The catalyst that will transform the fortunes of value-oriented trusts is difficult to pinpoint, but several appear well-positioned to come good for long-suffering investors.
One of the defining characteristics of the investment world since the financial crisis of 2008/09 has been the underperformance of value investing as a style. There has been much academic work suggesting that over the long term a value approach – in simple terms buying companies where the prices are cheap relative to fundamentals – usually pays off. But in the past 10 years this has emphatically not been the case.
In the decade to end-February 2019, the MSCI World Value index underperformed its parent MSCI World index by 7%. In contrast the MSCI Momentum index, based on selecting companies with the best recent 12-month and 6-month performance, outperformed MSCI World by 19%. In only three calendar years out of the last 10 – 2009, 2012 and 2016 – has value beaten momentum.
To this end, we assess how value’s underperformance has affected some of the UK’s best-known investment trusts and how they have reacted; suggest some reasons why this trend may have occurred; and consider the potential for it to reverse.
Of course, one should start with a few caveats: we can identify a broad category of value investing but the term ‘value’ means different things to different people. Further, concepts of value may change over time. Finally, it should be highlighted that the period prior to the last 10 years was pretty good for the value style: the bursting of the dotcom bubble vindicated the approach and most value managers had a pretty good financial crisis, at least in relative terms, by simply avoiding overpriced banks. It may be painful for some to recall, but in February 2007 RBS was priced at more than £60 and on a price/earnings ratio of 30. Today the shares are 250p.
Investing for income from UK equities has long been considered one of the homes of value investing, typified by Invesco-managed trusts Perpetual Income & Growth (PLI) and Edinburgh (EDIN). While Neil Woodford was the lead manager of Edinburgh until his departure in 2014 to form his own company, deputy Mark Barnett was already installed at PLI. He now manages both trusts.
How value-oriented trusts are performing against index benchmarks
|Net asset value total return after:|
|3 years (%)||5 years (%)|
|MSCI AC World index||50.7||70.9|
|UK equity Income/UK all companies|
|Perpetual Income & Growth||1.3||10.1|
|Schroder Income Growth||31.7||29.7|
|FTSE All-Share index||30.4||27.6|
|UK Small Cap|
|Miton UK Microcap||13.8||N/a|
|FTSE Aim All Share index||36.9||N/a|
|Aberforth Smaller Companies||27.6||19.7|
|FTSE Small Cap ex Inv Cos index||24||21.2|
|Henderson European Focus||33.5||42.8|
|FTSE World Europe ex UK index||38.7||38.4|
|EMIX Smaller European Cos ex UK index||44.7||50.6|
|Aberdeen Standard Asia Focus||39.9||46.1|
|Aberdeen Asian Income||46.8||47.8|
|MSCI AC Asia Pacific ex Japan index||59.8||65.7|
Notes:* The benchmarks selected are not necessarily those of the trusts in the table. Source: AIC and company factsheets as at 1 March 2019.
Scepticism is the heart of value
Writing in June 2012, Barnett’s outlook for PLI included the following: “Ultimately (quantitative easing) measures are likely to be seen as only symptomatic relief of the problems rather than addressing the cause – an excess of debt across the developed world.”
This world view engendered a cautious approach to stock selection, with a concentration on tobacco and pharmaceuticals stocks (tobacco had also been the mainstay of Woodford/Barnett investments during the dotcom bubble). By March 2015 the top five stocks in PLI included AstraZeneca and three tobacco stocks. So far, this approach has not paid off, with the three- and five-year net asset value (NAV) performance to end February 2018 lagging the FTSE AllShare index by 29 and 18 percentage points respectively.
The recent PLI performance record was particularly hurt by the two years to 31 March 2018, the trust’s year-end.
In the first annual period to March 2017, where PLI underperformed the FTSE All-Share by 12.4 percentage points, Barnett commented: “Control of supply [of commodities] has improved following the shock of the 2011-2015 downturn, but demand growth in China remains under pressure and the sector, to my mind, now looks vulnerable to a fall in the prices of certain key commodities.”
