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Value funds are almost guaranteed to outperform from here, says City Financial

09 February 2016

Following an extended period of severe underperformance for value funds, City Financial’s Peter Toogood says that no matter what happens to markets from here, they should outperform their growth rivals.

By Alex Paget,

News Editor, FE Trustnet

Value managers will outperform their growth-orientated peers no matter whether there is a 2008-style crash or a surge in economic growth, according to City Financial’s Peter Toogood.

It has been one of the longest periods on record where growth, as an investment strategy, has outperformed value.

According to FE Analytics, the MSCI AC World Value index (apart from a brief rebound following the global financial crisis) has consistently underperformed the MSCI AC World Growth index from a relative basis since January 2007.

Relative performance of indices over 10yrs


Source: FE Analytics

There have been a number of reasons for this trend, of course. First and foremost, global growth has slowed so – putting it simply – markets have favoured companies that have the ability to grow.

Secondly, as the demand for income has only intensified thanks to quantitative easing and low-interest rates, traditional bond investors have been forced into the equity market for yield and those companies with the safest and most reliable dividends tend to not to be in the value end of the market.

Thirdly, and more recently, value indices have been dominated by stocks which are highly exposed to major global headwinds such as mining, financials and energy stocks.

However, Toogood – investment director at the group – says this trend has to end soon despite the increased bearishness towards risk assets.

“As growth and inflation expectations have continued to fall, US 10-year treasury yields have marched lower. Investors have craved any and all stocks that could grow in this slow growth world. They have firmly rejected value stocks, which fall almost exclusively into the real economy bucket, namely: energy, mining, banks and many industrials,” Toogood said.

“Value managers are fully exposed to economically exposed stocks, while growth managers find themselves party to one of the most extended momentum trades in history – overpriced growth stocks. The price that growth managers are being forced to pay for high P/E stocks is eye-watering (high momentum stocks in the US are twice the price of the index).”

“Furthermore, income managers, the natural buyers of compounding growth stocks, are fretting about the valuations they are being asked to pay for the stalwart income sectors, such as staples and healthcare, as investors have sought out ‘safe havens’ for income and so pushed prices up.”

The difference in performance between value and growth funds has only intensified of late and this is clearly shown within the UK market.


For example, deep value funds have found themselves holding bombed-out mega-caps within the mining and energy sectors and posted significant double-digit losses over the past 12 months. These include Schroder Recovery, M&G Recovery and Standard Life Investments UK Equity Recovery.

Performance of funds versus sector and index over 1yr


Source: FE Analytics

On the other hand, funds in the IA UK All Companies sector over the last year tend to be those heavily weighted to growing medium-sized and smaller companies. The likes of PFS Chelverton UK Equity Growth have returned close to 20 per cent over one year, for example.

Toogood recently said that, following the Bank of Japan’s shock decision to push interest rates into negative territory, financial markets are nearing collapse. He says this difference in performance between value and growth funds also plays into that argument.

“When we describe 2016 as the year of reckoning, it is because we see such staggering anomalies in the market,” he said.

“Income managers are nervous about valuations and the potential for dividend cuts. Growth managers have nowhere to hide. Value managers increasingly have reasons for optimism but they can’t necessarily see the catalyst for a re-rating.”

He says, though, there are two outcomes that would see value outperform growth from relative perspective.

The first would be a 2008-style market collapse which would cause all areas of the market to fall, according to Toogood, but value would stocks would outperform growth they would already be cheap going into the crash as few currently own them.

The second (and slightly more positive outcome) is if economic growth revives in the second half of the year.

“This is more reminiscent of 2005, when growth fears were replaced by hopes for stronger growth in the future. Value trounced growth that year,” Toogood said.

Therefore, he says either way investors look at the market, value funds are almost guaranteed to outperform growth funds over the medium term.

“We have been increasingly wary of equity markets and continue to suggest a strong focus on absolute return funds,” he said.


“We stand by the assertion that for those who are inclined to invest long-term money, value managers were the way to go. The above analysis only reinforces the point that in a complete market washout, or a rotation led by stronger economic growth, value wins.”

Performance of indices in 2016


Source: FE Analytics

“The price action in recent months highlights the fact that value is slowly winning the battle. Fortune favours the brave.”

James Clunie, manager of the Jupiter Absolute Return fund, agrees with Toogood.

He says investors are now seriously over-paying for safety and, as result, he is shorting certain growth stocks (particularly in the US) and taking long positions in bombed-out value stocks within his £212m fund.

“For long/short investors such as ourselves, this phenomenon has provided rich pickings when it comes to shorting stocks,” Clunie said.

“As a result the Jupiter Absolute Return fund is currently around 12 per cent net short of equities, which includes meaningful short exposure to growth businesses listed in the US that we believe either have hubristic, capital intensive growth strategies and/or unsustainable market ratings.

“Given how sensitive these stocks tend to be to changes in risk appetite and fund flows, it has sometimes been painful to hold these positions. However, on average, balancing these shorts against a long book of ‘value, out of fashion’ stocks has resulted in a positive return for the fund in the past year.”

“We continue to try to position the fund for a time when the current regime – the current story – unwinds. Market behaviour early in 2016 may prove an early indication that this is occurring.”

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Data provided by FE fundinfo. Care has been taken to ensure that the information is correct, but FE fundinfo neither warrants, represents nor guarantees the contents of information, nor does it accept any responsibility for errors, inaccuracies, omissions or any inconsistencies herein. Past performance does not predict future performance, it should not be the main or sole reason for making an investment decision. The value of investments and any income from them can fall as well as rise.