Value stripped bare – a long term approach
Value stripped bare – a long term approach
Value investing is a charged and much-debated topic in investment management. But talking about value simply as a diversifier, or making the argument that there's a tactical case to add to value funds today, feels pretty uncomfortable for many value managers, ourselves included. This is because, for us, value is for life. It's not just for a few quarters. It's something we believe all investors should have exposure to in their portfolios in the long run.
Let's look at some really long-run data. Imagine for a moment that your great-granddad in the middle of the roaring 1920s had come into some money, and in 1926 invested $US10,000 in a growth portfolio of US equities. Today, that portfolio would be worth over $US80 million. That seems pretty appealing, and we probably would all be pretty pleased with old Grandpa Growth.
However, if he had invested the same $US10,000 in a value strategy, it would have grown to be worth a staggering $US780 million today.
So maybe old Grandpa Growth wasn't so great after all.
When people talk about the perennial war of value versus growth in the stock market from a zoomed out long-term perspective, they are right to conclude that war is over. But growth is not the victor.
Value’s long-term track record of compounding outperformance is incredibly strong - but because it goes through extended periods of relative underperformance and quite violent relative drawdowns it's easy for us to lose sight of the power of value as a long-term strategy for compounding client wealth.
Value is more than a factor
It's worth noting, however, that successful value investing doesn’t require treating value as a factor. Value is not just an algorithm that indiscriminately buys anything with a low headline PE multiple. Value was a bottom-up philosophy a long time before anyone spoke about factor investing.
Back when Ben Graham was formalising value investing in the 1930s, there was no such thing as factors. He didn't have a PC that could crunch through a bunch of statistical backtests to show how certain deciles of the equity market performed through time. He used pen and paper, common sense and intuition, and said if you want to consistently make money in the stock market while minimising your risk of losing money, don't fall into the trap of speculating on future growth. Instead, focus on finding bargains, find the companies that the market has knocked down to an irrationally low price. To do that, you roll up your sleeves, you go through the accounts, you learn from the history of a business, and you only buy shares where there's an inbuilt margin of safety - a nice gap between what the business is actually worth and the price the market is offering you today.
Value investing is nothing more complicated than that. It's bargain hunting in the stock market. The common-sense simplicity of what value investors do is lost when we start talking about value versus growth, and factor analysis, and what's happening with real yields, and what about inflation expectations, and the like.
In the long run, none of that noise will matter. What matters is consistently buying businesses below their true worth. That approach isn’t a factor; it is a bottom-up philosophy.
By way of example, the chart below shows a small selection of the companies that have been added to the Schroder Global Recovery Fund in the past 12 months. As you can see there are a variety of different opportunities that value investors have at their disposal.
As you might expect, some businesses that were caught in the eye of the COVID storm fell to extremely pessimistic prices in the Autumn of 2020. At this time the market provided an opportunity to buy a handful of genuinely world class businesses at a big discount because they were facing a truly exceptional period of disruption.
We bought a world-class leisure resort in Genting Singapore when the cash on the balance sheet was equal to roughly half their market cap. We bought Molson Coors when the world's leading brewer was on a mid-teen normalised free cash for a year. We bought Rolls Royce - a world class engineering business in a global duopoly - in a fire sale after its emergency rights issue was announced.
These are the kind of contrarian opportunities that don't come around that often, and smart managers grab them with both hands when they do.
It’s not all about the economic cycle
But contrary to the popular perception of value managers, the focus wasn’t just on cyclical businesses in the eye of the economic storm. We added a number of businesses last year that we would deem to be really high-quality franchises, often in more defensive sectors.
Whether that be pharmaceutical giants where the market started to worry about patent cliffs leaving a hole in their near term earnings, or companies like Bayer and Tiger Brands that have shot themselves in the foot and are facing litigation issues, or even the once loved tech giants - like Intel - that's suffered a manufacturing misstep and thereby disappointed the market. There were always a wide variety of different businesses and different sectors going cheap for different reasons.
It's not all about the economic cycle. It's about finding the idiosyncratic opportunities wherever they happen to crop up.
Value comes in all shapes and sizes, and value funds don’t have to be a one-dimensional macro bet. It's not all about interest rates or inflation - indeed none of the investment cases highlighted above have anything to do with interest rates or inflation. Equally, it's not all about banks and energy companies and what is happening there.
It's about hunting for cheap businesses wherever they reside to build a diverse portfolio for clients.
For the first time in a very long time, the market is being led by value rather than growth. In that environment, there can be big differences between what you get from the value factor and what you get from a bottom-up value style.
Value is far more than the top-down homogeneous factor. Active stock picking is crucial when you're fishing in the cheapest parts of the market and while the past few months is obviously a laughably short time period to judge anything, it is clear that a well-executed bottom-up value philosophy can offer clients something over and above what you'd get from a passive value index.
We retain our conviction that value is a strategy for the long term and is not just a temporary tactical opportunity.
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