Value Perspective Quarterly Letter – 3Q 2019
Leaving no stone unturned
While the funds are up in absolute terms this year, recent relative performance has been extremely disappointing. This period of relative underperformance is painful for our clients and it is painful for us both professionally and financially as our own money is invested alongside that of our clients. It is, however, not the first time portfolios have gone through a tough period. The nature of our concentrated, benchmark-unaware approach means portfolios will go through periods of underperformance. This doesn’t make it any easier in the moment of course, and it hurts today. We are examining and re-examining all of the positions held and are leaving no stone unturned. It is our firm belief that we hold a portfolio of companies with the most attractive risk / reward profiles available to UK equity market investors today, and that clients will ultimately be well rewarded for their patience.
A headwind from our style, and from stock selection
It is always the case that two fundamental factors will drive our relative performance: Do we have a headwind or a tailwind from the value style? And have we had a period of higher- or lower-than-average developments for our individual stocks?
We have addressed stock specific developments in the performance statement section. We believe the portfolio is in the best possible shape given the opportunities the market is offering us today. We retain a long-term view, and also remind ourselves that what can appear to be our largest mistakes over a short time period can go on to be our greatest successes.
In terms of the headwind for the value style, the seeds of outperformance are sown in bear markets. While it hasn’t been a bear market for the stockmarket, it certainly has been a bear market for value. If we look at the long-term history of the UK portfolios that we manage, it has been the case that the best time to buy (and also worst time to sell) our funds has been after sharp pullbacks in relative performance.
Put simply, over time our investment process has added considerable value, but this waxes and wanes. Following good periods, there have been tougher periods, and vice versa: following difficult underperformance the funds have gone on to produce great returns. Past performance isn’t a guide to the future, and of course we cannot say for certain that this pattern will continue. This is also not a market timing message. It’s feasible that relative performance may get worse in the near term. However, for clients with a genuine 5-year time horizon, history suggests that this is an attractive time to invest in our genuine long-term value style.
Bursts of value outperformance are getting more extreme
Value-oriented investments enjoyed a burst of stellar outperformance in the middle of September – a turn of events so short term we usually wouldn’t even think about commenting on. However, after a decade when growth investors have unquestionably been in the ascendancy, this all-too-brief episode is worthy of further analysis.
Before we go any further, let’s be clear: we are in no way arguing this ‘value flash rally’ is a sure sign of things to come. The week of 9 September, when some value portfolios outperformed their growthier peers by around 4%, was certainly very welcome but, given the first eight months of the year had seen growth forge some 12% ahead of value, it was no cause to celebrate.
We will not attempt to fit a narrative as to the trigger for this burst of outperformance. In our view, it all comes down to valuation. The elastic band between value and growth is extremely stretched, and as and when the market snaps back to its typical function as an arbiter of value, the outperformance of value is likely to be profound.
The chart below shows the valuation of MSCI UK Growth versus MSCI UK Value on a number of different metrics, since the financial crisis. If you go back further, the data shows growth hasn’t traded at such a premium for more than four decades. The takeaway is that the most expensive stocks have become more even expensive:
Ultimately of far greater importance than any ‘trigger’ from the September ‘value flash rally’ however, are two lessons that can be taken away from this episode – one by investors in funds in general and the other by value-oriented portfolio managers, such as ourselves.
The big lesson for equity investors in general has to be the importance of diversifying 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 solid approach to investment – and one that should apply every bit as much to style as it does to, say, geography, company size or industry sector. If you are not diversified by style, any larger-scale value recovery in the future is likely to be painful. The data for the style bias of all of the funds under management in the UK, provided by Morningstar, shows that less than 10% of all assets invested in the UK have a bias towards the value style today.
The other big lesson, we believe, is for true value-oriented portfolio managers, such as ourselves – and that is the importance of sticking to your guns. Our clients enjoyed the full benefit of the flash rally because, no matter what is happening in markets, we pursue a value strategy. We pursue a value strategy because it is evergreen. Irrespective of whether value is in or out of favour today, value investing has displayed a consistent pattern of mean reversion over almost 150 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 Value Perspective team
The views and opinions displayed are those of Nick Kirrage, Andrew Lyddon, Kevin Murphy, Andrew Williams, Andrew Evans, Simon Adler, Juan Torres Rodriguez, Liam Nunn, Vera German and Roberta Barr, 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.