Why should portfolios include value investing?
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 is value investing, and how does it differ from growth investing?
Very broadly, investment approaches adopted by fund managers 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. They may also seek a ‘margin of safety’ in that the intrinsic value of the business is close to, if not more than, the value of the business implied by the share price.
Investing for growth focuses on identifying companies they believe are capable of above-average growth in their earnings and profits. There are different types of growth businesses, ranging from early-stage companies making little or no profit to large and well-diversified ones with rapid growth potential in earnings. Ultimately, growth investors tend to care less what they pay for shares in relation to measures such as the ‘price to earnings’ ratio, which gauges how expensive a stock price is in relation to the company’s earnings. That’s because they believe that over time a steep upward trajectory for earnings will mean the company is worth much more in the long term, and they are willing to pay up for that.
Most long-term investors will question whether value or growth investing is right for their portfolio at some point, but 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, at least in relative terms on a global basis. The strategy has offered more muted returns for most of the past decade as growth stocks, led by the technology and e-commerce giants, have provided outsized returns. But could it be time for value stocks to shine again?
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, high 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.
Recent market moves perhaps suggest a broadening of market performance away from the domination of larger tech companies. 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. Blending different approaches can lead to better balance and greater resilience to a variety of risks.
Value or 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.
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 investment funds to consider
Many investors will already be aligned to growth through large, popular funds, including global trackers, 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. Many value funds and value investment trusts 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 their 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 by improving their cash flow and dividend payments.
2. UK: Man GLG Undervalued Assets
Henry Dixon and Jack Barrat, managers of the GLG Undervalued Assets Fund, believe 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 listed on the London markets: 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 they consider to be fair value and to replace them with fresh ideas in bargain territory.
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. To create a value investing portfolio across the US market, 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 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 investment style. This means targeting resilient businesses run by trustworthy management teams and buying them at a good 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 less expensive than the market on traditional metrics, the fund also tends to exhibit 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” could help the Trust deliver strong, longer-term performance in this higher risk region that includes the stock markets of 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. Bucking the trend of global markets, value investing in Japan has been a path to outperformance in recent years, a tailwind for the fund. Largely, it’s been a result of improved corporate governance that has had the greatest impact on the cheaper parts of the market.
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 diversification from the ‘growth’ style more generally through cheap stocks in a generally cheap market.
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.
Nothing on this website should be construed as personal advice based on your circumstances. No news or research item is a personal recommendation to deal.
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