WillisTowersWatson AssetManagersReview
2 Classic “value” investing seems to have lost its shine - will it re-emerge? Or has it morphed into something more suited to current investment conditions? Hannes van den Berg, portfolio manager at INVESTEC ASSET MANAGEMENT
says classic value investors globally have been having a tough time for a long time, since Q4 2009. The long but tepid global economic upturn since then has meant that equity markets have been trending upwards for nearly a decade. This has not been a fertile backdrop for classic value managers, who usually rely on a good old-fashioned bear market once in a while for some bear-capture outperformance.
Value managers have almost had to be flexible in their approach merely to survive in business for this long. Furthermore, the asset light tech revolution has required some soul searching for traditional value managers, as has the efficacy of a value methodology within the resources sector. But value will be back, as soon as the markets properly fear the next global economic recession. Duncan Artus, portfolio manager at ALLAN GRAY says there are various definitions of what value investing really is and many investors will have different views. It is correct that the winners in global markets have been growth stocks that have benefited from momentum - the significant trend towards passives and ETFs (especially in the US) and historically aggressive monetary policy.
Many of the largest stocks in the world are now technology shares, which are significantly disrupting existing business models.
“In our view, applying a simple, low, price earnings or book multiple filter is not the correct approach. We spend a lot of time trying to understand businesses and how they are or are not compounding their intrinsic value, and then determine a fair price to pay.
“That being said, we are very aware that many of the trends over the last number of years have been in favour of growth and momentum investing. This could change quickly as the outperformance by mining shares this year has proven,” says Artus. StJohn Bunkell, head of equities at PRESCIENT INVESTMENT MANAGEMENT
says it is unlikely that the broad value investment strategy will ever fall away as there will always be the opportunity for managers to invest in assets that will mean revert from a price perspective - and offer opportunities for alpha generation.
The inclusion of quality over and above a pure value play has become standard for many managers.
It is likely, however, that the inclusion of top-down macro-economic risk frameworks and potentially momentum driven behavioural strategies will also find their way into managers’ strategies. It makes sense that if these processes add alpha that they should be included. Managers doggedly holding onto value as the only strategy that generates an advantage may get left behind.
Ability to add additional excess return in the balanced fund space by additionally using tactical asset allocation methodology often relates more to macro-economic, top down factors and how this impacts the components of balanced funds rather than whether these offer value. David Cook, co-head of the Old Mutual Titan boutique at OLD MUTUAL INVESTMENT GROUP
says different styles work in different markets, and the recent success of one style means that it is less likely to work in the next period. This is because the more people that practice a specific style arbitrate away its advantages. After the dotcom and property bubbles ‘traditional value’ had definitely reemerged as the most successful style, and it is therefore not surprising that value has done less well in the past eight years than it had done before that.
“I believe a further reason that value isn’t currently working is the increasing level of disruption faced by all industries. Because value entails buying assets while they are facing challenging times, greater disruption means that it is increasingly the case that the challenging times facing the company are permanent rather than temporary, and value managers who buy cheap assets without giving proper regard for business fundamentals have found themselves holding many value traps,” says Cook.
“Value will re-emerge because fewer managers are practicing it, increasing the style’s chances of future success. And just as Benjamin Graham’s style was morphed by Warren Buffett and others, so too will today’s current style of value investing evolve into something slightly different, but still have discount to intrinsic value as its core feature,” he adds. Neville Chester, senior portfolio manager at CORONATION FUND MANAGERS says in South Africa, we have always taken the view that the market is too small to pursue a traditional value investing approach, so our comments apply to global markets. Over the last few years, the market’s breadth has been very narrow, in that a few mega caps have driven the returns of a few big markets - the so called FAANG stocks being a great example. These stocks have shown good earnings momentum, and on the back of this have attracted outsize interest and flows of funds, driving their ratings up to very high levels. This is all part of the classic Growth vs Value cycle. Ultimately a point is reached where the growth disappoints (as recently evidenced by the stunning collapse of the Facebook share price). Calling the duration and amplitude of these cycles is never easy. Many famous and well-known value investors threw in the towel just before the Dotcom bubble burst in 2000 and value bounced back. Brian Thomas, retail analyst and co-portfolio manager at LAURIUM CAPITAL
says in his view the market is cyclical; there will be times where value investing succeeds and times where growth investing succeeds. Growth is most successful in times where the bull is running, and value where the bear rules.
“We are coming towards the end of the longest bull run in US Equities that the world has ever seen. It is thus not a surprise that value investing has struggled over the last decade. Value investing will have its turn as the big wheel that is the market turns.” Nick Curtin, institutional investor relationship manager at FOORD ASSET MANAGEMENT says the company has always eschewed traditional style classifications and definitions, which serve little purpose except to aid industry agents to frame their advice. Philosophically, valuation is core to all active investing.
There are myriad ways to define and compute what is meant by value and in our view these parameters can and should change (the word “morph” has an unfounded, negative connotation). As such, value must be the bedrock of any active investment management process, as it always has been.
