Show me the value

If markets tend to overreact to bad news, where does that leave stocks after a year like 2020? Ninety One’s Value portfolio managers explain why value approaches could be valuable to investors next year and beyond.

11 Dec 2020

4 minutes

Alessandro Dicorrado
Steve Woolley

Show me the value

Value investors believe opportunities arise because markets overreact to bad news. So after a year of exceptionally grim headlines, where does that leave stocks? Ninety One’s Value portfolio managers – Alessandro Dicorrado and Steve Woolley – highlight seven reasons why value approaches could be valuable to investors next year and beyond, as part of a diversified portfolio.

For more from Alessandro and Steve – who manage Ninety One’s UK Special Situations and Global Special Situations strategies – listen in to their conversation with Peter Toogood, CIO of Embark and founder of The Adviser Centre: Click here to listen.

“Moving into next year, it’s going to be more dangerous if you just keep sticking with the traditional utility-like and/or full-on growth-type portfolios. The balance of risk says that part of your portfolio … must have a value component.” – Peter Toogood, CIO of Embark, founder of The Adviser Centre.
1. The value tide may be turning

After a tough start to the year, value stocks rallied hard in November as positive news on vaccines gave the market hope of a return to something like normality. We think this could be the start of a rotation back towards value. We have always believed that business conditions would improve eventually, and that the market had overreacted in a number of areas, and have been investing accordingly.

2. Value has plenty of room to run

Even after gains of 40-60% in some value stocks, value equities – many of which are in more cyclical sectors – are still massively underperforming the rest of the market. Don’t forget that, before the coronavirus, many people believed a recession was coming. Consequently, businesses perceived as cyclical were being hammered, while growth stocks soared. The coronavirus exacerbated these trends. We think ‘value’ still has a lot of room to run.

3. Value remains cheap

Value stocks remain cheap relative to our estimates of intrinsic value, and relative to growth stocks. Simply put, we still think they can offer great value. Before the pandemic, for example, you could buy a bank stock offering a 10% cash return to shareholders, even in a low-interest world. If a recovery continues, that same bank might one day offer a 15% cash return annually on the current share price, comprising dividends and share buybacks. We think that’s extraordinary when you consider what you are being asked to pay for some ‘growth’ companies.

4. Value is more than a recovery trade, but don’t ignore the cyclical opportunity

Value investing is about buying a company that is trading at a big discount to conservatively-appraised value, which may happen for many different reasons, from macro factors to company-specific issues. So it is far from just a cyclical play, as some investors seem to think. And nor is it only ‘deep value’ investing (i.e., buying mediocre businesses at very attractive prices) – in fact, ‘deep value’ opportunities are the smallest part of our portfolio.

Rather, many of our investments are good businesses in sectors that are experiencing structural growth, but whose valuation is depressed for some reason. This opportunity set has widened, because the COVID-related market falls have put more companies with structural advantages into the value camp.

5. Value can be ‘new economy’

People sometimes think of a value stock as an old-economy business, like a high-street department store. But this is a myth. Value rotates through sectors over time, and some of the tech darlings of today will be value opportunities in the future.

In our portfolio, we have invested this year in a number of technology companies that operate in the travel sector. That’s because the best risk/reward we could see when the pandemic hit was in travel-exposed companies that we believed could make it through the crisis. Travel generally is a structurally growing sector and not ‘old-economy’. But because of the coronavirus, companies within it have been trading well below our estimates of their intrinsic value.

6. Value can be sustainable

Value portfolios are sometimes perceived as being low-scoring from an environmental, social and governance (ESG) perspective. But they don’t need to be. We integrate ESG into our process, and take a common-sense approach to sustainability more broadly. And we engage with companies when an opportunity arises to make things better.

The whole world is transitioning to a more sustainable model, and we think the key is to be invested in businesses that will be around after that transition happens. You don’t have to buy into ‘pure-play’ low-carbon companies, such as those that only make electric vehicles. For example, we are invested in several auto-sector businesses that are investing massively in electrification.

7. Value doesn’t need inflation, but it would be a tailwind

With the US Federal Reserve (Fed) shifting to average inflation targeting and likely to not only tolerate but require an overshoot of its inflation target, there’s a chance of an inflationary scare next year. That would likely be a tailwind for a value portfolio and a headwind for growth stocks, which are long-durations assets [i.e., their value tends to rise when interest rates fall, and vice versa].

We think of a well-positioned value portfolio as one that offers exposure to cheap stocks that should do well in a cyclical upturn, with the additional advantage that it may provide some inflation protection. The latter is a quality you don’t get in many asset classes – particularly ones that offer income, in this case in the form of dividends.

Specific risks

Concentrated portfolio: The portfolio invests in a relatively small number of individual holdings. This may mean wider fluctuations in value than more broadly invested portfolios.

Currency exchange: Changes in the relative values of different currencies may adversely affect the value of investments and any related income.

Derivatives: The use of derivatives is not intended to increase the overall level of risk. However, the use of derivatives may still lead to large changes in value and includes the potential for large financial loss. A counterparty to a derivative transaction may fail to meet its obligations which may also lead to a financial loss.

Equity investment: The value of equities (e.g. shares) and equity-related investments may vary according to company profits and future prospects as well as more general market factors. In the event of a company default (e.g. insolvency), the owners of their equity rank last in terms of any financial payment from that company.

General risks

All investments carry the risk of capital loss. The value of investments, and any income generated from them, can fall as well as rise and will be affected by changes in interest rates, currency fluctuations, general market conditions and other political, social and economic developments, as well as by specific matters relating to the assets in which the investment strategy invests. If any currency differs from the investor’s home currency, returns may increase or decrease as a result of currency fluctuations. Past performance is not a reliable indicator of future results.

Authored by

Alessandro Dicorrado
Portfolio Manager
Steve Woolley
Portfolio Manager

Important Information

This communication is provided for general information only should not be construed as advice.

All the information in is believed to be reliable but may be inaccurate or incomplete. The views are those of the contributor at the time of publication and do not necessary reflect those of Ninety One.

Any opinions stated are honestly held but are not guaranteed and should not be relied upon.

All rights reserved. Issued by Ninety One.