Revisiting the value question

15 November 2019

By John Husselbee, Co-Fund Manager HC Verbatim Portfolio Growth Funds

Long-term followers of our portfolios – and readers of these articles – may remember we wrote last year that after a long period in the doldrums, it was time to consider re-boarding the value train.

We noted several encouraging signals at the time, including the huge disparity in valuations between value and growth stocks and potential overheating in many of the FAANG names (Facebook, Amazon, Apple, Netflix and Google). For balance, we also highlighted previous several false dawns in value and more than a year removed from writing the piece, it looks as though early 2018 may have been another in a long line of these.

A further spell of depressed returns from value has led to a fresh bout of commentators asking whether this style of investing is “broken”. Meanwhile, investment firm Sanditon was recently forced to sell two funds to a rival, expressing frustration so few investors across the market seem to have the appetite to buy into the value concept.

Simultaneously however, we also saw biggest one-day gain in value stocks in more than a decade in September, sparking renewed questions around whether this latest reversal could have legs.

So where are we in reality? History can always prove instructive to a certain extent and without getting too tied up in charts, the most recent point where value became so out of favour was during the tech bubble of the late 1990s. In a recent article, renowned value investor Alastair Mundy from Investec draws several comparisons between now and 1999, primarily a growing valuation dislocation between recession-indicating value stocks and growth names perceived as completely immune to any slowdown.

Mundy says that while he can give no indication of when the trend will reverse, the fact that value naysayers are at peak confidence once again and the misery of value investors is back in 1999 levels are both encouraging signs: “markets have a dreadful habit of marking the consensus look stupid at the point of peak comfort,” he adds.

Market watchers will remember just how quickly growth/value dynamics flipped in the wake of the burst technology bubble – albeit for a relatively short spell before moving back towards median levels.

We live in unprecedented times however, with years of quantitative easing and ultra-low interest rates clearly distorting markets, so would caution against predicting a similar turn this time around. But as our Macro Thematic and European income teams at Liontrust have stressed in recent months, value – at least in the UK and European markets – is currently cheap, under-owned and outperforming on an earnings level so there are encouraging signs.

Taking a step back, and looking beyond questions about return prospects, we also would continue to highlight the diversification benefits of value exposure – just as we do when anyone queries the worth of bonds in a multi-asset portfolio, for example, with their shaky prospects at present.

There are also problems that come with seeing ‘value’ in macrocosm: yes, the style overall has underperformed and our tilt towards it has not paid off in performance terms so far but we have selected value managers we trust to beat the market over the long term.

It should be recognised how reductive the value and growth terms can be, with ‘value’ investing developing considerably over the last few decades: this is no longer about buying plodding fixed asset behemoths in slow-moving sectors.

Ultimately, ‘value’ is simply about trying to buy companies at a cheaper price than they are worth – and the majority of investors are looking to do that. However excited people get about the disruptive power of technology, that ultimate goal will never be obsolete although value investors may need to seek out stocks in different parts of the market than they have in the past.

Looking forward, if this current bull run carries on, we feel investors wanting to participate may increasingly look towards the cheaper end of the market that has underperformed, offering both upside potential and downside protection. From another perspective, recent research from Barclays suggests that crowded positioning, extreme valuations and earnings cyclicality make growth stocks more vulnerable to a downturn, noting that value outperformed in the panic of Q4 2018 while the overall market and cyclicals fell sharply.

Either way, over the decades, value has tended to outperform during recovery periods and lag during slowdowns due to the capital-intensive nature of many value-oriented companies. Data from BlackRock highlights that while value can go through lengthy periods of underperformance, there is no reason to surmise the long-term premium is gone.

Figures on the US market stretching back to the 1920s shows that while the percentage of positive value premium has been only 50% when looking at daily data, this increases as the periods observed increase in length. Over rolling 20-year periods, the value premium has consistently been positive, highlighting the potential benefit of sticking with styles for the long-run as part of a diversified portfolio.

For our part, we continue to believe we can blend different styles to produce better returns than the index over the long term.

 

The value of investments and any income from them can go down as well as up and is not guaranteed. Your clients could get back less than they originally invested. Past performance is not a guide to future performance. The portfolios' investments are subject to normal fluctuations and other risks inherent when investing in securities. Verbatim Asset Management has taken due care and attention in preparing this document, which is solely for the use of professional advisers. Verbatim cannot be held responsible for any inaccuracies arising out of information detailed within and will not accept liability for any loss arising out of or in connection with its use. This article is for information only and should not be deemed as advice.