Growth has outperformed value over the past decade. The only real exception to this trend was in 2016 when value momentarily outperformed by double digits. Since then, growth has rallied strongly, driven primarily by a handful of mega-cap darlings. This resulted in the widest valuation spreads between growth and value on record, largely triggered by the significant performance dispersion over the last two years ending 31 December 2020, as seen in Figure 1.
In fact, this period is comparable to prior phases of multiple expansion, such as the Nifty Fifty and the dot-com eras, when growth stocks, such as Hewlett-Packard (HP) in the 1990s, surged. Since then, HP has matured into a value stock following a long, wintery period for its investors. Therefore, we believe value investors are well-positioned for a mean reversion in share prices, particularly if the growth stories linked to some of the expensive stocks fail to materialize.
Research shows that value helps to reduce drawdowns in multi-style portfolios in the long run
The value style is an effective diversifier in multi-manager portfolios. It has a negative historical correlation with trending markets and just a slightly positive historical correlation with high-quality or low-risk investing. Furthermore, research shows that value helps to reduce drawdowns in multi-style portfolios in the long run (i.e. value can function as ‘bubble hedge’) and improves risk-adjusted returns, even when we assume there is no positive value premium.1 Besides the overwhelming academic evidence in favor of value, we believe investors need to consider whether it is prudent to continue to bet against the style. In our opinion, the diversification benefit of allocating to value is reason enough to consider it in your portfolio.
Beyond considering an allocation to value, it can be challenging to choose the correct value stocks or the appropriate value strategy for your portfolio. If you just search for large-cap funds with ‘value’ in their names in Morningstar, you will find an overwhelming number of funds. If we analyze their styles, however, we find that many of these funds do not actually offer high value exposure. Some may offer partial value exposure. Others might have offered it in the past, but experienced strong style drifts.2 Ultimately, many ‘value’ funds do not offer deep, and more importantly, consistent value exposure over time. We believe, however, this is crucial when constructing a diversified, multi-style portfolio.
Indeed, we build deep and consistent value portfolios, but remain cognizant of potential value traps. The Robeco Value Equities strategy implements a sophisticated approach to harvest the value premium, which results in a portfolio of well-diversified value stocks. Risk awareness is integral to the investment process. The investment team aims to steer clear of value traps (including unrewarded distress risk) by incorporating signals, such as the probability of default and profitability, as well as other indicators, like earnings revisions.
Generic value strategies are often considered unsustainable as they are typically tilted towards asset-heavy sectors such as energy and materials. It is possible, however, to build sustainable value portfolios with reduced carbon footprints.
To avoid concentration in less sustainable companies in the Robeco Value Equities strategy, we incorporate environmental, social and governance (ESG) considerations in every step of the investment process. For instance, we establish that the portfolio’s ESG score is higher than that of the market index. We also ensure that its footprint on carbon, waste and water is lower than that of the benchmark.
In fact, we implemented an innovative methodology in 2019 to reduce the environmental footprint of our portfolio. While conventional value strategies (e.g. using book-to-price measures) often have an environmental footprint that is more than 50% above their respective benchmarks, our enhanced valuation measures do not exhibit tilts to high emitters.3 In 2020, we took another step by adding fossil fuels (e.g. arctic drilling, oil sands and thermal coal) to our exclusion list.
Prolonged periods of value underperformance, due to the expansion of valuation multiples, are historically followed by sharp rallies
Despite the protracted underperformance of value, there are good reasons to allocate to the style. Prolonged periods of value underperformance, due to the expansion of valuation multiples, are historically followed by sharp rallies. More recently, the announcement of successful Pfizer-BioNTech vaccine results on 9 November 2020 has triggered a broad rotation from growth into value, perhaps signaling the start of the long-awaited value comeback. Although timing equity markets and factors is extremely difficult, we believe the longer-term outlook for value is attractive.
1Please see: Van Vliet, P., and Baltussen, G., August 2020, “Will value survive its long winter?”, Robeco article.
2Please see: Baltussen, G., Rohof, J., and Hagens, J., March 2021, “Value investing: Now…but how?”, Robeco article.
3Please see: Swinkels, L., Ūsaitė, K., Zhou, W., and Zwanenburg, M., October 2019, “Decarbonizing the Value factor”, Robeco article.
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