This Equity Answer doesnt make sense

CFA Level III
#1

Q Bank Question

A recession is expected in an economy within the next year. Portfolio Manager A has shifted more of their stocks from the financial industry to the health care industry. Portfolio Manager B has shifted more of their stocks from the technology industry to the utility industry. Which of the following statements is most accurate regarding the performance of each manager?

A) Portfolio Manager A is expected to underperform the broad market while Portfolio Manager B is expected to outperform the broad market. B) Portfolio Manager A is expected to outperform the broad market and Portfolio Manager B is expected to outperform the broad market. C) Portfolio Manager A is expected to outperform the broad market while Portfolio Manager B is expected to underperform the broad market.

Your answer: C was incorrect. The correct answer was B) Portfolio Manager A is expected to outperform the broad market and Portfolio Manager B is expected to outperform the broad market.

Both managers are exhibiting style drift with both being beneficial to performance.

Value managers tend to have greater representation in the non-cyclical utility and cyclical financial industries whereas growth managers tend to have higher weights in the cyclical technology and non-cyclical health care industries.

Growth stocks are more likely to outperform during a recession as there are few other firms with growth prospects and a premium would be placed on growth stocks’ valuation.

Since the financial and technology industries are cyclical they will tend to under-perform during a recession whereas the healthcare and utility industries are non-cyclical and should outperform during a recession compared to cyclical stocks.

So everything I have read States

Value is utility and financial

Growth is Technology and healthcare

Growth outperforms in a recession.

I get that in the real world, technology and financial are cyclical and utiltiies and healthcare aren’t,

but everything I have seen in CFA land states technology is growth and utilities are value and growth is the recessionary play…

For example - from the sauce - “Value managers tend to have greater representation in the utility and financial industries…” and “Growth (i.e earnings focused) managers tend to have hither weights in the technology and healthcare industures”

anyone care to help cite where they are getting this answer from?

#2

Can’t help, i would have gone with the same answer you picked. I agree that it is absurd for the CFAI to have the balls to pretend they know what the hell they are talking about in terms of what outperforms in a bear market, but according to what I have read I agree with you that growth outperforms value in recession.

I have not seen an explicit statement that value outperforms the broad market, but through their logic I would think it would underperform (they make a big deal about earnings volatility being low on growth stocks which is why it outperforms in recessions, by the same logic value stocks would be higher than broad market volatility, so should underperform.)

In the real world, it is correct to say non-cyclicals would ouperform, but it seems they are mixing and matching the curriculum with the real world here.

I wonder how many of the people that design these texts are employed outside of academia.

#3

Agree, this absolutely sucks - http://www.analystforum.com/forums/cfa-forums/cfa-level-iii-forum/91310641

#4

the answer is obviously B because if you’ve ever managed money or lived on planet earth, you would understand that people do not defer medical spending or stop using electricity in a recession.

health care earnings holds up in a recession

utility earnings hold up in a recession.

they are largely non-discretionary, and therefore portfolios that overweight these areas will outperform.

#5

btw not all healthcare is “growth”. if you disaggregate healthcare spending, the vast majority of it is just inflation-plus indexed BS like doctors wages, basic supplies like blood tests, IVs, vaccine shots, etc.

the “growth” in healthcare is all new tech, drug discovery, etc. and that’s actually not the largest part of healthcare spending, although it is very sizeable.

#6

@ prophets…you are right, but nonetheless that isn’t “textbook” CFA. What I am trying to discern is why this answer diverges from the textbook.

#7

there are problems all over this curriculum. i could probably list a dozen right now. from the incorrect theory that information-based investors want tighter spreads (wrong, they want wide spreads) to the nonsense that it’s bad to engage in mental accounting as an individual investor but OK to do it as an institutional investor (like a life insurance co. that is segmenting liabilities by product type).

this part probably doesn’t conflict though because health care has historically grown at CPI plus rates (ie. growther than average) and it is still recession resistant. you can still be a growth product and recession resistant. I would argue that internet advertising and internet traffic is probably a perfect example.

#8

You’re overthinking it, but yes, you are right that the curriculum is not entirely consistent here.

#9

this is a Schweser question - throw it in the garbage and erase it froom your memory

QBank is rubbish!

