The past decade has been characterised by the haves and have nots in the investment world.
The past decade has been characterised by the haves and have nots in the investment world.
We have had our own version of austerity, with value managers having their handouts reduced and growth managers lording it over them, taking the lion’s share of assets and fees.
Has the tide turned? Is value about to make a stunning comeback?In a decade Terry Smith has gone from zero to more than £18bn with the eponymous Fundsmith Equity fund, irritating a few incumbents in the industry along the way.
Has the tide turned? Is value about to make a stunning comeback? Or are growth investors going to have to become more discerning and have to question price more when investing?
Portfolios comprised of only growth in the last decade have massively outperformed value; this is highlighted in the US stock market where the Russell 1000 Growth index has returned 285 per cent (in US dollars) versus 178 per cent for the Value index.
But how many investors have purely been in growth funds for that period? And if you have been, do you sleep well at night given valuations of some growth stocks?
My view on portfolio construction is that you need a balanced approach to manage risk.
Yes you can tilt the portfolio in certain ways, but you should very rarely exclude any region or style completely.
In other words, even though it has been a growth market for a long time, I am happy to have owned value.
The one caveat is that I want the best value managers to sit alongside the best growth managers; pairing a newer nimble fund such as BlueWhale Growth with Schroder Global Recovery, for example.
So growth has been the place to be invested for the past decade, but what of the future?
Market comparison
The graph above is interesting as it shows two value-focused funds compared to one growth fund: Man GLG Japan Core Alpha and Vanguard Developed Europe ex-UK equity relative to the growth of Baillie Gifford American.
Turning to the European first, and over the past year it has traded closely to the S&P, with a decent outperformance spike in recent months.
Compare this with most of the past decade and it shows why there are signs of encouragement.
However, the context of negative rates, quantitative easing and a German economy that narrowly avoided recession needs to be mentioned to temper the optimism slightly.
But investors know this and still the market has performed pretty well.
Key Points
- Growth managers have done very well over the past 10 years.
- Certainty will soon be less fashionable.
- Rate rises are not expected to be on the cards.
The Japanese fund is a slightly different story, largely as it has seemingly been in decline for 30 years.
According to Reiko Mito, GAM Star Japan Leaders’ manager, Japan’s profits have been world-beating. Corporate Japan has seen 10 per cent earnings per share growth a year over the past three years.
However, the stock market has underperformed – in other words, the market has derated.
The value in certainty
As we move into a more uncertain world, with growth slowing and stimulus measures having less of an impact, certainty will continue to be fashionable.
As we are late in the cycle, the willingness to pay whatever price for certainty will not be the same as a few years back.
Stocks that have bumps in the road are being punished severely – those that just churn out the numbers have been strongly rerated upwards.
Does it make sense going for the high multiple stocks today, knowing that if they disappoint in a quarterly update they will be punished?
If the growth value tilt is shifting, does that mean the likes of Fundsmith Equity, Blue Whale Growth and Lazard Global Franchise – all quality growth funds – will start to struggle as the higher multiple means more certain growth stocks become riskier?
Or can you actually buy good growth at a reasonable price? Interestingly, Lazard’s top 10 holdings trade on a price-to-earnings ratio of 16.9 and a price-to-book ratio of 2.2 – both lower than MSCI World.
Blue Whale’s portfolio trades on a PE of 30, but trumping the lot (no pun intended) is Baillie Gifford’s US fund, which has an eye-watering PE of 90.
Growth at any price seems more appropriate there.
I am not knocking any of the approaches mentioned, and I am a happy holder of Blue Whale Growth, but surely valuation has to matter.
If missing results by a few percentage points can worry investors enough to knock10 per cent or more off the current share price, and the world is slowing, that will become more commonplace.
Is there going to be a proper resurgence in value?
Without interest rate increases that seems unlikely, and rate rises are not on the cards due to the sheer amount of debt sloshing around the global financial system.
However, I think the price paid for growth will become more discerning and there are pockets of value that could see recovery.
For example, if there is some form of Brexit resolution in the near future, the UK stock market could prove to be a good hunting ground, with domestically focused value stocks seeing a bounce as both UK and overseas investors take advantage of the current historically cheap valuations.
What I do not see is a continuation of the past decade, where the divergence in performance between growth and value has been so stark.
Fundamentals have to reassert themselves at some point, bringing the price paid for low-but-certain growth down, and the value in value stocks becoming more obvious.
Ben Yearsley is a director of Fairview Investing
