Markets could be on the verge of the biggest value recovery in a lifetime – yet it is a recovery that 93 per cent of investors look set to miss out on if their current positioning is anything to go by, according to Schroders’ Simon Adler.
Adler, a fund manager on Schroders’ equity value team, pointed to a graph of rolling 10-year UK performance figures going back to 1987 that showed the value style of investing has outperformed its growth counterpart over the vast majority of time periods. He noted this is not limited to the UK and that over 120 years, value has outperformed growth in almost every investment market in the world.
However, the manager said the most arresting aspect of the graph is that it shows the value recovery in 2000 went from minus 20 per cent to plus 30 per cent – and what is “amazing” is that the opportunity for a value recovery is even bigger now than it was back then.
“The underperformance of value today is the longest it has ever been since the Great Depression and it is the most extreme it has been since the Great Depression,” the manager explained.
“So the opportunity is not just an opportunity of a generation for value to recover, you actually have to go back to before the Second World War to the Great Depression for value to have as big an opportunity as it has today.”
Adler said the bad news is that the underperformance of value has had a “somewhat predictable impact on markets”. The manager noted that MSCI characterises every stock as either growth or value and when fund management groups such as Schroders upload their funds to MSCI indices, the organisation calculates to what extent they rely on either one of the strategies.
“When you top that up with the assets in funds, you get an absolutely incredible chart showing that 93 per cent of assets are growth-orientated today,” Adler continued.
“So as we look at what could be the biggest opportunity for value in a lifetime, unless people move their assets towards value, 93 per cent will miss out on that.”
Not everyone is convinced about the value comeback, however.
The FAANG – Facebook, Amazon, Apple, Netflix and Alphabet (Google) – stocks that have driven much of the growth of the US market over the past five years are now trading on sky-high P/E ratios, but Scottish Mortgage Investment Trust’s Tom Slater said anyone who dismisses them as overvalued has failed to grasp “the fundamental changes to society these companies have set in motion”.
His lead manager James Anderson added: “There’s a persistent illusion that the normal is of relevance. It isn’t.
“The reality of stock market investing is that outstanding returns are reliant on the ownership of a remarkably small number of stocks over very long periods.
“It’s only of interest to traders, speculators and investment banks if quarterly earnings reports exceed or disappoint expectations.”
However, Adler said that even if the value comeback doesn’t take hold, the strategy can still pay dividends.
For example, the value-focused Schroder Recovery fund has made 190.24 per cent over the past decade, more than double the gains of its IA UK All Companies sector and FTSE All Share benchmark, despite the fact its value style has been out of favour.
Performance of fund vs sector and index over 10yrs
Source: FE Analytics
Adler attributed this to Schroders’ own interpretation of the value strategy, which begins with a screen highlighting the cheapest 20 per cent of stocks in the market.
The team then applies a checklist of seven different questions to each stock which leads it to reject 98 per cent of companies recommended by the screen.
This process results in a profile that is more volatile than that of the market, however Adler said this simply reflects the emotion of the market and not true risk.
“We are very confident we are not volatile and we don’t believe that the underlying investments we make are volatile,” he explained.
“We will be volatile on a short-term basis versus the benchmark, that will always be the case and we are not ashamed of that.
“Because we will simply sit in our office around the corner from here, waiting for the market to be volatile and other investors to be emotional and that is what gives us our opportunities.”
Schroder Recovery manager Kevin Murphy said the process proved its worth in helping the team avoid one of the highest profile company failures of recent months.
“Carillion had been screening up as one of the cheapest companies in the UK for the past 18 months,” he explained.
“We didn’t own it in any of our portfolios in the value team and that is because it failed on turning its profits into cash, failed the financial stress test and failed the business quality test.
“And if over time you can avoid those cheap companies that deserve to be cheap, and only pick the ones that are temporarily cheap, you have an edge over your competition.”
The £1.2bn Schroder Recovery fund has ongoing charges of 0.91 per cent.