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Value investing: dead or alive?

As a follow-up to our article on winning investment styles during the COVID-19 crisis, this piece explores why value as a style has fallen out of favour, and explores some circumstances that might engender a renaissance.

Growth continues to trounce value, and the fear of a deep recession resulting from the pandemic has only reinforced the belief that economic growth remains elusive and that, therefore, corporate earnings will be scarce. It is no coincidence that in recent weeks, several fund managers who invest with a value-driven approach have left the industry or changed firms. Those value managers who persist – and there are relatively few of them – face a daunting challenge given the longevity of underperformance from the value style.

Back to basics

The classic description of a value equity strategy would be “an investment strategy that involves picking stocks that appear to be trading below their intrinsic or book value”. To take that a step further – where a fund manager believes that the market is undervaluing either the assets or cash flows of a business.

For many decades, value and growth strategies competed for investors’ attention and the swings between them were dictated by the rhythm of the economic cycle and asset valuations. Typically, when economic growth was plentiful, value strategies would outperform, while in tougher times, growth stocks would dominate.

Within these two definitions, further distinctions can be made: defensive growth (e.g. consumer staples); secular growth (e.g. technology); defensive value (e.g. utilities); and, cyclical value (e.g. industrials). A manager’s approach to these different business types also influences the pattern of the outcome. However, it is also important to note that these definitions are fluid. Twenty years ago, banks were regarded as growth stocks but nowadays, they are more commonly held by value managers.

Why have value strategies been struggling?

Value strategies have been struggling since the global financial crisis.  Below we put forward some possible explanations for this extended trend:

  • Declining nominal GDP

The consistent decline in nominal GDP for the last twenty years has resulted in significant structural changes in the economic landscape. As baby boomers have moved into retirement, their desire to spend has waned but at the same time, the emerging markets are still geared up to sate the appetite of developed market consumers. As such, a challenging mix of reasonable (but not spectacular) demand growth with very limited pricing power means that GDP growth has been, in aggregate, sub-par and company earnings scarcer. As such, those with stable earnings profiles (consumer staples) are highly prized, as are the secular growth stocks (technology disrupters). Any business deemed to be highly economically sensitive is avoided by most investors. Anyone questioning this point might like to ponder why interest rates are at or close to zero in global developed markets…

  • The purpose of equity markets?

The equity market is no longer representative of the economy as a whole and we would argue that its main role is to provide a grand savings vehicle for retirees as the baby boomers move into older age. In other words, an increasing number of investors are motivated by the cashflow available from companies to fund their retirements, either directly or through their pension schemes. With this in mind, central bankers are acutely aware of the dangers of an asset price collapse, hence their strenuous efforts to keep valuations elevated.

  • ESG

Although ESG considerations are high on the investment agenda, we think that too little attention is being paid to the consequences of this trend on the growth/value dynamic. Specifically, the disinvestment of companies with lower ESG scores is clearly a factor in directing investment flow towards growth stocks, where the bulk of sustainable equities sit. Equally, carbon-intensive companies and the “sin” stocks are increasingly being shunned as they fail to pass muster.

  • Winners take all?

Growth companies are perceived to be disrupting every business, in every sector, and to have an unstoppable path to growth based on very high cashflows, no debt and dominant market share. We have heard more than one fund manager argue that Apple is now a utility-like company.

What are the possible catalysts for a value comeback?

  1. The most obvious reason for a value reversion is that the valuation disparity between growth and value stocks reaches an untenable level and snaps back, as it did in 2000. Many would argue that the likes of Facebook (on more than 8x price to sales!) are already pricing in a great deal of future good news and yet the technology-enabled winners continue to take market share and grow their earnings. The more cynical amongst us suspect that if their elevated valuations do not knock them from their perch, the regulators will.
  2. The ESG effect is very real and it may well be that the likes of tobacco and energy companies end up de-listing and moving into the private sector. It is worth noting that while many may welcome such a move, it would put a heavy dent into the dividend profile of the overall market.
  3. In our view, the most important consideration is the “Wall Street versus Main Street” debate. The blunt truth is that the targeting of asset prices has created wealth inequalities and we are approaching the point when nominal GDP targeting will become the order of day. Profits as a percentage of GDP have been in double digits for years and this has to change. If you doubt this point, see how companies are slowly integrating all stakeholders, including employees, into their strategic plans. Governments are equally keen to reflate the global economy. If Boris Johnson’s government is a proxy for the world, then everyone will be looking to “level up” their economies. Indeed, should Joe Biden win the US presential election, interesting times may well lie ahead…

Read more articles like this via our insights page

About the author

Peter launched The Adviser Centre in May 2014, whilst employed by City Financial He was co-founder of the original Forsyth-OBSR Ratings Service in 2002. He joined OBSR in 2008 and was responsible for establishing the firm’s fund advisory business as well as continuing to conduct manager research.

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