The fact that this question is being asked is, for us, a clear indicator of the late stage of this bull market cycle. It is a typical behavioural failing – to capitulate just before the cycle turns. Asief Mohamed, chief investment officer, at AEON INVESTMENT MANAGEMENT
says value cycles may re-emerge, but one does not know the timing thereof. Professor Philip Tetlock’s research indicates that the expert’s predictions are as good as a random guess. One should maybe also question whether categorization of value and growth style today is valid and applicable in a narrow investable universe of about 100 shares compared to ten years ago with an investable universe of about 300 shares. Charles Booth, chairman of investment committee and portfolio manager at TRUFFLE ASSET MANAGEMENT says it is true that value stocks have underperformed since the 2008 global financial crisis notwithstanding solid economic growth that is normally fertile ground for value. During the last decade value stocks have faced the headwinds of firstly the emergence of huge new age companies that have performed exceptionally well. Think Amazon, Google, Apple, Facebook etc. The sheer size of these companies and their outstand- ing share price performance has made it difficult to beat broad indices.
Secondly, hindsight reveals that value sectors such as energy may have been in a bubble in 2008, given that the oil price was north of $100/ bbl at that time. As values have normalised, energy stocks, an important component of value, have underperformed.
Thirdly, structural changes in consumer behaviour could result in a permanent diminution of value in some other non-energy sectors. Think property given the growth in e-commerce.
“In our view value as a strategy is not dead and will reemerge as valuations revert to the mean and the exceptional share price advance of the new age stocks reach exhaustion. However, there is a real risk of value traps distorting the allure of true value,” says Booth. Tony Bell, chief investment officer at VUNANI FUND MANAGERS
says value investing needs to be set in the context of its “value” proposition. Value investing does not necessarily mean that the opportunity must be assessed as being “cheap” but rather that the present value of future returns present a value opportunity because of the fact that some aspect of the company will deliver growth in some form or another. Value investing in the classical sense has not lost its shine it has merely morphed into a different form – namely the identification of value opportunities within a rapidly changing commercial environment. Benjamin Graham is as relevant today as when he penned his masterpiece in 1942. Mohamed Mayet, CEO of SENTIO CAPITAL MANAGEMENT says he has an issue with the narrow definitions of value, growth and other styles for two reasons. Firstly many overlap and tend to obstruct the actual investment objective of the manager, which should be more comprehensive than a mere semantic definition. Secondly, we are living in possibly the most dynamic period in living history from an economic and investment perspective. This evolutionary perspective requires constant evaluation of the environment and the investment perspective.
“We don’t believe that putting manager skills into boxes is necessarily going to be reflective of how managers will perform in the future. We don’t believe that ‘classic value investing’ necessarily disappears or reappears, we think that it will look different to what investors were used to.
“We believe that managing an optimal portfolio is about buying the cheapest risk-adjusted assets and selling mispriced expensive assets. You can call that value, growth or quality, it matters more whether the returns are achieved through a consistent process,” says Mayet. Shaun le Roux, fund manager at PSG ASSET MANAGEMENT
says value investing has come to describe a very wide range of investing styles, with highly differing ways of determining what constitutes value. The decade-plus global under-performance of traditional value factors (such as low price to earnings and low price to book ratios) has seen a material shift within active managers towards new age appraisals of value that are more focused on long-term growth assumptions.
“When we consider this in conjunction with the growth in allocations to passive and momentum strategies, we believe the long-term prospects for price-sensitive active management, including classic value investing, are good. We point out that the price divergence between expensive and cheap within global equity markets is extraordinarily wide, at levels last seen in the dotcom era. We think this bodes well for contrarian investing and the returns that can be derived from carefully selected cheap stocks,” says Le Roux. Navin Lala, business development: fund management at ASHBURTON INVESTMENTS
says similar to economic cycles, investment style’s go through cycles where some strategies may be rewarded while others are underperforming. The current cycle has been better suited to high beta and momentum stocks and less so to “value” strategies.
The current, post-crisis bull run, having delivered 302% on the S&P 500 (16.7% annualised return as at June 2018) is arguably in its late cycle, with increasing risks of tapering out leading to an environment that is better suited to “value” investors compared to the current environment.
Razeen Dinath, head of equity research at WARWICK ASSET MANAGEMENT says it is extremely hard for managers who follow an investment style that has been out of favour for almost 10 years to stick to the strategy; hence, style drift becomes an issue.
“We believe that classic ‘value’ investing is not a low PE or low PB strategy. Classic ‘value’ investing is an evaluation of the business’s earnings power, the sustainability of the earnings power and hence the fair price to pay for the business.
“Classic ‘value’ investing does not factor in high growth expect- ations in the business valuation, whereas a lot of managers now justify holding tech stocks based on an assessment of 20% plus growth prospects for many years to come.
“This assumption increases the riskiness of the investment, which is why we generally steer clear of these types of investments. Being conservative in valuation assumptions is an added source of ‘margin of safety’ and we would rather miss some opportunities than invest clients’ capital inappropriately,” says Dinath.