By Darius McDermott, managing director at FundCalibre
As interest rates rose, many investors predicted a brave new future for value investors. Across much of the globe, this resurgence was brief, with value managers having to compete with the rise and rise of mega-cap technology companies.
However, in the UK, it has been a different story. Value managers have been having a moment and – more importantly – they do not believe it is over yet.
The strength of growth over value may have been exaggerated. Over three years, the MSCI World Value is up 6.1%, compared to 6.1% for the wider MSCI World index.
However, it is worth remembering that this includes a difficult year for the magnificent seven in 2022, which countered some of their astonishing performance in 2023. Over one year, MSCI World is ahead of its value equivalent by around 5.5 percentage points.
By contrast, in the UK, value has been having a moment. The value style is ahead of growth over one and three years, helped by the strong performance from the commodities sector in the wake of the Ukraine crisis, and by traditional value areas such as banks, which have benefited from rising interest rates. The UK also has fewer traditional growth sectors such as technology, so the competition has not been as acute.
After some tough years during the period of low interest rates, good value managers have been making hay. Among the FundCalibre Elite Rated funds, R&M UK Recovery is first quartile over five years, having outpaced the wider IA UK All Companies sector by over 15 percentage points.
Schroder Income is 6.1 percentage points ahead of its IA UK Equity Income peer group over five years and 14.1 percentage points ahead over three years.
From here, value managers report one of the broadest and most diverse opportunity sets in decades.
Hugh Sergeant, manager of the R&M UK Recovery fund, said: “The stockpicking opportunity set is amazing, probably the best in my career on a risk-adjusted basis. Previous opportunities came during periods of significant stress, such as the global financial crisis or Covid, and you had to be very brave to participate.
“Today’s opportunities have been created by a buyer’s strike at a time when the fundamentals have been perfectly sound. There are opportunities across all types of company – from deep value banks to technology.”
This is primarily because so much of the UK market is cheap, with even growth companies trading at value multiples.
Sergeant added: “UK equities are trading on a P/E of 11x, which is low versus their own history and half the multiple of US equities. The UK has never been cheaper relative to the global benchmark.
“If you look under the bonnet of the UK index, many good companies can be purchased on single digit P/Es.”
Ben Arnold, investment director on the Schroders value team which runs the Schroder Recovery and Income funds, said the perception that value funds are just about oil and gas, mining and banks needs to be revised.
He said that while these sectors dominated their portfolio a few years ago, it is “a very dated view”.
“Over the last few years, there has been a huge broadening out,” Arnold added. “Our portfolios are now cheap, but they are also super-diverse.”
This extends to smaller companies. Arnold said the team is running the highest allocation to small and mid-cap businesses that it has ever had, with small and mid-cap valuations very depressed.
This is also an important part of the market for Sergeant, who added: “Smaller companies are on particularly modest multiples after suffering a severe bear market.”
But value is not just about cheapness. The other side to the equation is improving earnings. Sergeant said fundamentals are getting better.
“The economic outlook is improving with GDP growing again,” he explained. “Leading indicators, such as housing and industrial activity, are picking up. Consumers are now more confident. Wages are growing faster than prices. Company fundamentals are also getting better, with corporate updates starting to beat bearish expectations.”
The remaining problem for UK value managers is the same as for all UK equity managers – that the strength of UK companies is being largely ignored.
While Sergeant expects flows to become more supportive and thoughtful investors are starting to allocate to UK equities, there is a hill to climb.
In the most recent Investment Association statistics, UK Smaller Companies continued to see outflows of £110m, as did the UK All Companies sector (£890m) and UK Equity income (£337m) in the month of March.
Companies are buying their own stock, which is helping to realise value. This has included some vast programmes in typical value sectors, such as banks.
Barclays announced a £10bn dividend and buyback programme over three years in February – almost half of its market cap. Its shares bounced 30% on the news and continued to move higher.
Companies are also returning cash to shareholders through dividends. It is worth noting that the yield on the FTSE Small Cap index is now higher than that on the FTSE All Share.
M&A activity is also picking up, with bids for high-profile companies such as Currys and Direct Line, but also among smaller companies.
This is a good moment for UK value managers. Performance has improved significantly, and the cheapness of the UK market is giving them a wider opportunity set than ever before. The best value managers are taking advantage.
