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Chris Gilchrist: The value of value investing

Chris Gilchrist 700

Value investing is so out of fashion that most people do not even refer to it that way any more. Most big fund houses talk about style and factors rather than embracing the value concept. According to Schroders, in 2006, about 40 per cent of UK equity income funds had a value bias, whereas today it is just 13 per cent – most of it represented by funds run by, guess who, Schroders.

The underperformance of value strategies compared with growth is uncontested. The Russell indices in the US show value has underperformed growth by 40 per cent since mid-2006.

Because value has been a losing strategy for a decade, fund managers have gradually abandoned it and embraced variants of what professors Marsh, Elroy and Dimson (authors of Triumph of the Optimists, whose work is updated in the Credit Suisse Global Returns Yearbook) call momentum strategies, such as sector rotation or “business cycle” investing. These all involve market timing by switching to the right sectors or stocks before other investors – what John Maynard Keynes described as the game of Old Maid that professional investors enjoy playing among themselves.

Yet the long-term data is also uncontested. Over the long term, value strategies have beaten growth hands down in the US and the UK, the markets for which the longest data runs are available.

JP Morgan points out the recent underperformance of value coincides with a steady fall in the US Treasury yield since 2006. This seems counterintuitive: when interest rates go down, surely people should be more interested in buying value stocks/high-yielding shares?

But on most recent turns in the market, the same phenomenon has been obvious: investors uncertain about the future are prepared to pay higher prices for stocks where growth is, they think, predictable. Even if the growth rates are lower than are required to justify the valuations.

The big danger in this is well known to any professional investor: you may be right about the growth but wrong on the valuation. When the Nifty Fifty craze in the US ended in the 1970s, it took over 20 years for many of those stocks to return to their peak prices. Over that period they produced miserable returns for investors despite delivering most of the growth they had promised.

Is this a Tony Dye moment? Value managers Kirrage and Murphy at Schroders must be hoping that Dye – the value investing proponent who was sacked from Phillips & Drew in February 2000 just as the tech bubble was about to burst – is not a role model. Yet he had been wrong for only a few years, whereas anyone still propounding value today must have a solidly loyal client base to remain in business.

The factors that have meant high returns for growth and poor returns for value in recent years are psychological rather than economic. Analysts’ arguments in favour of continued success for growth strategies come down to “this time it’s different”. Does that mean value stocks, value styles and value funds are now a screaming buy? Perhaps. The iron rule of markets is that a trend is a trend… until it stops. At the least, those following today’s growth Nifties need to know they may be completely right about projected growth and yet get very poor investment returns.

Chris Gilchrist is director of Fiveways Financial Planning



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