- We've been publishing the Ideas Farm for a year – whoopee!
- When we started out a year ago it was investors who were targeting growth and quality that were making hay.
- Now it's all about value.
- Changes in style trends are a fact of life in investing.
- Different styles tend to work better at different parts of the economic cycle.
- Loads of fresh idea generating data.
It was a year ago that the first ever Investors’ Chronicle’s Ideas Farm was published. We hope it's bought readers some interesting insights in that time. The 12 months have certainly been eventful with a full blown crash turning quickly into a stunning recovery.
One of the standout changes we’ve seen over the year is a significant shift in the type of company generating big returns for investors.
Our semi-regular style chart, based on analysis of returns from 13 separate strategies, aims to give readers an idea of which investment approaches (Value, Quality, Growth and Momentum) are currently generating the best three-month results. When we first published this chart on 6 May 2020, 'value' investing was clearly only for losers. It was quality and growth stocks that were all the rage, and so it stayed until late 2020.
As this week’s style chart shows, a year on and things are very different. Value has now been way out in front for several months.
Such changes in dominant trends can feel surprising. It is easy to get comfortable with the idea that there is one true path when it comes to the question of which investment style works. That’s because there is strong logic underpinning most well-known investment approaches. Couple that with a period of strong performance and it does feel like a kind of truth.
But a number of different and seemingly contradictory investment approaches can all claim to outperform over the long term. This boils down to the fact that each approach's outperformance tends to be generated in distinct time periods rather than across the piece. The fortunes of investment styles wax and wane in the shorter term.
Work by quant firm Research Affiliates from late last year pointed to the parts of the economic cycle that tend to prove particularly good for certain 'factors' (quant jargon for investment style). Periods of economic recovery, as we will hopefully continue to experience for a while, tend to be a sweet spot for value and small-cap focused investors. As an economic cycle moves into its growth phase, value and momentum tend to do best. As the cycle ages and slows, it is strategies based on quality, low volatility and momentum that are most likely to outperform. And when it comes to recessions, it is once again quality and low volatility that have a tendency to come out on top.
The trouble is that it is not easy to predict where we will be in the economic cycle in six to 12 months time. Furthermore, based on Research Affiliates' work, the long-term historical performance of a strategy tells investors next to nothing about what it will do next.
But what Research Affiliates has recently found is that the most reliable predictor of which approach is likely to be most profitable in the future is simply its performance over the past year coupled with how unloved that style is (the relative cheapness of stocks embodying that style compared with history).
Changing horse mid-race can be perilous, though. There is nothing wrong with investors knowing their investment-style knitting and sticking with it. In fact, this is usually the most intelligent option.