Which future for Value-based Investment strategies?
This is a translation of an article originally written in French by Léon Kirch and published on 16 August 2016 in the Lëtzebuerger Journal.
(See pdf document for the original article).
Equity Management is divided into two main styles whose merits are often confronted: the Value style focuses on the company’s intrinsic value as well as on its capacity to generate earnings with its current production capacity. At the opposite, the Growth style centers its attention on the future development opportunities of companies.
Many academic studies have demonstrated the long-term supremacy of Value strategies compared to Growth ones; they have also established that this outperformance has usually been achieved at a markedly lower volatility than Growth approaches. In other words, value investors slept better while enjoying better performance than their growth counterparts!
And yet, from nearly ten years, since 2008 crisis, the Value Style is experiencing mixed results. 2015 can even be qualified as annus horribilis for European Value Equities with an underperformance of 14% compared to Growth stocks.
The below chart illustrates this paradigm shift.
Source: ECP, Bloomberg.
This difficult time is mainly explained by the current low rate environment resulting from the massive injection of liquidity by Central Banks. As an example, the rate of German Government Bond has passed from +3% in 2009 to currently negative levels. Thus, in a rather gloomy economic environment, investors have rushed into the few growing companies regardless of their valuations. Moreover, some analysis show that Value stocks have a tendency to react downwards in a low rate environment.
Does that mean that Value strategies have no future or is this current backlash temporary?
At European Capital Partners (ECP), we believe that, even if on a medium-term basis, interest rates will remain low, the Value style should regain its prestige; investors cannot indefinitely ignore the importance of valuations.
2016 could be a turning point: the first months of the year have shown signs of a trend reversal. And despite a short-term slowdown of the process due to the Brexit turbulences, the trend has turned again more favorable to value companies in July.
The main reasons for this long-term superiority of Value strategies lies, from our point of view, in the human-like market behavior (Mr. Market
as Benjamin Graham called it) which passed very quickly from a complete euphoria to deep depression. Furthermore, while one can easily get excited about the future growth potential of a company, it is however very difficult to predict it accurately. Many analysts have had a hard time with such forecasts, partly because they are blinded by the past growth rates of the companies when determining their projections. Value investors are exploiting those inefficiencies and only invest in a company when its stock price does not appropriately reflect its current economic reality.
As value investors, our aim is not to estimate the future growth of a company, we simply focus on its existing activity and on its ability to generate earnings.
Through a disciplined process we adopt a contrarian approach and stay away from glamour stocks which valuations are often excessive.
This investment strategy requires rigor, conviction and patience but has fully demonstrated its long-term relevance.