He says the move away from growth stocks that began once the world started to get Covid-19 under control is backed by rising interest rates and the attraction of the lower carbon footprints of many value-orientated companies.
Value investing is the practice of picking stocks whose market values do not reflect the company’s true potential, offering upside in the share price. More expensive growth stocks that had dominated since the global financial crisis left investors looking for ‘sure things’ for over a decade – but that winter for value is now thawing.
“The growth style is undefined from a factor perspective, whereas value has a clear approach,” says Graham, senior portfolio manager with the Robeco Sustainable Multi-Asset Solutions team. “The growth style is a mixture of earnings quality/predictability and business model momentum for those companies with potentially super-high profits that are on their way to market dominance.”
“Some companies will succeed; we know the household names. However, there are many that will fail as their business model is exposed, and the ‘cheap money’ runs out. Do you remember Napster, Boo, Broadcast, Netscape, Bear Stearns, Pebble, etc.?”
That’s not to say that the value style is without its own potential pitfalls, and as the old saying of ‘caveat emptor’ warns – let the buyer beware, he says.
“The most obvious downside of value investing is the ‘value trap’ where companies don’t innovate their way out of a ‘dying’ industry, or looking through a sustainable lens, those companies left with stranded assets,” he says. “There are many historical and current examples of companies and industries we can refer to; coal, tobacco, camera film, etc.”
“We can observe that the sectors and industries within the value style change – tech and health care make up 20% of many value funds today. We are strong believers in active management which can help avoid and mitigate these pitfalls.”
“The data shows that the rotation away from growth began in Q3 2020, so these are not recent observations. Financials started to make a comeback once the US Federal Reserve stopped the post-Covid QE and investors realized that the fiscal stimulus would require higher rates as economies reopened and labor markets recovered towards full employment.”
“In a nutshell, yield curves began to steepen and then flatten towards the end of 2021. This created a catch-up for part of the value universe, although by the end of 2021, the growth and value styles were performing in line.”
After a stock market wobble in early 2022 on high inflation fears, the value rally saw another resurgence when both the US Federal Reserve and the Bank of England raised rates to combat spiraling prices – and then Russia invaded Ukraine.
Graham says this means the value rally looks like it’s here to stay, a sentiment recently echoed by Robeco’s value investors in the US, Asia and Europe.
“Very rarely in bull markets does the leadership change,” he says. “Sustained underperformance of the bull market champions could signal tougher times ahead for equity market performance.”
“We note that the value leadership baton was passed to the mining and energy sectors as the economic recovery remained supercharged and supply constraints became tighter after Russia invaded Ukraine.”
“Multi-asset investors use ‘safe haven’ assets to dampen volatility in fund performance. However, from our vantage point in this episode, government bonds have failed to provide this diversification. This has meant that equity and bond prices have moved in the same direction – namely down.”
“The US dollar did not see flows from investors seeking safety; indeed the euro rallied as the ECB continued its hawkish tone and its alignment with Fed tightening. As the war in Ukraine escalated, the US dollar rallied, and investors questioned the alignment between central banks.”
“The ECB and the Bank of Japan are less able to raise rates, while the US has begun a tightening policy by raising rates and signaling that more is yet to come.”
Now, the rally is being given a boost by the need to combat climate change and achieve net-zero emissions by 2050.
“The value winter is thawing, and we are finding the stock-picking universe to be different to those of previous cycles, with investors finding IT and health care names eligible for investment within the value style,” Graham says.
“The recent leaders of the value style in the more conventional value sectors have environmental footprints that are 50% of their respective global equity benchmarks, and the style is still historically cheap.”
“At Robeco, we are committed to climate transition, and this includes the value style. The decarbonization of value allows us to fully capture the risk premium while significantly lowering our carbon footprints.”
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