Value as your equities hedge and source of long-term returns
As debate continues over whether we are in the midst of an AI-related tech bubble, we make the case for using active value strategies as a way to remain invested in equities while reducing exposure to expensive parts of the market.
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Timing an exit from the breakneck rally in all things AI related will look obvious only in hindsight. It’s therefore much better to diversify today than live to regret it tomorrow. But where should investors diversify? A very high proportion of active and passive equity funds, even within value peer groups, still have substantial exposure to the areas where much of the bubble risk may reside.
Recent research from our colleague Duncan Lamont shows that most valuation metrics in most equity markets are near the top end of their 20-year ranges, with current values shown as dots for each market metric. The US accounted for 72.5% of the MSCI World index as at 30 June 2026, so its extended valuation is a significant issue for passive and active global investors who follow the benchmark:
Current valuation vs 20-year range. 100% = most expensive in 20 years, 0% = cheapest
Source: LSEG Datastream, MSCI and Schroders. Data to 30 June 2026.
If that were not concerning enough, the correlation of the Morningstar Global Blend, Growth and Value peer groups to US large cap equities is notable (measured using three-year total return outcomes):
Source: Schroders, Morningstar, as at 30 June 2026. USD. Calculation based on monthly returns. This indicates the strength and direction of a linear relationship between two random variables. The value will range between -1 and 1. A value of 1 indicates a perfect positive dependency and -1 indicates a perfect negative dependency between the 2 investments. A correlation value of 0 indicates that no relationship between the 2 investments exist and are said to be independent of each other. The correlation between two investments can be determined based on the returns of the investments or the excess returns of the investments over a risk-free rate.
Given its lower relative correlation above, passive value may look like the answer. Under the bonnet, however, passive value ETFs have become increasingly exposed to the same areas over time, making them less likely to deliver the diversification investors expect. For example, the MSCI World Value index does not have a single stock in its top ten with a cyclically adjusted price-to-earnings (CAPE*) ratio below 19x, while the MSCI World Enhanced Value index has a weighting of >17% in Micron alone - which has a CAPE ratio approaching 200x. For context, the weighted average CAPE ratio on all Schroder Global Value Team portfolios is currently below 10x.
It is also important not to look only at technology stock weights in these indices, as default sector classifications do not fully capture some of the most expensive shares in AI today. In the MSCI World and MSCI World Value indices, Meta and Alphabet sit in Communication Services, while Amazon and Tesla are classified as Consumer Discretionary. If we instead look at the tech sector plus the Magnificent 7 not already included in the tech sector (“Tech+Mag7”), the MSCI World’s broad exposure to these companies includes all of its top ten names, with total index exposure of 47%. The equivalent figure is 20% for MSCI World Value and 35% for MSCI World Enhanced Value.
Global indices - top ten stocks by weight as at 30 June 2026
Source: Factset, as at 30 June 2026. Stocks mentioned are shown for illustrative purposes only and should not be viewed as a recommendation to buy/sell.
This is where we believe authentic deep value matters. Across our strategies, our disciplined process means we offer very different exposures to the above. As shown below, the Schroder Global Recovery Strategy correlation with large cap US equities is materially below passive value levels, while still delivering strong absolute performance for investors.
Three year correlation with S&P 500 and three-year absolute performance
Past performance is not a guide to future performance and may not be repeated
Source: Schroders, Morningstar, as at 30 June 2026. USD. Calculation based on monthly returns. This indicates the strength and direction of a linear relationship between two random variables. The value will range between -1 and 1. A value of 1 indicates a perfect positive dependency and -1 indicates a perfect negative dependency between the 2 investments. A correlation value of 0 indicates that no relationship between the 2 investments exist and are said to be independent of each other. The correlation between two investments can be determined based on the returns of the investments or the excess returns of the investments over a risk-free rate.
The next chart illustrates the point more directly. It again shows the performance of the Schroder Global Recovery Strategy but this time during each of the ten largest drawdowns in the “Tech+Mag7” over the last decade. The strategy outperformed in all but one of these episodes: the early Covid-19 period when markets collapsed as global lockdowns were announced. We believe this demonstrates how an authentic, actively managed value portfolio can deliver very significant diversification benefits, while allowing clients to maintain their equity exposure.
MSCI World Information Technology sector + Mag 7: largest ten drawdowns from June 2016 (based on daily returns, USD)
Past performance is not a guide to future performance and may not be repeated.
Source: Eikon, based on MSCI World Information Technology sector plus “Magnificent 7” names not included in the sector (Amazon, Alphabet A, Alphabet C, Meta and Tesla). Schroder Global Recovery Strategy is based on representative fund share class data. Total returns in USD, from 30 June 2016 to 30 June 2026. Drawdown period dates show the start and end of respective drawdowns.
Meanwhile, the “Tech+Mag7” has become a much larger share of the broader MSCI World index. This group of darlings has grown from 21% of the index in September 2018 to 47% today, making it an extraordinary concentration risk for investors who are not properly diversified.
Importantly, however, we do not think value is useful only as a short-term hedge against a potential tech bubble. Over the long term, authentic value funds can compound at an impressive rate too, thanks in part to value investors’ discipline and consistent refusal to get swept up in periods of irrational exuberance. The chart below shows the long-term returns of Value versus Growth and highlights the extraordinary long-term returns Value has delivered.
Value and Growth performance 1926 - 2025, based on $10,000 invested in June 1926
Past performance is not a guide to future performance and may not be repeated.
Source: Schroders. Fama French Database, Factset, Bernstein analysis. US data, as at 31 August 2025. Portfolios are formed on BE/ME at the end of each June using NYSE breakpoints. The BE used in June of year t is the book equity for the last fiscal year end in t-1. ME is price times shares outstanding at the end of December of t-1. All NYSE, AMEX, and NASDAQ stocks for which we have ME for December of t-1 and BE for June of t-1. Value and growth defined as Highest 30% of the stocks by BE/ME is considered as Value Portfolio and Lowest 30% by BE/ME is considered as Growth Portfolio.
So, for investors who want to both grow their capital over the long term and protect themselves from irrational exuberance while retaining equity exposure - we think value has an important role to play. But it’s important to acknowledge that not all value exposure is equal. Passive value is unlikely to be the optimal diversification choice. And for those choosing active value, we are one of the longest-running value teams around, with more years of experience today than we’ve ever had before, a process we can evidence has consistently added value, and a suite of authentic, actively managed value strategies across the UK, Europe, Global and International.
*The cyclically adjusted price-to-earnings (CAPE) ratio, also known as the Shiller P/E, is a valuation metric that divides a company or index's current price by its average, inflation-adjusted earnings over the previous 10 years.
Capital is at risk. The value of investments and the income from them may go down as well as up and investors may not get back the amount originally invested.
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