Does 'value' investing still matter?

Value investing has had a tough time – but it shouldn’t be ignored altogether.

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  1. Rob Morgan

Value investing – aiming to buy shares that are cheap in relation to their earnings or assets – has been a poor strategy for most of the past decade. Although it makes sense to buy into companies below ‘fair value’, the performance of funds adopting this approach has been underwhelming.

That’s partly because the make-up of the value ‘universe’ in various geographies has included some challenged areas such as tobacco, where increased regulation and a move to e-cigarettes have clouded the outlook for sales, and oil & gas and mining where the price of commodities has been weak. Meanwhile, many growth funds have been buoyed by the inexorable rise of the technology giants such as Amazon and Google. In addition, low bond yields have made low but very resilient growth companies in areas such as consumer goods look especially appealing.

Yet with the valuation of growth stocks versus value now at historical highs maybe everything has a price? Could now be an opportunity to buy in to unloved areas for a long-awaited rebound?

That could be a higher risk strategy. Much of the uncertainty relating to value stocks hasn’t gone away. Indeed, in many cases it’s been accentuated by the disruption caused by the spread of COVID-19. Energy and commodities have been hit by the slowdown in global growth, and many traditional retail, travel and leisure businesses have seen their earnings decimated. Meanwhile, many of the areas in the growth camp, such as technology, consumer staples and healthcare, have comparatively brighter prospects as a result of the virus. Businesses in these areas have generally seen less drop off in demand, and some are even seeing some benefit from the enforced measures of staying at, and working from, home.

What’s more, the longer the crisis goes on the more solvency becomes an issue. Some companies in the eye of the storm could simply run out of cash – meaning they either go bust or need to raise fresh capital, thereby diluting the value of shares for existing holders. That means potentially more ‘value traps’ for the unwary. A value trap is an investment that appears on first inspection to be cheap but ultimately represents a fundamentally impaired business whose prospects are destined to deteriorate further. They are an investor’s worst nightmare: a fool’s gold whose value is illusory.

Value investing involves negotiating an investment universe littered with value traps, notably companies whose business models are at risk of disruption (and thus significant earnings decline), have a shaky balance sheet through too much debt or, in the worst cases, a combination of the two. These are the enterprises most at risk.

We must acknowledge that backing value investments usually means some exposure to higher risk business models, and, more often than not, it means being highly geared to the wider economic picture – for better or for worse. Yet picking the right businesses is likely to be fruitful. Good value companies that not only survive but go onto thrive, contrary to popular expectation, could make excellent investments over the longer term. Value investing is going to remain challenging but it’s not dead.

Value investing options

We don’t know whether growth will continue to outperform from this point or whether value will have a renaissance. We would suggest, however, that investors have a spread of investments and do not position their portfolio too far in one direction. Many investors will already be aligned to growth through large, popular funds such as those from Fundsmith and Lindsell Train.

Here are two options of funds that have a value mentality at their core, which could help diversify a portfolio dominated by growth areas. They also have experienced managers at the helm that focus on potential downside, which could help them avoid the value traps in the market.

GLG Undervalued Assets

Henry Dixon, manager of the GLG Undervalued Assets Fund, believes conventional equity valuation principles often place too much emphasis on forecasted future earnings.  Instead, by focusing more on the current shape of the balance sheet he targets companies whose share prices do not fully reflect their ‘intrinsic’ value.

He searches for two types of company: those trading below the analysis of their “replacement cost”, and those whose profit streams he considers are undervalued by the market. He aims to sell assets as they come to be priced at what he considers to be fair value and to replace them with fresh ideas in bargain territory. Presently, the fund has significant positions in housebuilding, construction, insurance and transport with larger firms in energy, mining and tobacco also featuring.

Fidelity American Special Situations

Manager Angel Agudo targets companies that have gone through a recent period of underperformance and where he believes little value is ascribed to recovery potential. His philosophy is that the stock market is inefficient at pricing companies that have gone through a troubled period and are consequently unloved and out of favour. He constructs a relatively concentrated portfolio of around 50 best ideas (which can add to the risk) across a range of company sizes.

The manager assesses a variety of company factors, including balance sheet strength, asset backing, resilience of the underlying business model and market position. Given the very pronounced value tilt of this fund we would expect it to have trouble keeping up in an environment where the market is being driven by growth stocks – as has been the case in recent years. In particular, Mr Agudo has been steering clear of highly rated technology stocks and has invested in more ‘boring’ stocks in the sector.

Past performance is not a reliable guide to future returns. This website is not personal advice based on your circumstances. No news or research item is a personal recommendation to deal. Investment decisions in fund and other collective investments should only be made after reading the Key Investor Information Document or Key Information Document, Supplementary Information Document and Prospectus. If you are unsure of the suitability of your investment please seek professional advice.

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