The past few years have seen growth style stocks outperform value. But as valuations for growth companies start to look expensive, is value making a comeback?
Growth stocks have outperformed over the past few years. Performance of the iShares MSCI World Value Factor Ucits ETF highlights this, returning -3.27 per cent in 2015 compared to 2.48 per cent for the iShares MSCI World Growth Factor Ucits ETF.
Looking to funds, the average return of value funds in the IA Global sector was -1 per cent over the past year compared with 4.35 per cent for the average of growth funds in the sector, according to data from FE. In the past five years, 2012 was the only time value beat growth in the Global sector, returning 11.4 per cent compared with growth’s 11.17 per cent.
But why have value stocks lagged growth? What has driven investors to growth stocks, and is the market primed for a turnaround?
The hunt for yield has played its part in growth outperformance. Low yields on many bonds and traditional income stocks have led many investors to income-yielding and dividend paying stocks. These tend to be larger companies with more stable earnings, falling into the growth bucket.
Heartwood Investment Management investment analyst Benjamin Matthews says in particular tobacco, food and beverage companies have benefitted from the trend. Since March 2007 the consumer non-durables sector, into which these companies fall, outperformed the broad MSCI World index by more than 80 per cent.
Matthews says: “The current uncertain environment has favoured long established companies with reasonable dividend yields, partly as a substitute for the lack of income available from other sources, such as bonds and cash. This trend is not unprecedented but the degree of valuation differential between non-cyclical and cyclical companies is, in our analysis, extreme.”
Meanwhile, value stocks, which tend to fall into cyclical sectors, have underperformed. A large part of this underperformance is due to a slump in banking, which makes up a big chunk of the sector. Energy and mining stocks, which have underperformed recently, also represent a big portion.
The level that investors have been shunning value strategies is highlighted by Morningstar flows figures.
Value funds in the Morningstar US Large-Cap Value Equity and UK Large-Cap Value Equity categories saw outflows in every quarter in 2015, totalling €7.25bn (£5.84bn) and €739m respectively. Meanwhile, the Europe Large-Cap Value Equity sector saw €154m inflows in Q3, following four quarters of outflows totalling €3.75bn. It returned to outflows in Q4 of €161m.
Sarasin & Partners fund of funds manager Lucy Walker says: “Investors were quite unnerved by a lot of stocks that have uncertainty and instead ran towards any companies that had consistency in their growth.
“That’s only attractive if you’re not paying a high multiple for those companies, but suddenly today quality is as expensive as its ever been and so actually the companies that are delivering that consistent growth are very expensive.”
Square Mile senior investment research analyst Andrew Johnston says: “Given the recent performance dispersion between these two styles value should clearly be an area of consideration.
“We would say that clearly growth, and defensive growth at that, has been very much in vogue in recent years, with investors appearing happy to pay up for reliability in a low growth world. However, we have seen some value areas, especially mining, finally having a better time of it this year.”
The past few weeks have offered “early signs that a change in leadership could be underway” says Fidelity Special Values portfolio manager Alex Wright. “And in many cases, investor’s positioning over the past two years will have left them ill-prepared for this.”
“If this more benign macroeconomic picture endures, the market will re-appraise the prospects of the stocks currently in the reject bin, and the gulf of valuations will have to narrow.
“In my experience, when the risk premium is so high, it can help to focus on the fact that the price you pay for the stock more than fairly compensates you for the uncertainty of the outcome,” he says.
Walker has initiated some positions in value strategies, doubling the equity exposure to value stocks in the past two years in the Sarasin & Partners Global Strategic Growth fund of funds. Most recently she invested in the Schroders Recovery fund late last year, which she describes as at the “deep end” of value. She has also added a position to the US fund Vulcan Value Equity.
Schroders Recovery fund co-manager Kevin Murphy says value has been “the only thing that is trading at a significant discount to where one would expect”.
He says: “It has performed extremely poorly over the course of the last almost five years. As such, history would suggest, it will rebound and when it rebounds it will be a significant rebound.”
In particular he highlights banks as one area likely to offer the best risk-reward payoff, including Lloyds, RBS, Barclays, HSBC and Standard Chartered. He also highlights emerging markets as the best geographic area to find value.
However, he says it is hard to tell when the sector will bounce back. He adds: “What I can say is they are due a rebound in performance at some point over the next three to five years.”