Value funds kaput? Don’t rule out a recovery

Everyday communication and work patterns have been transformed

Few trends have been more marked in the recent market mayhem than the swing towards high growth internet stocks. Parallel to this has been the slump in traditional “defensive” value shares and funds. It has come to resemble the long withdrawing roar of an ebb- tide, dragging all the “value” pebbles down the beach. Some investment managers believe this tide to be irreversible.

Value shares are defined as those that trade at a lower price relative to their fundamentals, such as dividends, earnings or sales. For millions of investors they had great appeal, playing on our defensive bias towards companies on apparently modest ratings, with the prospect of higher than average dividend income and the likelihood of capital growth over time.

Common characteristics were a relatively high dividend yield and a low price-earnings multiple. That they were seen as dull or unfashionable compared with the Fang high-fliers (Facebook, Amazon, Netflix and Google) only added to their appeal: as their products and services were often the basic staple requirements of everyday life they would suffer less in any market “correction”.

But this “carpet slippers” style of investing was on the wane long before coronavirus struck. Ever-changing economic dynamics brought advances in digital technology, the huge expansion of cloud computing and the internet. The relentless rise in online shopping was one of the most visible symptoms. But everyday communication and work patterns have also been transformed.

Covid-19 did not instigate the giddy valuations on digital stocks, but gave them a further upward push. Fast-growing tech giants looked immune to the lockdown – the draconian curb on physical proximity and face-to-face communication. Today the market capitalisation of Microsoft is not far off that of the entire FTSE 100.

Little wonder a word of warning is sounded by Edward Troughton, partner at Oldfield Partners. Speaking last week to Anthony Luzio, editor of Trustnet magazine, he reminded us that “this time it’s different” are four of the most dangerous words in investment.

Tech giants are priced for endless growth – a concern echoed by James Klempster, director of investment management at MGIM. “Some of the valuations are in P/E multiples of hundreds”, he notes, “and to justify that you’ve got to see either a massive increase in revenue or some kind of massive increase in the ability to translate that revenue into profit.”

There is an assumption here of exponential growth. But Troughton asks investors to consider this: how differently would this have worked out if the virus had been technological rather than human?

Tech companies may be in the ascendant now. But “the time will come when people will return to pubs, cafes, theatres and they will hold weddings again. People will desperately wish to travel and catch some much-needed sun, relax and forget about the current nightmare.

“And, much more mundanely, they will buy homes, catch a train and drive cars, driving up the consumption of oil and use of financial services in the process. In short, there is a time coming when the pent-up demand will be released and stocks that have often been priced as if they were being driven to extinction will perform. And good, solid companies with the best chance of surviving these tough times are long-term winners that will not only survive but also, with patience, perform exceptionally. There has, arguably, never been a better time to invest in these types of companies.”

Meanwhile there are billowing financial hazards on the horizon that command attention from investors. Among the most radical is the possible resort to negative real interest rates – a development that would upend traditional approaches to pension fund investing. While this still looks unlikely in the immediate term, there could be a resort to a regime of dual interest rates – increase rates on savings but push key lending rates into negative territory. Perpetual loans might also make an appearance.

Investment guru David Stevenson has listed nine “nutty policies” for investors to beware. Among these are a speed-up of the abolition of cash on public health grounds.

Now would seem the worst possible time to impose higher income taxes given the blow this would deal to a household spending revival. But the clamour to hit those higher incomes and capacious pension pots will intensify. Among possible “solutions” to attack the debt overhang, Stephenson predicts, would be a special one-off limited time duration (two-year) special income tax surcharge of 5p on all higher rate taxpayers.

Prepare to say goodbye to higher rate pensions relief and Aim-related reliefs. But prepare for the arrival of a tax on the wealthy (more than £1 million in liquid assets). It might even take the form of a pensions surcharge of, say, 10 per cent (one-off ) for those with savings pots of over £1 million.

And do not rule out the attempt to establish a universal basic income. Sheer practicalities work against the concept, says Stephenson, rating it as only a 15 per cent possibility. But since when have concerns over practicality dented the urge to experiment?