For some time now the outperformance of growth stocks and subsequent underperformance of value stocks has been a notable topic of conversation, and whether or not the latter can find their form again is a matter of much debate. 
However, some of the factors that have been supporting this dynamic do perhaps appear to be waning, most notably low interest rates and low inflation. Broadly speaking, growth stocks are potentially more sensitive to changes in interest rates compared to their value counterparts. This is predominantly due to the longer dated nature of their expected future cash flows, which can make them more vulnerable to changes in discount rates.
Furthermore, generous headline valuations of many classic growth stocks within the technology sector, which may also be finding themselves under increased regulatory scrutiny, could now be making the odd investor a little jittery.
On the other side of the coin financials, particularly banks, have struggled in recent years and these make up a very significant portion of value indices. In the MSCI World Value index for example, financials account for circa 26 per cetn, compared to technology at circa 9 per cent. Likewise, in the MSCI World Growth index, financials make up only circa 8 per cent compared to the, unsurprisingly high, circa 29 per cent in technology.
Therefore, much of the dispersion in returns between growth and value, can be explained not only by share price strength of firms within the technology sector, but also by the fact that financials have largely lagged the wider market in years gone by. This is perhaps not overly unexpected given that the environment which has suited growth stocks, notably low interest rates, has been a headwind for banking profits. Though in the US especially this clearly appears to be reversing at the moment, as interest rates are gradually being normalised.
For global equity value managers a natural underweight to technology tends to go hand in hand with an underweight to the US market given that many of the world’s largest technology firms can be found across the pond. However, valuations throughout much of the US market have been fairly off-putting to global value managers.
With the S&P 500 having outperformed the MSCI AC World index in four of the past five years this has been an unhelpful headwind. This is also perhaps more pronounced for global equity income strategies, which struggle to overweight a market that tends to be naturally lower yielding compared to other developed market countries. As such, 2018 has been challenging for global value and income managers, not least because the US market, and more specifically the technology sector, are once again leading the charge year-to-date (despite some weakness in the latter more recently). Furthermore, areas of seemingly better value, emerging markets and Europe (including the UK), have suffered some setbacks this year.
Source: FE Analytics and Square Mile
Whether or not now is the tipping point we do not know, but it could well be a time to, if one has not already done so, add some balance to portfolios should they be lacking in value exposure. One such fund that is fairly unashamedly managed with a value bias is River & Mercantile Global Recovery.
This is typified at present by the portfolio’s limited US holdings, overweight in financials and its emerging market exposure. As such, performance this year has been difficult for the strategy, though it should be well positioned to take advantage of any resurgence in the value style of investing.
Source: FE Analytics and Square Mile
In the US, one fund worth taking a look at is the Dodge & Cox US Stock fund. Which, bar a welcome, but brief, renaissance for value in 2016, has struggled to make much headway versus US indices in recent years. As such, the portfolio’s underweight technology (with significantly less FAANG holdings) and overweight financials positioning should offer some comfort that this strategy may be able to provide a hedge should the long-awaited style shift finally make a more assertive appearance.
Returns are net of income reinvested in GBP
Andrew Johnston is a portfolio manager at Square Mile Investment Consulting & Research. The views expressed above are his own and should not be taken as investment advice.