FINALLY we are seeing tentative signs of a recovery in ‘value’ investing. This recovery has been a long time coming – almost a decade, to be precise. But we believe now is the time for investors to consider increasing their allocations to ‘value’ funds.
Buying good businesses at attractive prices and not overpaying for illusory growth appears a sensible approach in anyone’s book. It has worked well for over 100 years. However, it has not delivered over the past 10 years now and many investors have given up on the strategy.
The sustained outperformance of, in our view, fully valued quality and growth stocks such as the famous FAANG (Facebook, Amazon, Apple, Netflix and Amazon) stocks has gone on for much longer than most economists expected.While we have some sympathy that investors will value defensive and growth attributes when economic growth is declining, the divergence is nevertheless extraordinary.
What we have found surprising is that value stocks, until recently, have continued to underperform during the recent market collapse, despite having materially underperformed in recent years. There would appear to be no market conditions in which value outperforms!
Value managers are losing assets, mandates and their jobs. The consensus view is that the increasing importance of ESG (environmental, social and governance) will only exacerbate this trend.
Over time, and because of the long-term continued outperformance of growth and investor style drift, there are now very few truly value-orientated portfolios in the global segment.
The other notable feature of equity markets has been the absence of any discussion on valuation when assessing many businesses that are covered in the quality or growth segments. It seems a strange approach to ignore the price you pay, when considering an investment.
Similarly, if there is an attractive price to buy a share, there must also surely be a price when it is overvalued and should be sold. It seems as if the industry has forgotten, or more likely, conveniently ignored any sell process to allow managers to retain shares, when they intuitively know they are expensive: but there is safety in numbers.
The current underperformance of value is now so extreme that on May 15, growth’s outperformance of value hit an all-time high. We believe that this disparity is now simply too big for investors to ignore and note the significant improvement in value performance since then.
So what could be the catalyst for this trend to reverse?
The sharp and severe recession caused by the impact of Covid-19 may provide the stimulus for a long-awaited change in market leadership. Value usually outperforms post recessions.
A combination of the steepest recession on record with unprecedented monetary and fiscal support should help the recovery and increase investors willingness to rotate into value stocks.
Bear markets end with recessions, they do not begin with them!
In addition, many investors own the same, expensive shares, which are proving in many cases to be no less cyclical than other lowly rated sectors.
Buying global leading businesses that have the potential to grow over the long-term but being disciplined in the price that at which one buys and sells – a “pragmatic” value style - has clearly been out of favour (particularly over the last couple of years) given the markets disregard for valuation metrics. However, it is vital to avoid style drift and adhere to one’s investment process. Our fund has never had a greater value bias and our process has not changed.
The global economy will eventually recover. There is no reason to believe this time will be different. The combination of the steepest recession on record with unprecedented monetary and fiscal support should boost economic activity. This is usually a positive scenario for ‘value’ investors.
Signs are recovery are tentative but more and more investment managers appear to be considering the possibility and beginning to blend their portfolios to ensure they capture some of the potential recovery.
Their efforts may soon be rewarded. Value has begun to perform in recent weeks. We firmly believe that this is the (long-overdue) beginning of a more sustainable trend, as earnings and valuations once again take centre stage.
Graham Campbell is the co-manager of TB Saracen Global Income & Growth Fund
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