Abstract
Market-based value style equity portfolios do not systematically outperform market-based growth style equity portfolios, despite considerable academic research that suggests that they should. This is an unresolved puzzle in the long lineage of work on this topic. We ask whether portfolio constituency rules employed by active growth and value equity investment managers might explain this puzzle. We find that restrictive constituency rules that omit the smallest, most illiquid stocks improve the performance of both value and growth stock portfolios. However, we find the impact of constituency rule restrictions on portfolio returns to be asymmetric with respect to value and growth in the small-cap investment space. Growth portfolios benefit from these changes more than value portfolios. Consistent with prior research, we find that value and growth style portfolios constructed from more liquid equities to be void of a statistically significant value-minus-growth return premium. We suggest these results might go a long way in explaining why market-based growth fund returns generally equal those of their value fund counterparts over time.
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