The ongoing debate about whether growth or value is the superior style of investing is a “gross oversimplification” of an argument that ignores the fact these are “two sides of the same coin”, according to SVM Asset Management’s Neil Veitch
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Veitch (pictured), who heads up the SVM UK Opportunities fund, said his strategy can be characterised as a value approach, with a portfolio of stocks on P/E (price-to-earnings) ratios that are consistently cheaper than the market.
However, the manager pointed out “this is not your grandfather’s value fund” as it has evolved over time, taking into account the unprecedented level of disruption across numerous different industries since the turn of the millennium.
“What makes it slightly different in my view is that value and growth are two sides of the same coin,” he explained.
“Both sets of investors aim to buy stocks that are cheap relative to the growth on offer, but how they go about it differs.
“What that means is that we will, on occasion, invest in companies that many investors would label as ‘growth’ because we believe the market is underestimating the duration, or sustainability, of those returns, all within the context of a portfolio that is consistently cheaper than the market.”
Source: SVM Asset Management
The manager said that while examples of this in the UK are less clear-cut, there are numerous businesses in the US that fit this profile. For example, he described companies such as Microsoft, Alphabet, Visa and MasterCard as oligopolies or even monopolies, due to the high barriers to entry in the areas of the market where they operate, while their scale benefits and capital-lite business models mean they can continue to generate a superior return on capital for a prolonged period of time.
Yet Veitch said that someone rating these companies on traditional valuation metrics would likely conclude they are overly expensive.
“I think it is a gross oversimplification to look at tech as a heterogeneous entity, you can’t treat them all the same,” he continued.
“Microsoft, which has been a fantastic performer for a number of years, trades on a mid-20s P/E, has about 20 per cent of its market cap in free cash flow and its yield to EV [enterprise value] is probably 3 to 4 per cent, which isn’t a kick in the teeth off where Unilever’s free cash flow yield is.
“It is also growing cash flow at 10 to 15 per cent per annum and is on the right side of technological change. Yet I think most value investors would say it’s expensive.
“I actually think that with the growth trajectory that it has relative to its inherent strengths, it’s not.”
Veitch claimed that dumbing down is partly to blame for the amount of emphasis being placed on the binary growth versus value argument, with fund managers presenting their strategy to potential investors and clients in a way “that can fit neatly into a presentation pack”.
He said this tends to lend itself to a uniform screening-type approach that suggests you can narrow the universe down into a small number of variables – which is not the way markets work.
“For me, my investment process is more of a mosaic, which immediately sounds a little bit vague, like it lacks sufficient rigour and there’s no discipline,” he explained.
“But I think ultimately that’s the nature of investment: investment is shades of grey. Screening is a useful tool and we do use it, but an overreliance on screening can lead you in the wrong direction, just as overreliance on any one factor can.
“Ultimately, screening tells you where a company has been – it doesn’t tell you where the company is going.”
Veitch said this can be particularly problematic for value investing, as by definition it pushes you towards stocks that are out of favour, which is often for a good reason.
Yet he still believes that value is better placed to outperform than growth, pointing out it can exploit behavioural traps that investors often fall into when the market extrapolates the current situation into the future.
For example, he said some of the most attractive opportunities are thrown up when a company or an industry is undergoing a fundamental change that is yet to be reflected in financial performance.
“One of the things that we look for is a change in an industry structure whereby – and this is classic, economics 101 – capacity leaves an industry. Therefore, margins normalise, profitability improves and those shares outperform.
“You only have to look at the low-cost airline space over the last two to three months, the Ryanairs and the easyJets of this world. They were all fundamentally out-of-favour, the perception was that industry supply in terms of new capacity was stronger than people had believed and demand a little bit weaker because the economic outlook had deteriorated.”
Performance of stocks over 3 months
Source: FE Analytics
He added: “Airlines’ earnings are heavily operationally geared, so small changes and a relatively small number of variables can lead to large differences in profitability.
“We had Thomas Cook go bust, Norwegian has had a few more difficulties as a consequence of the economic outlook, a little bit is the impact on oil price, and the capacity outlook for next summer looks much more benign at a time when demand has stabilised.
“Ryanair’s share price has moved from below €9 in early August to almost €14 last week which, given the size of the business, a €6bn market cap, that’s fairly startling.”
Data from FE Analytics shows SVM UK Opportunities has made 604.98 per cent since launch in March 2000, compared with gains of 152.32 per cent from the FTSE All Share and 140.84 per cent from its IA UK All Companies sector.
Performance of fund vs sector and index since launch
Source: FE Analytics
The £130m fund has ongoing charges of 1.03 per cent.