Equity
exposure
can
be
broadly
segmented
by
market
capitalisation
(small,
mid,
and
large)
and
style
(value
versus
growth),
as
represented
by
the

Morningstar
Style
Box
.

Correlations
within
equity
groups
tend
to
be
fairly
high,
although
small-cap
stocks
tend
to
have
the
lowest
correlations
with
the
broad
market.
In
our
recently
published 2023
Diversification
Landscape
Report
,
however,
we
found
there
can
be
significant
benefits
to
diversifying
a
portfolio
by
investment
style.

Recent
Performance
Trends

The
nine
boxes
included
in
the
style
box
go
from
the
relative
extremes
of
large-cap
growth
to
small-cap
value.
The
divergence
between
these
two
portions
of
the
style
box
shows
the
long-running
gap
in
returns
between
value
and
growth
stocks
on
the
one
hand
and
large-
and
small-cap
stocks
on
the
other.
For
many
years,
the
dominant
story
line
was
simple:
the
larger
and
growthier
the
style,
the
better.
That
narrative
held
true
nearly
every
year
starting
in
2009,
as
the
market
recovered
in
the
wake
of
the
2008
bear
market.

Some
of
these
long-running
performance
trends
have
shown
signs
of
reversal,
though.
Amid
surging
inflation,
central
banks
repeatedly
hiked
interest
rates
during
2022,
sending
North
American
stocks
into
a
bear
market
that
continued
throughout
most
of
the
year. 

As
higher
interest
rates
prompted
investors
to
mark
down
previously
high-flying
technology
stocks
and
other
growth-oriented
issues,
the
Morningstar
US
Growth
Index
suffered
a
36.4%
loss.
Value
stocks,
meanwhile,
survived
the
year
relatively
unscathed.
The
Morningstar
US
Value
Index
finished
the
year
just
barely
in
the
red,
losing
0.7%.

This
relatively
resilient
showing
followed
on
the
heels
of
a
strong
value
rebound
in
2021.
Value
stocks –
particularly
in
sectors
such
as
energy,
financials,
and
real
estate –
benefited
from
the
strong
economic
recovery
after
falling
behind
their
growth
counterparts
in
2020
and
previous
years.

A matrix showing three-year correlation coefficients for the Morningstar US Market index and nine Morningstar Style Box indexes.

The
large-versus-small
narrative
also
shifted
a
bit
during
2022.
After
dominating
the
market
for
several
years
running,
the
market’s
biggest
stocks
were
trading
at
steep
valuations
at
the
beginning
of
the
year,
giving
them
more
room
to
fall
as
valuations
dropped.
As
a
result,
the
Morningstar
US
Large
Cap
Index
fell
behind
the
broader
Morningstar
US
Market
Index
for
the
first
time
in
six
years.

Style
box
performance
in
2022
also
marked
a
dramatic
shift
from
performance
trends
during
the
pandemic-driven
bear
market
in
2020.
As
Covid-19
kicked
off
a
fast
and
severe
bear
market
in
the
first
quarter
of
2020,
the
Morningstar
US
Large
Growth
Index
fared
best
in
relative
terms,
dropping
30.9%
during
the
downturn
from
19
February
through
23
March.

This
was
about
17
percentage
points
better
than
the
Morningstar
US
Small
Value
Index’s
47.7%
drop
over
the
same
period.
Large-growth
stocks
also
bounced
back
much
better
than
their
value
counterparts
as
the
market
recovered
later
in
the
year.

The
take-home
point
is
that
a
high-correlation
coefficient
doesn’t
translate
into
similar
returns;
correlation
measures
only
the
direction,
not
the
magnitude,
of
returns.
Indeed,
most
of
the
nine
boxes
have
had
high
correlations
with
the
broader
equity
market
over
the
past
three
years,
as
shown
in
the
exhibit
above.
The
Morningstar
US
Large
Core
Index
had
the
highest
correlation
coefficient
(0.98)
with
the
broader
equity
market,
while
the
Morningstar
US
Small
Value
Index
was
the
lowest
at
0.87.

While
all
nine
boxes
showed
close
correlations
with
the
Morningstar
US
Market
Index,
correlations
between
individual
style
boxes
were
sometimes
much
lower.
Over
the
trailing
three-year
period
ended
in
December
2022,
the
Morningstar
US
Mid
Value
and
Morningstar
US
Small
Value
indexes
had
correlation
coefficients
of
just
0.64
and
0.66,
respectively,
with
the
Morningstar
US
Large
Growth
Index.
The
Morningstar
US
Large
Value
Index
also
had
a
relatively
low
correlation
of
just
0.67
with
its
large-growth
counterpart
over
the
trailing
three-year
period.

Longer-Term
Trends

Since
2000,
correllations
for
the
nine
style
box
indexes
have
trended
higher
overall,
suggesting
that
style-based
diversification
is
becoming
more
difficult.
However,
there
have
been
some
notable
divergences
over
time.

For
example,
small-cap
stocks
decoupled
from
the
Morningstar
US
Market
Index
to
the
greatest
degree
between
2015
and
2018.
From
October
2015
through
September
2018,
the
correlation
coefficient
for
the
Morningstar
US
Small
Value
Index
fell
to
0.78,
and
the
same
metric
decreased
to
0.82
for
the
Morningstar
US
Small
Growth
Index.

A line graph showing rolling three-year correlations for four Morningstar Style Box indexes from 2000 through 2022.


These
results
reinforce
the
importance
of
broad
diversification.
While
all
nine
style
boxes
have
had
relatively
high
correlations
with
the
Morningstar
US
Market
Index,
they
have
often
shown
marked
divergence
in
returns
across
the
group.
Until
recently,
for
example,
investors
would
have
paid
a
high
price –
during
both
rallies
and
down
markets –
for
overweighting
value
at
the
expense
of
growth.


But
the
huge
performance
differential
between
value
and
growth
during
the
2022
bear
market
is
a
testament
to
the
value
of
style-based
diversification.
Because
it’s
impossible
to
predict
which
style
will
fare
best
in
any
particular
market,
it’s
prudent
to
maintain
a
diversified
portfolio
and
avoid
overweighting
either
value
or
growth.

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