In the short term this proved a wrong judgment, since in the following year’s annual report the chairman commented: “The year’s return shortfall relative to the FTSE All-Share Index (6.8 percentage points) derived mainly from not holding mining stocks, a setback in tobacco stocks and issues affecting certain individual holdings, particularly Provident Financial and Capita.”
The year to March 2017 had also encompassed both the vote for Brexit, which hurt UK domestically focused stocks and favoured international earners through the depreciation of sterling, and the election of president Trump, whose tax policies gave a boost to US earners.
In summary PLI’s medium-term underperformance can be seen as a product of four factors: scepticism about the ability of QE to stimulate the global economy, leading to an overly cautious stock selection; suspicions about Chinese growth, in particular resulting in no commodity exposure; an over-reliance on UK domestic stocks; and finally some stock-specific issues, particularly Provident Financial and Capita.
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Suspicions of China
The latter are perhaps the most surprising mistakes for a value investor. These stocks were longstanding holdings of the Invesco value stable, but could have been sold on price/earnings multiples in the mid to high 20s before they went wrong. Such multiples for a door-step lender and a not very well-regarded support services company surely should have raised some alarm bells. In other words, one can forgive the macro views, which may eventually come right, but the stock-specific issues seem surprising.
Hopefully, the specific stock-selection errors are in the past. PLI is perhaps a classic contrarian play in that the relative performance over three years in particular has been so poor that some turnaround seems likely; depressed valuations of UK domestic stocks provide some support, as do the trust’s 11%- plus discount and a yield of 4.3%. The trust is still geared at around 15% so would suffer in a very severe recessionary environment, but the ongoing yield and upside potential should more than compensate for this risk.
At the Temple of value
Temple Bar (TMPL) is another value-oriented trust with a proud long-term record (a trust with which I was previously associated) which has lost some of its mojo, although recent performance has picked up markedly. The five-year record to 28 February 2019, however, lags the All-Share index by a whisker.
Here, we see many of the same themes that have impacted PLI: concerns about the level of global debt and scepticism about the effectiveness of QE in doing anything other than generating inflation were to the fore. In December 2014, manager Alastair Mundy commented: “Geopolitical problems, central bank policy, emerging market problem areas and the growing levels of government debt around the world all suggest the potential for higher volatility and reasons to believe that there will be better times to take on more risk.”
Here again the manager’s world view suggested a cautious approach, but in Temple Bar’s case this manifested itself in holding a relatively high degree of cash and, because of inflation concerns, an allocation to precious metals. Both of these decisions hurt performance in a period when stockmarkets have generally been on the up and inflation has largely been quiescent.
Mundy also shared a suspicion of Chinese growth, which led him to under-allocate to mining stocks as well as fuelling his scepticism about global growth. His general view about China was summed up in an interview a few years’ back, when he said: “Last time I looked they had a communist government.” True, but possibly lacking in a nuanced assessment.
To be fair, Temple Bar has largely escaped the kind of car-crash stocks that have cost the Invesco stable. Interestingly, the manager bought into Capita after it had fallen a long way – too early as it turns out so far – but sticking very true to value investing principles.
If both the US and the UK markets – the latter at least at the small company level – were dominated by the performance of a small number of stocks, usually in technology or internet-related sectors, this was also true of investing in Asia.
Hugh Young, head of Asia investment for Aberdeen Standard (previously for Aberdeen) is another value manager with a strong record who has hit a rocky period. Over both three and five years to 28 February 2019 Aberdeen Standard Asia Focus Trust (AAS) (formerly Aberdeen Asian Smaller Companies) underperformed the MSCI AC Asia Pacific ex Japan index by close to 20 percentage points.
The shortfall in the group’s general Asian performance (which also hit other trusts) has been attributed by Young to an under-allocation to China, a familiar theme, and in particular to not holding the Chinese technology and internet companies Tencent and Alibaba. As with the so-called FAANG stocks in the US, these two have dominated index performance in Asia.
