Value-oriented investments enjoyed a burst of stellar outperformance in the middle of last month.
Rather than becoming too excited about this brief glimpse of sunshine in what has largely been a gloomy decade for value investors, however, we prefer to focus on two questions it begs.
Having first looked at what underpinned value’s ‘flash rally’ in September, let’s now consider what, if any, lessons investors can take from it.
When discussing the context of the rally, we highlighted two research notes published that same week – by analysts at Société Générale and at UBS. Both teams flagged up the huge disparity in investors’ valuations of growth and value stocks, with the UBS team going on to focus on the imbalance between supply and demand as more and more investors jostle to fish in a diminishing pool of fast-growing businesses.
One striking manifestation of this has been the way UK and European funds have drifted away from value stocks and towards growth – a trend we have highlighted, here on The Value Perspective, in articles such as Beware ‘style drift’ and A basic rule of investing.
And as the flash rally showed in snapshot, such a lack of diversification by style – that is, by value and growth – is potentially very risky.
It is a point not lost on the SocGen analysts, who write that their primary argument for buying value stocks “was not dependant on accelerating GDP growth or an economic regime change but largely about the need to diversify interest rate risk”.
“There is too much bond price momentum priced into asset prices and, to hedge this risk, you need to buy cyclical upside,” they add.
As we discussed in our piece on the context for the flash rally, we are more concerned with objective reality (where we are) than any associated narrative (how anyone reckons we got here).
Still, with the SocGen analysts having concluded investors should hedge risk and buy cyclical upside, it was interesting to see ways they suggested achieving this included through bank stocks, autos and, more broadly, value.
The last of these they described, eye-catchingly, as “by definition, a portfolio of the world’s problems”, before later noting: “Too many investors are poorly exposed to positive news.
Value stocks, a portfolio of doom-laden stories as we have seen in recent days, provide such a hedge.” This mirrors warnings we ourselves have given as investors sought the perceived safety of ‘bond proxy’ stocks, regardless of valuation.
Lesson 1: Diversify style exposure
The big lesson of the flash rally for equity investors in general, then, has to be the importance of diversifying their style exposure.
Directing money towards different assets on the basis that, even if some are falling in price, others may well be rising, is a pretty solid approach to investment – and one should apply every bit as much with regard to style as it does to, say, geography, company size or industry sector.
Put simply, if you are not diversified by style, any larger-scale value recovery in the future is going to hurt.
Furthermore, as we argued in A basic rule of investing, you surely do not have to be a diehard value advocate to look at the wider market’s current bias to growth and think it might be sensible to have more exposure to cheaper assets and less exposure to the assets that, having done very well, are now very expensive.
Lesson 2: Stick to your guns
The other big lesson, we believe, is for value-oriented portfolio managers, such as ourselves – and that is the importance of sticking to your guns.
Here on The Value Perspective, we enjoyed the full benefit of the flash rally because, no matter what is happening in markets, we pursue a value strategy – and always will.
This is why people invest with us and any ‘drift’ in style by us would be a betrayal – of their faith and our principles.
We are in no way arguing that that one week last month is a sure sign of things to come but it should serve as a reminder the future is uncertain and investors should always look to position themselves for a range of possible outcomes.
Certainly anyone who takes the view value will come good can rest assured that, here on The Value Perspective, we will not waver from pursuing just such an investment strategy, which almost 150 years of historical data suggests could, over time and on average, outperform the wider market.
Past performance is not a guide to future performance and may not be repeated.