Value investing – aiming to buy shares that are cheap in relation to their earnings or assets – has recently enjoyed something of a renaissance. The strategy has offered relatively poor returns for most of the past decade as growth stock, led by the technology and e-commerce giants, led the way.
The value ‘universe’, inhabited by unloved areas such as oil & gas, mining, financials such as banks and tobacco, has recently been prized for its more defensive characteristics in the face of increasing inflation and interest rates.
’Growth’ stocks, on the other hand, have had a tougher time as inflation fears have escalated with future profits deemed to be worth less in a perceived era of rising prices. Some less proven businesses without a clear pathway to sustainable profits have been especially punished as investors adopted a more sceptical view. Other, more established businesses that have announced disappointing results have also experienced sharp share price declines.
Consequently, the reversal in fortune for many tech and growth-orientated funds has been very rapid. It is a reminder to investors not to have a portfolio skewed too much in one direction.
Growth or Value?
We would not suggest investors try and switch back and forth between growth and value to improve performance. Anticipating the market mood is nigh on impossible. The next phase of market action could be led by stocks in either camp: some value areas could remain buoyant if inflation remains a real issue and interest rates rise further or faster than expected, whereas growth could take over if inflation recedes and interest rates turn out to be on a relatively shallow trajectory.
Instead, we suggest investors are prepared for both these outcomes and maintain a well-diversified portfolio that can capture opportunities in all parts of the market. Indeed, recent price action may be setting up some decent opportunities in some quality growth companies for the longer term.
It is also worth noting value investing isn’t easy and being selective is very important. It can involve negotiating an investment universe scattered with ‘value traps’: companies that are cheap for good reason. They could, for instance, be in financial difficulty with a shaky balance sheet or declining earnings. Cheaper businesses not imminently imperilled by their financial state may instead experience a slower decline owing to structural trends such as increased digitalisation, automation or the substitution of lower cost products or services.
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 if they are bought at the right price. Some can offer profitable recovery, others a generous income with more limited growth and, just occasionally, there can be a complete reinvention that turns a value opportunity into a growth one.
A best of both approach
Many investors will already be aligned to growth through large, popular funds, as well as investments biased to tech and healthcare stocks. For those with little in the way of differentiated, value investments in their portfolio here are some options of actively-managed 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 the potential downside, which could help them avoid the value traps in the market.
Please note: each of these funds is part of our Preferred List of funds selected by our Research Team. They are provided for your information but are not a guide to how you should invest. Before investing in any fund please read the relevant Key Investor Information Document or Key Information Document, and Prospectus to ensure they meet your objectives and risk appetite.
Global: Artemis Global Income
This fund is run with a bias towards value stocks due to the requirement to generate a premium yield, but also because the manager is both disciplined and contrarian in nature, seeking out ‘turnaround’ situations. This gives it a different return profile from competitors that favour stocks with minimal earnings volatility and are prepared to pay up for these more defensive names. It therefore provides variety and diversification within an income portfolio or an option for growth investors seeking diversification from more tech-orientated global funds.
There is also a macro-economic element to the process with performance partly reliant on manager Jacob De-Tusch-Lec’s ability to interpret prevailing conditions correctly and to identify undervalued stocks that can surprise the market in that context. Very recently, he has reduced exposure to more economically sensitive areas and added to selected defensive areas that have become a bit cheaper. The fund has even less exposure than usual to technology – and no exposure to expensive companies trading on high multiples of their earnings with low (or no) cash generation.
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.
The fund is comprised of two types of company: those trading below the manager’s 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 and insurance, with larger firms in energy and mining also featuring.
There is an important distinction to be made between this kind of approach and a ‘recovery’ fund that targets cheap areas where fundamentals have deteriorated but a turnaround is possible. The manager is keen to guard against financial risk and has a strong preference for companies with little or no debt. The emphasis is on quality and strength as well as good value. In seeking out companies with strong cash generation and balance sheets – but which are also relatively unloved – he aims to construct a portfolio that is materially better value than the broader market and can outperform over the longer term. The fund experienced a tough Covid crisis, but we believe it remains well placed to exploit the behavioural biases in investors that underpin the performance of value investing.
This fund favours companies that have gone through a period of underperformance, where relatively little value is ascribed to their potential. 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 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 until recently. The manager has recently increased allocation to the healthcare and energy sectors and remains significantly underweight in the technology sector. The fund trades at a sizeable discount to the index on all traditional valuation metrics so it makes a good diversifier to a growth or tech orientated US fund.
Asia: Fidelity Asian Values
Manager Nitin Bajaj takes inspiration from Warren Buffet’s style of ‘value investing’. This advocates targeting good businesses run by trustworthy management teams and buying them at the best possible price. This investment approach tends to lead him to smaller companies that are not widely followed by professional investors and areas that are being widely ignored. At the same time, he looks to take profits from areas that perform strongly over his 3 to 5-year investment horizon and reinvest in new ideas through overlooked, cheaper stocks.
While cheaper than the market on traditional metrics, the fund also exhibits some ‘quality’ characteristics, avoiding unproven business models, highly indebted companies, cyclical businesses on ‘peak margins’ and stocks trading on high earnings multiples. We believe the manager’s mantra of “good businesses, good people and good price” and his determination to target resilient businesses should help the Trust deliver strong, longer term performance in this higher risk region that includes the fast growing economies of China, India and Southeast Asia.
Japan: Man GLG Japan CoreAlpha
The fund has a very particular, high-conviction value approach, which can undergo periods of underperformance and is not suited to all market environments. The team believes cyclicality is a strong influence in virtually every sector of the Japanese market, and outperformance can be generated by being contrarian and exploiting extremes of valuation through buying stocks that are unloved and selling them when they become popular. Currently, fund has sizeable weights in banks, insurance and autos.
The strategy tends to struggle in relative terms versus its peers and benchmark in a market that prioritises certainty of earnings from companies rather than cheap valuations; However, we believe it is worth consideration by those looking for exposure to out-of-favour Japanese firms and, through cheap stocks in a generally cheap market, diversification from the ‘growth’ style more generally.
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