It would be a “heuristic mistake” to look at value investing as a short-term strategy, according to Albemarle Street Partners’ managing director Charlie Parker, who said all the data showed that buying stocks for less than they are worth has proved to be the most effective strategy for making money over the long term.
In an article published on Trustnet in April, Keith Ashworth-Lord of the top-performing CFP SDL UK Buffettology fund revealed he was unconcerned about his underperformance in the value rally of the prior six months, saying he was confident his focus on quality businesses would win out over the long term.
“The first out of the traps when the market turns tend to be those businesses that have been left behind, that look cheap on grounds like P/E or whatever,” he added.
“My experience of so-called value rotations is they last for a matter of months and then the quality businesses start to pick up the baton and run with it.”
Yet even a growth focused-manager such as Ashworth-Lord may be surprised by how quickly the value rally has faded.
Value stocks rocketed after “Vaccine Monday” on 9 November 2020 and extended their lead in February as their growth counterparts sold off on inflation concerns. Yet the latter group has bounced back to such an extent that nine months after what was hailed as a turning point in market leadership – with macro conditions finally working in favour of value after a decade of headwinds – the two styles are neck and neck.
Performance of indices since 9 Nov 2020
Source: FE Analytics
However, Parker was confident that value investing will reassert itself over the long term.
“I've seen a lot of commentary recently where people are saying that if you go and buy this value thing, you're being short-termist,” he said.
“I think that's a heuristic mistake, a bad psychological trap, because actually the evidence says that in the long term, topping up on expensive growth is short-termist and the really sensible long-term decision is to aim for the cheaper stuff.”
Parker pointed to the graph below highlighting the relationship between the starting cyclically adjusted price/earnings ratio of the market and expected returns. He said it showed a “very simple story”, which is that if you buy equities when they're cheap, you tend to make a lot of money over the long term, but if you buy them when they're expensive, you don’t.
Source: Albemarle
He continued: “If you are saying ‘don't buy anything of value right now, just go back to growth, it's short-termist to buy value’, you're saying this relationship has broken and you no longer get rewarded for buying cheaply, particularly at the beginning of economic cycles.
“We would say to investors, be mindful of the seasonal factor, this is exactly the moment where investors are scared out of cyclical positions and get punished for it. So hold your ground.”
Parker noted that anyone who hoped to capture the cyclical recovery of the past nine months through large-cap value funds alone was likely to have been underwhelmed by their performance, adding they would have been better off playing it through other areas of the market, such as smaller companies.
Smaller companies are one of the best-performing asset classes over the long term and even kept pace with the mega-cap driven growth rally of the past decade.
This suggests that investors could use these to take advantage of cyclical rebounds, rather than pinning their hopes on a value revival. But Parker said that, while there is plenty of evidence to show that small caps beat large caps over the long term, the outperformance is not as powerful as that of value over growth.
“There's also a good base of evidence that suggests that blending factors, then rebalancing them, beats owning any one factor.
“If you own some small over large and some cheaper over expensive and then you keep rebalancing into that, that beats any one factor.”
He added that one of the reasons why UK small cap funds have held up well while value has fallen by the wayside is that most of these now have a quality-growth bias. Yet while this has stood them in good stead recently, Parker said this has come at a cost.
“Namely, they're not pro-cyclical, pro-UK or pro-domestic in the way they used to be, so they will lag if the value rally reconvenes in a classic seasonal pattern in the next month or two,” he continued.
“I think a lot of investors go and buy UK smaller companies because they think they're getting a very bullish view on the UK. But because so many of these managers have drifted towards quality, they are not getting quite as much of that as they thought.”
However, other investors claim value investing belongs to a bygone age.
In a previous article published on Trustnet, Dave Bujnowski of Baillie Gifford American claimed we are living in an era of “unprecedented disruption”, which is why growth has outperformed value for so long and can continue to do so.
“Of course, the idea of disruption has become well publicised over the years and it's hardly a novel narrative,” he explained.
“However, we believe the entire dynamic is still tremendously underappreciated, specifically just how many disruptive forces are happening in unison and how potent and early they still are.”