If you don’t believe you know all the answers, pick value
For as long as value investing has been around, people have put forward different narratives as to why it is no longer a valid strategy – yet it has continued to confound the doubters
Why might value no longer work as an investment strategy? The question cropped up last month during a panel debate at London Business School’s annual asset management conference – entitled, as we have heard more than once before over the last few years, ‘Is value investing dead?’ – and the moderator helpfully offered a couple of reasons as to why that might now be the case.
One is the idea the environment of ultra-low interest rates and quantitative easing measures that has persisted since the global financial crisis of 2008/09 has comprehensively favoured growth assets over their value counterparts. Given the terrible time value stocks have had over the last decade or so, that narrative would, at first glance, appear to have some substance.
Empirically, however, as a fellow panellist argued, the data is not so supportive of the argument that a low interest rate environment is demonstrably bad for value investing. More anecdotally, of course, we might point to Japan experiencing super-low interest rates for decades and value investing doing exceptionally well there for the best part of 30 years.
A second narrative, which we have also considered in Three new arguments, is that value investing has been undermined by the way companies now present their accounts – in effect, that a significant amount of the value created within a business now relates to ‘intangible’ aspects, such as brand recognition, goodwill and intellectual property, and modern accounting does not adequately reflect that.
Cash is king
In some respects, this is a great example of why there is still life left in active management because these intangibles are tough to adjust for, mechanically, through a screen. Nevertheless, almost every professional investor would agree ‘cash is king’ and, whatever system or valuation metric we might use, ultimately we are trying to measure the cashflows a business produces over time.
So value investors will make the appropriate adjustments – and areas where a price-to-book screen continues to work quite well include financials and the more extractive industries, such as mining and oil and gas, where there is not a huge amount of intangible value. A value approach will still offer a reasonable understanding of what you are buying in such areas therefore – you must then just work out whether that is real or illusory.
One point worth bearing in mind on the whole idea of adjusting metrics to make value investing more relevant to today’s world is that, if you go back three, five or 10 years, there is almost no adjustment a value investor could have made that would have enabled them to buy the six biggest stocks in the US. Apple, Amazon, Facebook, the two Alphabet (Google) share classes and, to a lesser extent, Microsoft, were never really value.
If you disaggregate the US’s main S&P500 index into what we might call the ‘S&P6’ and the ‘S&P494’, the difference in performance returns is index-moving. So frankly, not holding those stocks, or some element of those stocks, has been hugely influential for investor portfolios – and there is really no value screen you could have made an adjustment with and found yourself with a way into the ‘S&P6’.
All of which might reasonably beg the question that actually closed the panel session – how on earth do value investors stay true to their discipline through the inevitable difficult times? As part of my answer, I reflected on how what brought me to value in the first place was a keen awareness that, as an investor, I could not pretend I had – or would ever have – all the answers.
I knew I was not going to be any more intelligent than everyone else and I also knew I could work every hour in the day and still not know more than others. Instead, I decided to focus on value – a field where I would always know the answer and where I would always know the place to look for investments ... just so long as I had the fortitude to actually do it when things were really tough and my job was on the line.
Very early in my career, I watched a presentation from a noted economist, who argued that, if you were a value investor for a typical career of 30 years, you had a 70% chance of underperforming the market for three years in a row – and you would end up sacked. And I remember thinking at the time – I really hope those three years come at the end of my career and not the beginning!
In its own way, that reaction told me all I needed to know about what sort of investor I wanted to be because
it demonstrated I was not completely put off by the demands of the value style. If you do not believe you have all the answers as an investor, and you want to base everything you do on empirical evidence, then value continues to be a really interesting approach.