#10

Prophets, the answer is NOT clearly B, so sorry. As all of us mentioned, in the REAL world, yes, B makes sense. But for that matter growth stocks outperforming value stocks during recession is a bullshit blanket statement too.

Given that we know this entire section is bogus, we have to stick with what the CFA tools tell us to… which would mean regardless of cyclicality, growth beats value in recession.

#11

This infamous question also shows in the concept checker of Schweser online class…It got the same answer but different explanation. Horrible question to waste our energy.

#12

Hey, I have gotta 2011 version of question bank it says the answer is C (in line with in texts). Here its goes

A recession is expected in an economy within the next year. Portfolio Manager A has shifted more of their stocks from the financial industry to the health care industry. Portfolio Manager B has shifted more of their stocks from the technology industry to the utility industry. Which of the following statements is most accurate regarding the performance of each manager?

A) Portfolio Manager A is expected to underperform the broad market while Portfolio Manager B is expected to outperform the broad market. B) Portfolio Manager A is expected to outperform the broad market and Portfolio Manager B is expected to outperform the broad market. C) Portfolio Manager A is expected to outperform the broad market while Portfolio Manager B is expected to underperform the broad market.

Click for Answer and Explanation

Both managers are exhibiting style drift. Manager A’s drift is actually beneficial to performance while B’s is not. Value managers tend to have greater representation in the utility and financial industries whereas growth managers tend to have higher weights in the technology and health care industries. Growth stocks are more likely to outperform during a recession as there are few other firms with growth prospects and a premium would be placed on growth stocks’ valuation.

#13

this is actually contrary to academic research. growth stocks get killed in a recession because they are often newer technologies that do not get approved for spending during periods of economic duress (no company going through a cost cutting/recessionary period is spending huge sums of money on barely proven, new technology). companies only spend money on what they have to spend on, not newer technologies and speculative growth additions.

the reason why food stocks, healthcare, and utilities outperform is because they are non-discretionary.

if CFAI is telling people that growth outperforms during a recession, they are sorely mistaken. because it’s factually not true.

#14

ID#:92355

Corrected in 2012.

#15

^ funny, they corrected it & made it more controversial ^~0

#16

Prophets, could you list some resources for the academic research? I’m trying to find examples and so far have come up with mixed conclusions. for instance: the two largest downturns in american history (1932 and 2007) were both concentrated around the financial sectors (a value sector), while the 2001 downturn was more technological (a growth sector).

I have seen this type of question before with similar reasoning. I realized that I had made a link between growth stocks and cyclical stocks, even though there is not necessarily a correlation. There are some cyclical industry’s that are considered growth and some that are considered value. I think you have to look at this question in terms of which industry’s are more cyclical, and not necessarily which are “growth” and which are “value”

They do make the statement that growth outperforms value in recessions, but with conflicting evidence it’s hard to say either way which stocks would outperform, but the CFAI is pretty conclusive in their statement. With as many financial professionals that use these materials I find it hard to believe they would have something so blatently wrong. Do you have evidence that it is actually “factually not true”?

#17

i’ll try to dig something up. i don’t have the same resources since i left my job.

I think to some extent, you are thinking about this wrong.

finance also has growth parts to the industry. industries are rarely just pure value or pure growth. i would argue the hedge fund, international consumer credit segments of the finance industry have been very growthy over the last 20 years.

I think you need to look at it on a cyclical vs. non-cyclical basis. and separately on what types of companies grow faster than GDP or slower than GDP.

I think the way they might get to the point that growth outperforms value in a recession would be in the tail end of a recession, growth stocks start to move, commodities start to move, because the assets are anticipating a recovery. but going INTO a recession, it’s simply not the case. non-discretionary will outperform (whether its growth is higher htan gdp or not).

there are some studies out there about earnings certainty and how companies with higher earnings certainty are awarded higher P/E ratios. Well, if you think about the earnings uncertainty with some companies into a recession vs. companies that are non-discretionary (food, grocery stores, etc.), the change in the p/e ratio is non-uniform across industries – ontop of any earnings change.

#18

amazing. i boot up Qbank for the first time ever to start working questions.

first test, first question and this is the one that pops up out of 2600 possible.

#19

^ lol