Darius McDermott: Value is not dead it’s just resting

Central banks have put value on the back foot again in 2019

With the exception of two very short periods in the past decade, value investing has been in the shadow of growth, as quantitative easing from the world’s central banks has continued to aid markets.

The last time value stocks excelled was in 2016, but there was hope 2019 could be their year as the flow of artificial money was turned off by central banks and we moved into an environment of rising interest rates.

However, the first half of 2019 has seen a number of central banks choose to abandon plans to tighten monetary policy – even the US Federal Reserve is likely to cut rates rather than raise them.

It’s put value investing firmly on the back foot once again; however, some have taken this a step further by claiming the strategy is actually dead – thanks to changes in the global economy, the persistence of low interest rates and disruptors in the technology industry.

I do not believe that to be the case and I feel that at some stage value will rally to a strong degree. My rationale is based on the longer-term – not what the market has been doing in the past 12-24 months.

According to Goldman, the valuation gap between expensive and cheap stocks is now the widest it has been for nine years and this scenario has typically “foreshadowed strong performance for value names”.

It’s a view supported in a presentation I recently saw from RWC Partners, which showed high growth companies have been trading on valuation premiums only exceeded by the pre-dotcom bubble since 1996.

The challenge is what is likely to lead to a turnaround in their fortunes? Spotting a catalyst for a value rally is very hard to do and can normally not be seen until 3-4 months after the rally has already begun.

For investors, it is very much about playing the long-game by buying a cheap stock with a low valuation and being paid to wait. Take banks for example. Many were hit very hard during the credit crunch and eurozone crisis. They have since seen significant regulatory tightening – through stress testing – to help them de-risk. However, they still trade on low valuations in the UK and Europe due to past sentiment.

Naturally, disruption is something investors should watch out for given we’ve seen so many retail businesses falter and eventually fold due to the likes of Amazon. But this is where active management will aid your cause.

A key point to remember is that when value does rally the best performance often comes early on, such as in 2016, and if you are out of the game you can easily miss out on the best returns.

We have been adding to our value exposure in recent months, but we remain market neutral between the two styles. What I would say is the long-term argument remains a strong one and that having some exposure towards value funds before any potential rally is essential – particularly as the discrepancy between growth and value stocks is so strong now.

For those looking at value funds Schroder Recovery, managed by Nick Kirrage and Kevin Murphy, is a strong option. The fund, which has returned 218.1%* in the past 10 years currently has half of its exposure in financials (30.3%**) and consumer services (19.5%**).

Industry veteran Alistair Mundy’s Investec UK Special Situations fund is another alternative. The 48-stock portfolio has GlaxoSmithKline, Capita and Travis Perkins as its top three holdings** and has returned 158.6%* over the past decade. The R&M UK Recovery fund is another I’d consider. Manager Hugh Sergeant holds approximately 200 of these out-of-favour stocks in the portfolio, looking to add to them at almost fire-sale prices in volatile times, while being patient with their turnaround. Over the past 10 years, it has returned 281.4%*.

*Source: FE Analytics, total returns in sterling, 10 years to 9 July 2019
**Source: Fund fact sheets, 31 May 2019

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