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How style can equal substance in the world of investment

24/11/2016

Kevin Murphy

Kevin Murphy

Fund Manager, Equity Value

Why should you consider owning value? Let us count the ways. Here on The Value Perspective, there is one and only one reason why we ourselves own value investments. That said – and contrary to some of the less kind things people can say about value-focused investors – we do possess some imagination and we can think of two other plausible reasons, in addition to our own excellent one, why others might buy a value fund.

Our own excellent reason is that, though of course past performance should not be used as a guide to future performance, value as an investment strategy has outperformed over time and can therefore be profitable – always a good quality in an investment strategy. As we have highlighted plenty of times before, here on The Value Perspective, many academic studies have underlined this point and, at the same time, we have yet to find a single one that has refuted it.                            

That arresting fact notwithstanding, there is a relatively small pool of conviction value purchasers in the world – value, after all, requires a degree of mental and emotional discipline not every investor is prepared to sign up for – though we would presume regular visitors to The Value Perspective would be among that demographic. So what might convince other investors to join them – even temporarily?

A plausible reason for considering buying value, and one that has received an increasing amount of media coverage of late, is that while you may not believe in the power of value over time, you might believe that now could be an appropriate point to buy value-oriented investments – for a short-term trade, perhaps, or in the pursuit of some other kind of mean-reversal strategy.

It is not something we ourselves would do but you could construct a narrative that, for example, US president elect Donald Trump’s inclination towards infrastructure spending should lead to rises in both long bond yields and inflation – thereby increasing the attraction of banks and other cheap assets. Or else you might believe that, after a number of years of relative underperformance, value is so weak it is due a bounce.

The other plausible reason for considering buying value investments is as a hedge against other assets in your portfolio, which leads us to the following chart. Put together using Morningstar’s own data, it offers a striking picture of the data provider’s 1,100-strong UK universe and of the percentage of its £500bn-odd total funds under management that could be said to have a value style of investing.

  

Source: Schroders, Morningstar Direct, based on Morningstar UK domiciled funds using fund data available at 31 May 2016.

 

As you can see, Morningstar’s analysis concludes just 9% of that £500bn under management is in value-focused funds – defined as having a greater than 50% bias to value – compared with 91% in more non-value- oriented offerings (sometimes known as ‘growth’, but probably more accurately called ‘momentum’ funds). So, despite all the evidence that value has outperformed over time, its shorter-term run of underperformance means nine out of 10 funds are targeting where returns have been, not where the potential returns will be.

And if that chart looks vaguely familiar, it may be because we ran a similar one a few months back in Full tilt, which showed the same sort of thing happening in Morningstar’s UK Income universe (13% of funds under management in value, 87% in growth). We could also show you charts that highlight exactly the same percentage for Global Equity funds and an even starker split (5% versus 95%) for European Equity funds.

To return to the chart above, however, the fact it refers to 91% of funds under management rather than 91% of fund managers means the average investor’s portfolio is going to be similarly skewed. They may believe they have built in some protection by holding a number of different UK funds but, even if they have diversified their fund manager or group risk, the numbers strongly suggest they have not diversified their style risk.

Here on The Value Perspective, we would posit that most investors, on learning they were so heavily exposed in one direction, might wish to consider balancing things up a bit. For what it is worth, the 40/60 split that could be found within the sector a decade ago – and which was also the case in Morningstar’s UK Income universe, as we highlighted in Full tilt II – would seem to us a potentially more rational allocation to target.

And if you felt persuaded by any or all of these three reasons, it surely makes sense to seek out the most value-focused investments you can find. If you believe value outperforms over time, then you should buy the purest reflection of value. If you believe it is a short-term trade, then you should do likewise. And if you believe it is a hedge, then obviously the more exposed to value you are, the more effective that hedge will be.

Author

Kevin Murphy

Kevin Murphy

Fund Manager, Equity Value

I joined Schroders in 2000 as an equity analyst with a focus on construction and building materials.  In 2006, Nick Kirrage and I took over management of a fund that seeks to identify and exploit deeply out of favour investment opportunities. In 2010, Nick and I also took over management of the team's flagship UK value fund seeking to offer income and capital growth.

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The views and opinions displayed are those of Ian Kelly, Nick Kirrage, Andrew Lyddon, Kevin Murphy, Andrew Williams, Andrew Evans and Simon Adler, members of the Schroder Global Value Equity Team (the Value Perspective Team), and other independent commentators where stated. They do not necessarily represent views expressed or reflected in other Schroders' communications, strategies or funds. The Team has expressed its own views and opinions on this website and these may change.

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