11 Dec 2020
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.
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.
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.
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.
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.
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.
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.
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.