Value Perspective Quarterly Letter – 1Q 2016
A nascent recovery in value
Having underperformed Growth for the longest-period on record, the first three months of 2016 have seen Value rebound to outperform Growth as an investment style. This ‘rotation in style’ has garnered much attention in the financial press. We, however, are not getting carried away. Humans have a tendency to extrapolate current trends when forming future expectations and the performance of the past three months may or may not prove to be the beginning of a sustained return to the market’s typical function as an arbiter of value. The only certainty today is that value investing has displayed a consistent pattern of mean reversion over more than 100 years. The road is seldom smooth, but history suggests that the resulting outperformance of the portfolio from today’s level should be significant on a 10 year view.
The market remains highly polarised
Despite the resurgence of some of the cheapest areas of the market over the quarter (most notably basic materials) the disparity in valuations between the cheapest and most expensive parts of the equity market remains extreme. The premium paid by investors for the perceived safety of many traditionally defensive stocks – such as food & beverages and tobacco companies – has continued to increase.
By attempting to avoid volatility investors are accepting elevated valuation risk
There is a growing body of evidence to suggest a primary consideration for investors over the years since the credit crisis has been avoiding volatility. This only enhances what we might term the ‘bond proxy paradox’ – the hunt for supposedly safe and stable stocks since the credit crisis pushing up the valuations of these stocks to a point where they can really no longer be considered safe or stable. As ever, such things tend to move in cycles and what was once considered an advantage will, after a certain critical point is reached, become a disadvantage. There is no such thing as an asset that is always safe or one that is always risky – your risk is determined by the price you pay.
Volatility is an opportunity, not a risk
Often we see other investors classifying ‘risk’ as volatility. However, volatility in itself is not a risk – real investment risk is the chance of permanently losing some or all of the money that you have invested. In-depth analysis of balance sheets and financing arrangements ensures that the capital risks of investment are well understood, and a robust balance sheet provides a ‘margin of safety’ against unknowable risks. In fact, since the intrinsic value of companies seldom moves substantially over short time periods, volatility suggests emotional behaviour and, as a consequence, generates an opportunity for value investors.
The positioning of our funds
As long-term investors, we have learned that trying to second guess short-term trends, and using these to position portfolios, seldom delivers returns. Instead, we try to stand back from the market and attempt to identify long-term trends that we can use to create long-term value: placing emphasis on cash-generative businesses with robust balance sheets, strong management teams, and cheap valuations.
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.
This article is intended to be for information purposes only and it is not intended as promotional material in any respect. Reliance should not be placed on the views and information on the website when taking individual investment and/or strategic decisions. Nothing in this article should be construed as advice. The sectors/securities shown above are for illustrative purposes only and are not to be considered a recommendation to buy/sell.
Past performance is not a guide to future performance and may not be repeated. The value of investments and the income from them may go down as well as up and investors may not get back the amounts originally invested.