||20.3|
|Jensen Quality Growth / JENSX||-21.1||0.91||17.1|
|MFS Massachusetts Investors Growth / MIGFX||-21.8||0.96||17.8|
|Neuberger Berman Genesis / NBGNX||-23.8||0.97||19.5|
|Pacer Trendpilot 100 / PTNQ||-15.6||0.72||15.9|
|VanEck Morningstar Wide Moat / MOAT||-17.4||0.96||18.5|
|iShares Russell 1000 Growth / IWF||-29.9||1.08||20.6%|
Note: Returns through June 13. Volatility and beta data are for the three years ended May 31.
Quality, admittedly an ambiguous term, is a recurrent theme for many defensive growth-stock funds. Typically, a high-quality company has a dominant market position in its industry and high barriers to entry for competitors—as Warren Buffett calls it, an “economic moat.” Such dominance gives it price control over its products, a valuable advantage in today’s inflationary environment.
“Our companies, for the most part, should be able to increase pricing to offset [their increased] costs,” says Brett Reiner, co-manager of Neuberger Berman Genesis (NBGNX). He points to one of his largest holdings— Pool Corp. (POOL), a pool equipment supplier: “They’re the largest wholesale distributor of swimming pool supplies in the U.S., with a 35 to 40% market share, multiples higher than the next biggest player in the industry.” Despite a dramatic 34.5% decline in Pool’s stock price in 2022, Reiner thinks the company’s dominance can enable it to pass on higher costs to its customers via price hikes.
The Neuberger fund is interesting, as it is one of the few low-risk small-cap growth funds. It’s easier to find dominant blue-chip growth companies with wide moats, such as Alphabet (GOOGL) and Microsoft (MSFT). There aren’t many search engines that can compete with Google.
Reiner searches for small companies in a niche business they can dominate. Yet he still has a healthy 26.8% weighting in technology, a sector ruled by behemoths. “We stay away from businesses that have to compete directly with those 800-pound gorillas,” he says. Instead, he invests in companies like Manhattan Associates (MANH), which provides reasonably priced but difficult to replace “mission critical” supply-chain software to businesses.
There are low-cost index exchange-traded funds that focus on wide-moat companies, but many lack another important ingredient to risk control—a focus on valuation. Most defensive actively managed mutual funds employ a growth-at-a-reasonable price, or GARP, strategy—not a growth-at-any-price one. This is especially important now, as rising bond interest rates hurt expensive stocks the most. That’s because bonds pay their yields up front, while expensive stocks promise profits in the distant future. The higher the average bond’s yield, the less willing stock investors are to wait on a pricey stock’s promised growth.
For this reason, in the ETF space it might make more sense to buy a blended fund that incorporates growth and value factors in its selection process—such as VanEck Morningstar Wide Moat (MOAT) or Franklin LibertyQ US Equity (FLQL)—than a pure growth one like Vanguard Mega Cap Growth (MGK). The VanEck and Franklin ETFs are each down about 17% to 18% this year, versus Vanguard Mega Cap Growth’s minus 32%.
In the mutual fund space, Massachusetts Growth, Neuberger Berman Genesis, Jensen Quality Growth (JENSX), Calvert Equity (CSIEX), and Janus Henderson Enterprise (JAENX) all employ valuation disciplines to keep risk in line.
Morningstar’s director of manager research, Russ Kinnel, is particularly fond of Jensen Quality Growth. While it can still get hurt in market downturns or recessions, its strict quality and valuation discipline protect it, he says: “If I’m wrong, and the recession has another leg down, or the market is down, I’m still going to make [my investment] back because there’s some good defense characteristics here.”
There are other ways to control risk. In addition to seeking high-quality companies, Capital Advisors Growth (CIAOX) typically holds some cash—11% of its portfolio as of March 31—for defensive reasons. It’s down 19.9% in 2022. Pacer Trendpilot 100 (PTNQ) can go to 100% cash if market conditions are rough.
Of course, holding cash at a market bottom could cause you to lose significant upside in a recovery. If you’re going to play growth stocks today, you have to be willing to accept the potential for some pain, albeit hopefully not too much.