Is a value-focused approach due its time in the sun, asks Seneca’s Gary Moglione.
With stockmarket indices near all-time highs, capital growth has not been a problem over the last decade or so: investors have had a good ride. Quoted companies have found it cheap to borrow money, which has led to greater levels of capital expenditure and boosted profits, in turn encouraging more investors to buy shares and pulling prices up.
The elephant in the room is the artificially low and accommodative global interest rate environment, which many admit may have artificially inflated asset prices and profitability. It has underpinned the investor optimism that has been a key feature of the developed financial markets over the last decade.
What happens next?
But what happens when that optimism begins to wane? What happens when capital growth cannot reward the investor any longer? When capital market expectations begin to change, and monetary policy ammunition recedes? An increasing number of market commentators and investment experts believe we are approaching the end of the bull-market run. If correct, where does this leave growth-oriented investors used to prolonged positive capital returns?
We have already seen a lot of pre-emptive action, and many investment managers have cut their exposures to growth equities in anticipation of this market turn, understanding that growth stocks take the biggest hit to valuations when markets fall.
However, the effect on higher-yielding stocks (yield is what a company pays out compared to its price) tends not to be quite as extreme, and this is a feature we consider to be an important factor of ‘value’ investment.
An important point to note about value investing is that it is not about finding the cheapest price among similar assets. Rather, it is about identifying the intrinsic value of a company and assessing whether the market has priced this correctly. Almost like arbitrageurs, value investors are effectively looking to make profits in companies that have strong fundamentals but are not recognised as such by the market. However, the market must then correct itself for them to profit – and therein lies the risk.
Good value investing also requires a disciplined investment process, a high-conviction approach and a long-term view. If you think about value investing as actively seeking stocks the market is underestimating or being unfair to, the position should end up being a very contrarian one – and at times a lonely place for an investor.
As the cycle turns, though, a return to a value ethos could protect and enhance portfolios over the next phase of the business cycle. In a market downturn where there are more sellers than buyers, this means being exposed to higher-yielding value shares, where the shorter-term, income-based cashflow will return more to investors than lower-yielding stocks relying on overly optimistic capital market expectations.
Value investing is not just restricted to equities and bonds.Diversification, as Modern Portfolio Theory states, reduces volatility without sacrificing potential returns. In this sense, value investing need not just be relegated to traditional asset allocation mixes of equities and bonds, and can instead take a wider perspective using other assets such as property, private equity, specialist financial and infrastructure.
Not just equities and bonds
Invesco Perpetual European Equity Income – This fund is run by an experienced manager in Stephanie Butcher, who uses core fundamentals and a value approach to navigate the European investment landscape.
Morant Wright Fuji Yield (unhedged) – managed by a highly experienced team of six value-orientated portfolio managers, who seek companies with strong balance sheets and/or business franchises that are trading at low valuations. The majority of the portfolio trades at a price-to-book ratio of less than one, and a large portion of the companies it holds have cash and/or investments that are valued higher than their market capitalisation.
Ediston – There is a misplaced perception that this property trust is exposed to high street retail holdings; as a result, it currently trades at a 22% discount to net asset value and is currently yielding almost 7%. The team focuses on a mix of office and out-of-town retail parks. Retail behaviour is certainly changing as a result of internet shopping; Ediston’s thesis is that consumers still enjoy the shopping experience at out-of-town retail parks, while retailers benefit from stores with convenient parking that commuters can use to pick up online orders.
Gary Moglione is a fund manager at Seneca Investment Managers.