Can value investing help balance your portfolio?

Most investors will question whether value or growth investing is right for their portfolio at some point. One of the interesting aspects of investing is that there is no single ‘right’ way to go about it. Diversity of personalities and philosophies leads to different investment approaches. What works for one investor won’t appeal to another.

It’s also the case that different investing styles tend to work at different times. Sometimes no matter how good the investor and their process, they can’t fight the tide of sentiment. What passes for investment genius or foolishness can just be the ebb and flow of these styles, especially over shorter periods.

It’s human nature to be attracted to investments that have performed well in the past, and there is often ‘momentum’ behind a particular style as more investors are drawn to it. Yet, as we are obliged to point out, past performance is not a reliable indicator of future returns. Outsized gains can quickly turn to disappointment if investors crowd into an appealing area, theme or approach and subsequently move on.

This is why it’s best to take a long-term view and be broad minded about different investment strategies when constructing a balanced portfolio. Our Preferred List has always been structured to provide a menu that features a variety of different styles. As well as passive investments designed to follow an index at low cost, there’s a selection of actively managed funds that adopt distinctive approaches.

What’s the difference between value and growth investing?

Very broadly, investment approaches can be categorised into ‘value’ and ‘growth’, although some lie in between the two because they incorporate elements of both.

Value investors aim to buy shares that are cheap in relation to their earnings or assets. They look to uncover businesses whose share prices are at a discount to their true worth in the hope that, over time, their full value will be realised. Value investors are naturally contrarian, wish to avoid fashionable areas and instead target widely ignored parts of the market in search of unappreciated bargains.

Growth investors focus on identifying companies they believe are capable of above-average growth in their earnings and profits. There are different types of growth companies, ranging from nascent companies making little or no profit to large and well-diversified companies where there is potential for rapid growth in earnings. Ultimately, growth investors tend to care less than the exact price they pay for shares because they believe that over time a high trajectory for earnings will mean the company is worth much more in the long term, and they are willing to pay up for that.

There can be pitfalls for both strategies. A strict value philosophy means concentrating more on the underlying value of a business, rather than aiming to anticipate earnings trends into the future, which could be less predictable. However, care needs to be taken to avoid ‘value traps’, companies that appear great value but are in decline and end up being poor investments. Meanwhile, growth investments usually deserve to be more expensive, but if they don’t meet their lofty expectations, they can end up costing investors dear. Even a small earnings miss or short-term obstacle to business progress can hit shares hard.

Read more: How to generate income from your investments

Will value investing make a comeback?

In recent years a value approach hasn’t provided much joy for investors, apart from a brief renaissance in 2022. The strategy has offered relatively poor returns for most of the past decade as growth stocks, led by the technology and e-commerce giants, including the ‘Magnificent Seven’ led the way. But could it be time for value stocks to shine again?

Much depends on the economic outlook. Growth stocks tend to do better in eras of low interest rates and inflation as their future value is seen to be worth more in the present day’s money. Value stocks, meanwhile, are more ‘jam today’ than ‘jam tomorrow’, so they often cope better with a burst of inflation. In particular, the more economically sensitive areas such as financials, energy and mining can be more resilient if inflation is accompanied by strong economic growth. Meanwhile, more defensive value stocks such as utilities and consumer staples might prefer a slower growth environment where interest rates are cut more quickly.

Recent market moves perhaps suggest growth stocks are starting to crack under the pressure of expectations of interest rates staying higher for longer. Certainly, there has been a pause in the upward trajectory of the previously all-conquering Magnificent Seven with some such as Tesla and Apple falling sharply from their previous highs. It’s a reminder to investors not to have a portfolio skewed too much in one direction and to consider rebalancing as different areas perform at different rates.

Sometimes growth will outperform value, sometimes it’s the other way round. Often it depends on the economic situation, or it is simply prevailing investor sentiment. Being solely value-driven can mean giving up returns from companies that appear expensive but are poised to deliver exceptional growth through important structural trends or from their own efforts. Meanwhile, growth investors can miss out on share price appreciation that comes from unfashionable areas returning to favour; and sometimes from greater merger and acquisition activity whereby trade buyers see more value in businesses than the market does.

Read more: When will interest rates go down?

Value investing vs growth investing: which strategy suits your portfolio goals?

We suggest investors maintain exposure to both growth and value areas to create a ‘best of both’ approach. To anticipate the market mood and switch back and forth between growth and value to improve performance 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 outperform if inflation and interest rates turn lower faster than expected.

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. Both growth and value investing strategies can perform well over the long term if the process is well implemented, so investors looking to maximise long term returns through investing in shares should consider blending both styles.

Value funds to consider

Many investors will already be aligned to growth through large, popular funds, as well as investments biased to tech 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 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 for new investment 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 with your objectives and risk appetite.

1. Global: Artemis Global Income

This fund is run with a bias towards value stocks due to the requirement to generate income from dividends, but also because the manager is both disciplined and contrarian in nature, often seeking out ‘turnaround’ situations where out of favour companies return to form thanks to a pick-up in its industry or through management efforts. 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.

2. UK: Man GLG Undervalued Assets

Henry Dixon and Jack Barrat, managers 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 they target companies whose share prices do not fully reflect their ‘intrinsic’ value. Although contrarian in approach, the managers are keen to guard against financial risk and have a strong preference for companies with little or no debt.

The fund is comprised of two types of company: those trading below the managers’ analysis of their ‘replacement cost’, and those whose profit streams he considers are undervalued by the market. They aim 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 banks, property, infrastructure, construction and insurance with energy and mining also featuring.

3. US: Fidelity American Special Situations

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 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. 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.

4. Asia: Fidelity Asian Values

Manager Nitin Bajaj takes inspiration from Warren Buffet’s style of ‘value investing’. This means 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 or highly indebted companies. 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.

5. Japan: Man GLG Japan CoreAlpha

The fund has a high-conviction, value approach, which can undergo periods of underperformance and is not suited to all market environments. The management 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 more 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 businesses and, through cheap stocks in a generally cheap market, diversification from the ‘growth’ style more generally.

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.