Over the last decade, growth investing has outperformed value investing over almost all time periods, as measured by the MSCI World Growth versus World Value indices. However, the first two weeks of October have seen a reversal, with the price of many growth stocks, including in technology and healthcare, falling.
As the economic cycle appears to be turning, some advisers and wealth managers believe that this could be the start of a long-term resurgence for value stocks, while others take a more guarded view.
The value investing style, which involves looking for under-priced companies, has trailed the growth style for so long because the prevailing environment of monetary easing has suppressed bond yields, pushing income-hungry investors towards dividend paying growth stocks. Consequently, value funds have become so unloved that many have folded.
But there are signs that the picture is changing, particularly as central banks unwind their quantitative easing programmes and interest rates start rising again in the US and UK. This means bond yields are rising again, leading growth stocks to suffer as the relative appeal of their dividend stream weakens.
For example, the Federal Reserve’s quantitative tightening regime has pushed up the US 10-year Treasury yield to more than 3%. This makes it a more attractive alternative to growth stocks, particularly during a period of heightened stock market volatility. If the economic wheel is turning, companies that have worked hard to grow earnings could start to struggle and even have to adjust profit expectations, potentially leading to a steep price decline.
As one fund manager said recently – paraphrasing investment guru Warren Buffett –, you only see who has been wearing trunks once the tide goes out – and we might see a few bare bottoms over the coming weeks.
The hunt for value
Jonathan Jackson, head of equities, Patronus Partners, said value is important but warned that other forces such as market disruption might overshadow it. ‘We look to diversify portfolios and not rely on any one style,’ he said. ‘We buy good companies when they are reasonably priced; and that reinvest their profits to generate compounded returns over time.
‘Growth stocks have been pushed higher, in part, by low-interest rates and a strong global economy. Rising rates could therefore be positive for value stocks and negative for growth stocks. However, many growth companies have benefited from technological disruption at the expense of old-world companies.’
It’s true that many sectors continue to be shaken by disruptive business models, wrought by new entrants and those with technological advantage. But this presents an opportunity for good value managers to pick the right value stocks, selecting the companies they think will make a comeback.
‘Looking at some of the major European indices, it’s evident that growth stocks over the last decade have over-performed by close to 50 per cent, representing one of the longest periods of underperformance for value indexes,’ said Isaac Chebar, lead manager on the DNCA European Select Equity Fund1, ‘Yet, you only have to go back to the so-called ‘tronics’ in the 1960s – or the ‘Nifty Fifties’ in the 1970s – to see a similar moment in the cycle where a relatively small segment of popular large cap stocks have outperformed. People questioned the future of value investing back then too.
‘The prospect of central banks raising interest rates means people will simply have to be more discerning about the equities in which they invest. The bull-run won’t last forever. And, in such an environment, we believe that a cheaper fund – one with a low price to cashflow and a good dividend yield – will be additionally attractive to investors’.
Darren Lloyd Thomas, managing director at Thomas and Thomas, said: ‘In our higher risk level portfolios, we have carried the value style through the years even when it was unpopular. It is well worth hanging on to in the long term; and it has showed the odd glimmer of outperformance recently.
‘Growth stocks are getting decimated,’ he said. ‘People are falling out of love with large stocks such as Facebook, Amazon, Apple, Netflix, Google (FAANG). This could play into the hands of value. Value managers are an almost extinct breed. It is an art, which has been overlooked for years. But it will be harder to make money now. So we’re going to need these more savvy and diligent stock pickers, who are not just following the momentum.’
Thomas acknowledged that value investing has changed from the days when it was simply measured by price to book ratio. This is because much of a company’s value is now intangible and no longer on the balance sheet.
But he said that the remaining value managers in the market have developed an acute understanding of how value works in the modern economy and are ‘way ahead of the curve’.
Daniel Nicholas, client portfolio manager at Harris Associates, an affiliate of Natixis Investment Managers, said the current market is an opportunity for value investors because market volatility often leads stock prices to move more and quicker than business values do.
‘So when the rest of the market is worried about headlines and stock price moves, the gap to value opens,’ he said. ‘We put the blinders on. We focus on identifying businesses that have value and are steering towards continued growth and allocating capital wisely. If they are, that's an opportunity to act while others are fearful; and pick up those cheaper prices, leading to better prospective returns.’
1 DNCA Investments is an affiliate of Natixis Investment Managers.
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