The market rotation into value has potentially reached an inflection point, according to Whitechurch investment manager Ben Willis, who has decided to buy into Neptune European Opportunities. 
For almost the last decade the quality growth style of investing has outperformed the value style, with investors nervous about buying out-of-favour stocks following the financial crisis in 2008.
Since then, a low growth, low inflation environment has contributed to the rise of the ‘bond proxies’ or ‘expensive defensives’ – stocks that are high quality consistent earners that return more than low levels of inflation.
This has been particularly pronounced in Europe, where the MSCI Europe ex UK Growth index (103.96 per cent) has outperformed the MSCI Europe ex UK Value index (29.40 per cent) by 74.56 percentage points over the last 10 years.
Performance of indices over 10yrs
Source: FE Analytics
FE Alpha Manager Rob Burnett, who runs the Neptune European Opportunities fund, said: “Though European value has significantly outperformed growth over the long-term, it has endured a tough time from 2007 to early 2016.
“We’ve seen a big recovery over the past six months or so, and while some investors may think they’ve missed the boat, we believe this marks just the start of a sustained period of outperformance.”
His confidence in the return to prominence of the value style has convinced Ben Willis to invest, with half of his exposure to Europe in his above-average risk portfolio now in the fund.
“We invested with Rob years ago and we’ve always highly rated him but he has got a distinct value style and obviously that has been out of favour – he would say for nigh on a decade – but definitely for several years,” the investment manager said.
“He’s been talking the value style up and he’s been a bit premature in some of his timings but he’s always stuck to his conviction and he was talking about it last year and it really resonated with us.
“However we didn’t have enough conviction to go in as we weren’t entirely convinced – there had been a few false storms before.
“We do like the value style but we’ve seen quality growth had been outperforming year-in and year-out because everyone thought the low growth, low inflation environment - which we could go back to but currently the market says that’s not going to be the case – would last forever.”
However, last year there a turning point, with European value stocks outperforming by 8.51 percentage points over the course of the year.
Willis (pictured) said: “I think Burnett sums it up really well by saying what you’ve got with these companies on a 20-year view is yeah they’re going to deliver still because they’re solid companies but on a two-year view they’re under pressure because they’ve been in so much demand,
“There was a view that the low growth, low inflation environment was going to remain forever and a day so people were quite prepared to pay up for that visible low income and growth and were quite happy to pay any price – as long as it was beating the low level of inflation then it didn’t matter.
“What you’ve got now – if you have inflation expectations picking up – what follows is an interest rate cycle and what happens then is these companies, because their share prices have gone up so much, is that all of a sudden the price you are paying from the shares and the yield you are getting from them is not going to beat inflation and other assets are going to look more attractive.
This shift led to the fund performing particularly strongly, returning 29.07 per cent – the second highest in the IA Europe ex UK sector.
Performance of fund vs sector and benchmark in 2016
Source: FE Analytics
“The catalyst for the turnaround was because he quite likes his banks – he’s a financial analyst so he quite strong on the banking sector,” Willis said.
“The European Central Bank had done negative interest rates in Europe but they realised they had made a policy error there and the outlook was that there was going to be no more negative interest rates.
“I think that for him he didn’t need to see interest rates go up he just needed to know there wouldn’t be any more cuts going forwards.”
Performance of index in 2016
Source: FE Analytics
As the above graph shows, the MSCI Europe/Banks returned 16.84 per cent over the year, with much of this coming in the second half of 2016 – though the index does include some UK banks.
Indeed, Burnett (pictured) says a number of stocks within his portfolio performed well, with the top performers all from the financial sector. 
“We have taken profits in some areas and recycled these into undervalued companies that are earlier in their recovery,” the Neptune manager said.
“We still remain holders of BNP Paribas and Société Générale but we have trimmed these positions and used some of the proceeds to invest in the likes of Caixabank and Bank of Ireland.
“We have also added some of the investment banks such as UBS and Credit Suisse. We continue to see significant valuation and dividend support in many of the European banks.”
Willis adds that since global financial crisis, banks have had increased regulatory burden to deal with meaning they’ve had to recapitalise and are in far better shape than they were.
“Burnett thought this was the turning point and he was proven right – his fund did phenomenally well last year and so when we saw him it was already up and people are going to think have they missed it but you know I don’t think they have,” the Whitechurch investment manager said.
He adds that the firm decided to buy into the £289m Neptune European Opportunities fund as a complement to the five crown-rated, £1.3bn CRUX European Special Situations run by FE Alpha Manager Richard Pease.
Willis said: “He doesn’t care about the macro, for him it’s all about buying good quality management, good sound businesses that he understands in the mid-cap region of Europe.
“He’s done phenomenally well out of that focus on quality growth even though he is not an out-and-out large cap quality growth manager.
“But we wanted that barbell. We realise this could be an inflection point and we’re quite happy to have both value and growth running together in the same portfolio basically to cover both areas of the market.”
However, while both funds had strong years in 2016, with French, Dutch and German elections this year, as well as possible elections in Italy, Europe has been generally unloved by investors.
“We try to look through that. I think last year taught you anything it is that you can’t predict anything. The markets tend to be shrugging it off more and more,” Willis said.
“You see what happened post the Brexit vote and when it became clear that Trump was going to win the election and markets reacted unfavourably for all of a morning so you just can’t position your portfolio for that.”
With this uncertainty Neptune’s Burnett says he will continue to be diligent with his investment process but adds that it could present opportunities for value investors in 2017.
“While we are optimistic about the recovery in the European economy, we acknowledge that political risks pose a threat to sentiment in 2017,” he said.
“We will be watching the situation in The Netherlands, France and Italy very closely, and will be ready to capitalise on value opportunities as they arise.”