Investors should be excited about attractively-valued and under-the-radar opportunities at the moment rather than worrying about the strong performance of most major indices, according to Orbis’ Dan Brocklebank (pictured). 
The director of Orbis Investments – which runs a global equity fund, a multi-asset fund and a UK equity fund – says the increasing popularity of high-quality, dividend-paying stocks has led to industry ‘laggards’ trading on attractive valuations.
Not only this, he says the price of value plays tends to have an inverse relationship with their returns and is therefore seeing plenty of opportunities across markets.
This comes at a time when many investors have been worried about valuations, with a number of managers opting to position themselves away from traditional assets given low yields on bonds and strong returns of dividend-paying blue-chips.
Performance of indices over 5yrs
Source: FE Analytics
However, given the high levels of geopolitical and macroeconomic uncertainty on the horizon, many industry professionals are continuing to buy dividend-paying stalwarts or ‘bond proxies’ in a bid to protect their portfolios.
In an article published last week, Rathbone’s Carl Stick said he is buying into these types of stocks in a bid to build a “dull” and safe portfolio that can protect against choppy markets.
“If I’m feeling a bit more bearish – and I am – it’s maybe a case of simply going back into a more defensive mode,” he said.
“Now, we may be wrong. If interest rates go up because economies are growing, then bond proxies may not be the best place to be. But, as I say, I am taking a more defensive tact.
“So we want businesses with low business risk, some financial risk but not too much, but also relatively low price risk. We recognise they’re bond proxies.”
Brocklebank says a general focus on yield has morphed into a focus on buying high-quality companies, which has in turn led to a select group of defensive mega-caps performing exceptionally well over the last five years.
As a result, there has been a greater dispersion between this select pool of stocks and those which fall outside of this category.
Brocklebank and his team at Orbis are therefore using their quant system to compare the top 20 per cent of the global market with the bottom 20 per cent of the market over the last five-to-seven years.
This aggregate valuation – as shown in the below chart – suggests that market ‘laggards’ are historically cheap and, although past performance is no guide to future returns, the director believes we could be near a turning point where value stocks will outperform growth holdings.
Valuation and returns of ‘laggards’ vs ‘leaders’ since 1990
Source: Orbis Investments
“You can see that the aggregate valuation – the blue line – has bounced around all over the place. The way we’ve structured this chart is that, if the laggards in the market are cheap, this line is high,” he explained.
“Sometimes the laggards have been a bit expensive. At the moment, the laggards in the market are still very cheap relative to history. We’ve been writing about this since the end of 2015 and, since then, our performance has been very strong this year.
“Coming back to starting valuation and subsequent return, you can see that when the laggards have gone onto underperform when they’ve been relatively expensive. When they’ve been cheap they’ve gone onto outperform.
“There is a broad correlation so we’re pretty excited about the number of opportunities and the biggest portion of that really comes from avoiding stocks that are popular at the moment.”
However, Brocklebank says that investors need to have a particularly long-term time horizon to spot this trend.
He reasons that this is why active managers have struggled to outperform recently – not only have expensive, low-volatility stocks surged in popularity and outperformed, they are often extremely large companies and are therefore well-represented in their respective indices.
As such, the director argues that active managers would have to hold incredibly high weightings in these businesses in order to beat their benchmarks and, given that such companies don’t tend to offer the best returns over the long term, they are often overweight smaller companies instead.
“Because active managers have not performed very well because of all of these things going on, the passive industry has said, ‘look at these terrible active managers, they’re absolutely hopeless at their job and they charge you crazy fees. You can get the market average if you come to us and you’ll be paying a fraction of the fees’,” Brocklebank continued.
“This whole thing is feeding on itself and I don’t know when it’s going to end. It’s starting to unwind already. We’re certainly starting to see a level of press coverage that suggests we’re closer to the end than we are to the beginning. It’s been everywhere – ‘the death of active management’, ‘active management is a dying business’ and it gets me really excited because it signifies we’re nearly at the end.
“If you think about our biggest exposure, it is probably to companies we don’t own and it’s these low-volatility bond-proxy companies.
“Make no mistake, these companies are great. I may buy products from them every day. But, it doesn’t mean the stocks are a good investment. Linked to this is the notion that all you need to do to outperform is to buy high quality companies and hold them forever. But valuations matter.”
From a regional perspective, both Orbis funds are also underweight the US market for valuation reasons.
The team’s research shows that, when looking at the S&P 500 index’s price-to-revenue ratio versus its real rate of return (return minus inflation), the index achieves a stronger performance when it is on a lower starting value. Again, this is shown in the below graph.
Starting valuation and subsequent real returns of index over 25yrs
Source: Orbis Investments
“As you would expect, the lower the starting value the higher the subsequent return, which is a good sign – starting valuations really matter,” Brocklebank said.
“In general, you’re seeing a downward sloping curve which is what you would expect. Where are we today? We have never seen a subsequent five-year period from this starting valuation where you have positive real returns. I think that’s very ominous.
“Bearing in mind that inflows at the moment are all into S&P 500 trackers. Wake up everybody – I don’t know what you’re expecting but there’s a high risk you’re going to be disappointed.”
Instead, the area of the market Brocklebank sees the most opportunities in is emerging markets, although he says this isn’t a blanket call as there are lots of different areas and pockets of opportunity throughout the sector.
As with other major indices, he warns there are larger companies which also account for large portions of the indices that investors would do well to avoid.
“In developed markets companies with growth potential – the Amazons, the Microsofts – they’re really well-recognised and you pay massive multiples for them,” Brocklebank explained.
“In emerging markets, companies with very good growth potential are far cheaper. This is where your macro risk comes in. A lot of people were saying this time last year that emerging markets are very risky and, low and behold, they’ve been the best-performing equity region this year.
“We have seen this start to unwind a little but we still think it has a long way to go. If you look at the price-to-revenue metric again, the divergence between emerging and developed markets is almost back to where it was in the early 2000s.”
Orbis’s five crown-rated Global Balanced fund has outperformed its average peer in the IA Mixed Investment 40%-85% Shares sector by 37.15 percentage points since its launch in 2012.
Its Global Equity fund has three FE crowns and is in the top quartile for its total returns over one, three, five and 10 years as well as over the last three and six months.
Performance of fund vs sector and benchmark over 10yrs
