The Misclassification Risk in Growth ETFs: Why Value Characteristics Are Infiltrating Growth Strategies

The investment landscape has undergone a seismic shift in the past five years, driven by structural changes in ETF composition and evolving investor behavior. While growth ETFs have long been synonymous with high-flying tech stocks and speculative bets, a quiet but significant trend is reshaping their DNA: the infiltration of value characteristics. This phenomenon, fueled by market dynamics, regulatory innovations, and investor demand, is creating a misclassification risk that could distort risk-return profiles and mislead even seasoned investors.

Structural Shifts Redefining ETF Composition

The rise of active ETFs has been a cornerstone of this transformation. In 2024 alone, 934 new ETFs were launched in North America, with 78% adopting active strategies. These funds, which now account for 9% of total ETF assets under management (AUM) but 27% of inflows, are increasingly blending value-oriented elements into growth-focused portfolios. For instance, active fixed-income ETFs have tripled in inflows since 2022, while derivative-based strategies—such as buffer ETFs and income-generating products—are being repurposed to offer downside protection in growth portfolios.

Another pivotal shift is the integration of digital assets into traditional ETF frameworks. The 2024 launch of spot Bitcoin and Ethereum ETFs marked a watershed moment, with these products attracting $64 billion in inflows by year-end. These funds, while labeled as growth-oriented, often incorporate value characteristics through their exposure to high-yield, low-valuation digital assets. Similarly, multi-coin ETFs and in-kind trading mechanisms are blurring the lines between growth and value, as investors seek yield in a low-interest-rate environment.

The Eurozone Paradox: Value Outperformance Challenges U.S.-Centric Narratives

While U.S. investors have fixated on the "Magnificent 7" tech giants, the Eurozone has told a different story. The MSCI EMU Value Index has outperformed the core index by 0.4% annually over the past five years, with a 1.6% annual outperformance in the last three years. This divergence highlights a critical misperception: value investing is not inherently inferior to growth.

The Eurozone's balanced sector composition—only 12.7% exposure to IT, compared to over 30% in the U.S.—has allowed value stocks to thrive. For example, the MSCI EMU Value Index traded at a P/E of 9.8x in early 2025, 18% below its 10-year median, while the core index traded at a 50% premium. This valuation gap, exacerbated by energy price shocks and regulatory challenges, has created fertile ground for value strategies. The revival of the financials sector, particularly banks, further underscores this trend: the MSCI EMU Banks Index traded at a P/E of 6.0x in February 2024, a stark discount to U.S. peers.

Investor Misperceptions and the Risks of Misclassification

The structural shifts in ETF composition have led to a critical misalignment between fund labels and actual risk exposure. Morningstar's 2020 revision of its Low Carbon Designation (LCD) methodology serves as a cautionary tale. Prior to the update, funds with insufficient carbon metrics were misclassified as high-carbon, leading to a 0.51% monthly flow loss compared to LCD-designated funds. This error, though technical, had tangible financial consequences, as investors reacted to flawed ratings.

Similarly, growth ETFs with embedded value characteristics—such as those incorporating buffer ETFs or derivative income strategies—may mislead investors about their risk profiles. For example, a growth ETF with a 20% allocation to high-dividend, low-P/E stocks may exhibit lower volatility than its label suggests. Conversely, a value ETF with aggressive growth-oriented derivatives could carry hidden risks.

The Role of Active Management in Mitigating Misclassification

Active value strategies, such as the SSGA Eurozone Value Spotlight Strategy, have demonstrated the potential to outperform both core and value indices by diversifying sector exposure. These strategies mitigate the concentration risks inherent in value indices (e.g., the MSCI EMU Value Index's 37% weighting in financials) while capturing undervalued opportunities. For investors, this underscores the importance of scrutinizing fund holdings rather than relying solely on labels.

Investment Advice: Beyond Labels to Substance

To navigate the misclassification risk in growth ETFs, investors should:
1. Analyze Underlying Holdings: Scrutinize sector allocations, valuation metrics, and derivative exposure to assess true risk-return profiles.
2. Diversify Across Styles: Blend growth and value strategies to hedge against market cycles. For example, a 60/40 portfolio with a 20% allocation to active value ETFs could enhance resilience during growth corrections.
3. Leverage Active Management: Prioritize ETFs with transparent, rules-based strategies that adapt to shifting market conditions.

Conclusion

The infiltration of value characteristics into growth ETFs is not a flaw but a reflection of evolving investor needs and market realities. However, this convergence demands a more nuanced approach to fund selection. By understanding structural shifts, recognizing regional performance disparities, and prioritizing active management, investors can mitigate misclassification risks and build portfolios that align with their true risk tolerance and return objectives. In an era of rapid innovation, the labels on ETFs are no longer sufficient—what lies beneath is what truly matters.