Over the long-term, value investing has proved to be one of the best performing styles. Indeed, some of the most celebrated investors in history – such as Warren Buffett, Benjamin Graham and John Templeton – made their fortunes by diligently applying the value approach.
Yet, in recent years the style has underperformed.
The MSCI The World Growth index has significantly outperformed its value counterpart over the past decade returning 286.12 per cent against a 193.39 per cent gain for the MSCI World Growth index. However, the prior 10 years reveal a different story with value trumping growth, as the below chart shows.
Performance of indices in 10yrs to end-2008
Source: FE Analytics
So what happened?
Unlike some investment strategies, value investing is quite simple. At the heart of the strategy is the principle of not overpaying for stocks: it’s essentially about finding assets to buy below their intrinsic value.
“Even many growth investors would argue that the stocks they own were good value relative to their future potential,” said Daniel Pereira, investment research analyst at Square Mile Investment Consulting & Research.
Peter Elston, chief investment officer at Seneca Investment Managers, said the reason that value investing has had such a rough time in recent years is because some poor-quality companies have been bolstered by the low interest rate environment and quantitative easing pushing investors into risk assets in search of growth.
“Value investing works if there is a level playing field,” he explained. “For the last 10 years, bad companies have been propped up by low interest rates, so they’ve had an advantage they don’t normally have.”
But interest rates will not stay low forever, he added, and once they normalise – as they surely will at some point – value investing as a style could make a comeback.
For Square Mile’s Pereira the growth style’s outperformance has also been helped by another trend in markets.
“Investors have chased growth in the stock market, which would have been further exacerbated by a rise in algorithmic trading (passive/smart beta/factor investing) which buys index positions, regardless of price or valuations,” he said.
While value has gone through periods of underperformance before, such as during the dotcom bubble, this is the longest period of underperformance on record.
Indeed, the value style’s chronic underperformance during the post-crisis period has prompted some market participants to question whether the cyclical nature of investing will be able to restore it as a winning strategy.
Although there have been some brief spells of value outperformance since the crisis – such as in 2016 – they have been few and far between,
Pereira said: “Such catalysts for value to enjoy a sustained rally are difficult to predict, even for the most highly regarded economists and market commentators.”
Annualised performance of indices over 10yrs
Source: FE Analytics
In an environment of low economic growth, he said, stocks that are cheap are seemingly remaining so or becoming cheaper for extended periods.
“Today’s value investors are only seeing short-lived periods where the style is in favour and they must be ready to capitalise on such periods,” he said.
However, the debate about value or “growth” is a false one, according to Royal London Asset Management’s Mike Fox.
“For me, personally, it is about disruptive versus non-disruptive,” said the FE Alpha Manager, noting that valuations were becoming meaningless in an environment where some companies are facing serious disruption and deteriorating business fundamentals.
“I started 10 years ago, I've seen value markets and market cycles as well, so I'm often oblivious to the indoctrination of growth and [the notion] that’s the only thing I’ve ever believed and works," he said.
“I think if you've started in investments within the past 10 years that's a massive risk because you've not seen value markets. But I've seen them, and I know what they look like and I also know what [you’ve] had to do to adapt to the dominant style of investment.”
Fox added: “I'm happy to buy stocks at 10 times earnings, I'm quite happy with that, but they need to be quality companies that meet our requirements. It's not a case of expecting to buy a BMW for the price of a Ford: life's not like that, so why does that mentality exist in investing?”
But not everybody agrees that the value versus growth debate is over.
“It will always be more sensible to buy cheaper companies than expensive ones, even if you have to wait a few years for them to demonstrate their credentials,” said Seneca’s Elston.
“We think that value is likely to outperform at some given point,” added Pereira. “However, we’re honest enough to admit that we can’t predict when.”
As such, the Square Mile analyst recommends patience and warns against trying to time the market.
“If you have invested in value over the last 10 years, the worst thing you could do would be to switch into a growth strategy at arguably the wrong time, especially if we are indeed nearing the end of growth’s dominance,” he explained. “Value as a style can deliver very strong returns, and this reversal could happen in a very short space of time.”
For potential value investors who do not want to be at the mercy of the style a relative value approach might be more suitable, said Pereira.
“Rather than solely investing in deep value areas, they should perhaps consider a fund that follows a strict valuation discipline but retains a broad market exposure. It is therefore likely to keep some pace with the market, should growth continue to soar,” he concluded.