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When Diversification Doesn’t Diversify

Value and growth index fund investors may be surprised by their returns last year.

Investors commonly own both value and growth stocks to diversify their portfolios—the idea is that the two investment styles may take turns outperforming.

For some index investors, however, that strategy fell flat in 2023. As the chart shows, the S&P 500 Pure Value index and the S&P 500 Pure Growth index ended the year by essentially crossing the finish line together—with the Value index up 8.2% and the Growth index returning 8.3%, for a difference of a whopping 0.1 percentage points.

Source: Bloomberg, as of 12/29/23

Such lockstep performance serves as a reminder of the limitations that can occur when using a passive approach to style (and other factor-based) investing. For example, one reason these indices failed to provide diversification benefits is that they are rebalanced just once over the course of a calendar year rather than being rebalanced based on changing market conditions that may present opportunities at various points. When it came time for the annual rebalancing at the end of 2022, many sharply underperforming tech stocks from that year were shifted from the growth index to the value index—resulting in largely atypical holdings in both indices that contributed to the 2023 returns noted above.

In contrast, actively managed portfolios with value and growth allocations may offer greater flexibility in the particular stocks they hold from each style and the timing of trades—potential advantages that we believe increase the ability to capture the return potential of each investment style.

The upshot: Gaining exposure to value and growth stocks may take more than owning funds with “value” and “growth” in their titles. When creating diversified portfolios, the details are important.

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This commentary is written by Horizon Investments’ asset management team. All returns are sourced from Bloomberg and as of 12/29/23. Past performance is not indicative of future results. Nothing contained herein should be construed as an offer to sell or the solicitation of an offer to buy any security. This report does not attempt to examine all the facts and circumstances that may be relevant to any company, industry, or security mentioned herein. We are not soliciting any action based on this document. It is for the general information of clients of Horizon Investments, LLC (“Horizon”). This document does not constitute a personal recommendation or take into account the particular investment objectives, financial situations, or needs of individual clients. Before acting on any analysis, advice, or recommendation in this document, clients should consider whether the security in question is suitable for their particular circumstances and, if necessary, seek professional advice. Investors may realize losses on any investments. Asset allocation cannot eliminate the risk of fluctuating prices and uncertain returns. All investing involves the risk of loss.

The S&P 500 is a stock market index tracking the stock performance of 500 of the largest companies listed on stock exchanges in the United States. The S&P 500® Pure Value index is a style-concentrated index designed to track the performance of stocks that exhibit the strongest value characteristics by using a style-attractiveness-weighting scheme. The S&P 500® Pure Growth index is a style-concentrated index designed to track the performance of stocks that exhibit the strongest growth characteristics by using a style-attractiveness-weighting scheme. Reference to an index does not imply that any account will achieve returns, volatility, or other results similar to that index. An index’s composition may not reflect how a portfolio is constructed in relation to expected or achieved returns, portfolio guidelines, restrictions, sectors, correlations, concentrations, volatility or tracking error targets, all of which are subject to change. Individuals cannot invest directly in any index. Indices are unmanaged and do not have fees or expense charges which would lower returns. The investments recommended by Horizon Investments are not guaranteed. There can be economic times when all investments are unfavorable and depreciate in value. Clients may lose money. This commentary is based on public information that we consider reliable, but we do not represent that it is accurate or complete, and it should not be relied on as such. Opinions expressed herein are our opinions as of the date of this document. These opinions may not be reflected in all of our strategies. We do not intend to and will not endeavor to update the information discussed in this document. No part of this document may be (i) copied, photocopied, or duplicated in any form by any means or (ii) redistributed without Horizon’s prior written consent. Forward-looking statements cannot be guaranteed. Other disclosure information is available at www.horizoninvestments.com.

Horizon Investments and the Horizon H are registered trademarks of Horizon Investments, LLC

©2024 Horizon Investments LLC.

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