Any value manager will tell you that the past 10 years has been a challenging period. Not only have growth shares outperformed, but the dispersion in price performance between the two styles is currently the widest it’s been over this period. Looking at the performance of the MSCI value and growth indices (see chart below), it’s tempting to conclude that value is all but dead.
Value is beaten down over the past decade
Value vs growth period returns, % p.a.
Source: FE, Lonsec
The reason for this dispersion starts to make sense when you think about what it is the value and growth investing styles represent. Value style investing seeks to identify companies trading below their intrinsic value. Value investors tend to be focused on long-term performance, believing that the companies they invest in will tend towards their intrinsic value over time.
Conversely, growth style investing focuses on companies whose earnings are expected to grow in excess of the market. Growth investors are typically willing to pay a premium for this growth, believing that the earnings trajectory will continue to rise and support equity prices. There are numerous studies suggesting that over the long-term the value approach out-performs growth, with well-known investors and academics such as Ben Graham and Warren Buffett being notable proponents of value style investing. The chart below compares the performance value and growth across the globe over a 20-year period.
Value and growth are neck and neck over 20 years
Growth of $10,000
Source: FE, Lonsec
So why has value style investing lagged growth over the past decade? Like all things related to markets the answer is not simple, but there are some things we can point to. Firstly, the low interest rate environment which followed the global financial crisis in 2008 has benefited growth companies. Growth companies that are expected to grow their free cashflow in the future are typically more sensitive to interest rates, in a similar way to a long duration bond. With interest rates at low levels and continuing to fall in some markets, growth stocks have continued to perform well.
Secondly, global equity markets, including the US, have been fuelled by the strength of high growth sectors such as the technology sector with the so called FAANG stocks (Facebook, Apple, Amazon, Netflix and Alphabet), which have until recently driven a significant portion of US market returns. Australia is not to be outdone with its own version of growth darlings – the so-called WAAX stocks (Wisetech Global, Afterpay, Altium, Appen and Xero).
Increasingly, investors are questioning the ‘value’ of value style investing and whether it can deliver for investors in the current environment. The last time similar questions were asked was in the 1990s when markets were dominated by high-growth tech companies trading at high price-to-earnings multiples and investors were fearful of deflation. While the environment is different today (many tech companies are supported by actual earnings and interest rates are at record lows thanks to ‘unconventional monetary policy’), value investing is a long-term investment approach and will inevitably experience extended periods of relative under-performance versus growth.
It’s safe to say value is currently out of favour given the dispersion between value and growth stocks is widening. However, from a portfolio perspective, being over-exposed to a single factor or investment style can be risky if market conditions change. Being aware of your portfolio biases by engaging in deep investment due diligence on individual fund manager teams and investment products is a critical element when building a quality portfolio. Assuming that current market dynamics will continue into perpetuity is dangerous, particularly in a market where volatility is on the rise and the ‘status quo’ can shift rapidly.
Author: Lukasz de Pourbaix, Chief Investment Officer, Lonsec Investment Solutions - July 26, 2019