AAS itself may not have been able to invest in these stocks because of their market size, but technology has not often featured in the top 10 investments. In a recent interview Young stated that his emphasis was on “quality and good balance sheets and maybe not the raciest of companies – really solid, well run, middle-tier growth, rather than companies seeking to double earnings every year”.
Has Aberdeen’s Asian performance been affected by the Standard Life merger? Often when fund managers merge the result is not too happy for one side or the other, but in this case, performance is more likely a result of style than disruption.
Both European Assets (EAT) and Henderson European Focus (HEFT) have had a value bias and a good long-term record but have suffered medium-term setbacks. Over the three years to 28 February 2019 HEFT, for example, has underperformed the FTSE World Europe ex UK index by 5 percentage points.
The same theme as that adopted by Young of sticking to the knitting in terms of value versus growth/ momentum is evident from HEFT’s manager John Bennett. For the year ended September 2018 he comments: “There is, of course, nothing to say that tech must stop now, at 30% of US market capitalisation. However, it is worth noting that it has doubled its weighting since 2004. It is also worth noting that 2018 was a record year for IPOs of loss-making businesses in the US equity market. The mean reversionist cannot help but reflect that a lot of benefit of the doubt is granted to the mooted winners of the future.”
Bennett adds: “Now is not the time to abandon a selection of so-called ‘value’ stocks in favour of an all-out ‘growth’ (or momentum) portfolio. Happily, Europe offers an ample selection of both styles and our investment DNA contains the pragmatism necessary to capitalise.”
Not dead but sleeping?
Many well-known investment trusts with good long-term records have suffered recently chiefly because of their value bias. Recent years have seen a perfect storm against value: an economic recovery regarded with huge suspicion because of QE; low inflation and low interest rates which have favoured growth stocks and ‘bond proxies’; disruptive technology which has hurt established companies; and a populist surge (with the Brexit vote in particular affecting UK domestic stocks adversely) leading investors to be cautious.
As to the future, what will be the kiss that wakes the sleeping beauty of value? The truth is that catalysts are rarely visible, but most scenarios should see value outperform at least relatively, although admittedly many have been saying this for some time.
The difference now, perhaps, is that valuations are so depressed in value versus growth/momentum stocks that it is hard to see value underperforming in a recession. If the global economy regains some strength, then value should come into its own. And, of course, in the meantime there is always the comfort of a high dividend yield, which is often a feature of value stocks and the investment trusts which invest in them.
Of the value-oriented trusts above, looking at three contrarian trusts as a portfolio, we like the combination of Perpetual Income & Growth (very defensive UK exposure), Henderson European Focus (balanced exposure to Europe) and Aberdeen Asian Income Fund (AAIF), as an income alternative to AAS, which also gives some exposure to Asian growth.
Value to bounce back in UK micro-cap?
Another manager with a strong reputation and a good long-term record is Gervais Williams, who now co-manages Miton UK Microcap (MINI).
Over the three years to end-February 2019 (the trust was established in April 2015), the NAV has grown by 13.8% versus 36.9% for the FTSE Aim All-Share index.
The trust puts this underperformance down to not holding some of the larger Aim-listed growth stocks: “The very best of the returns within the Aim exchange have been driven by a number of high-profile UK growth stocks,” the managers say. The comparison being made is with the outperformance of the FAANG stocks in the US, albeit on a much smaller scale.
Not only were these stocks generally outside the market capitalisation restrictions of the trust, but they were not perceived as fitting in with the manager’s value approach.
UK micro-cap probably has suffered disproportionately from the Brexit vote, but the strong performance from stocks with momentum, often in the technology sector, has clearly hit the relative performance of value managers. This could be an area to bounce back strongly if the global economy regains momentum, subject to some sort of satisfactory outcome to the Brexit negotiations.
The author is chief executive of IpsoFacto Investor.