- The rotation to value appears to be just starting
- You have to pay a premium for US-listed value stocks relative to other areas because they are more profitable
- UK and Japan funds appear to be good ways to tap into value opportunities
fter a decade of struggling to keep up with global indices, funds that have a value investment style – buying stocks that appear to be trading for less than their true value – are finally faring better than funds that focus on growth stocks. In keeping with this, the value-heavy UK market has outperformed rivals around the world.
And a glance at valuation ratios suggests that the rotation could just be getting started. “Value looks cheap relative to growth and cheap relative to history in all markets,” says Mick Gilligan, head of managed portfolio services at Killik & Co.
He points to the simplistic method of dividing the price to book (P/B) ratio of value indices by the P/B ratio of growth indices and comparing that to their long-term averages. The table below shows how the major indices compare, with the MSCI US Value Index’s P/B ratio only 0.26 times that of the MSCI US Growth, and substantially lower than its long-term average since 1995. A similar trend is clear across the world.
|MSCI index region|
Value P/B divided by growth P/B
Average value P/B divided by growth P/B since 1995
|Europe (ex UK)||0.31||0.48|
|Source: Bloomberg via Killik & Co, 10.05.22|
|Index performance 1 January 2022 - 12 May 2022|
|MSCI World IMI Growth||-24%|
|MSCI World IMI Value||-7%|
|MSCI United Kingdom IMI Growth||-13%|
|MSCI United Kingdom IMI Value||5%|
The data suggests that “we need to see a further 50 per cent relative move of value versus growth to get back to the long-term average”, says Gilligan, adding that he likes to look at the P/B ratio when assessing valuation as it is a stable measure. However, he adds that for certain industries such as mining, price/sales has been a better forecasting tool.
Andreas Wosol, head of value at Amundi, notes that the war in Ukraine changed the recovery narrative from reflation and reopening to stagflation, with energy and miners offsetting weakness in financials and other consumer sectors such as autos, retailing, and travel and leisure. “These sharp movements offer opportunities for long-term value investors,” he says.
He adds that the sell-off in growth parts of the market, especially semiconductors, luxury and apparels, is starting to offer attractive opportunities in itself.
Other commentators broadly agree. “Between growth and value, there is still room for value to continue its recent rally but most of the margin has been taken up already," says Richard Champion, deputy chief investment officer at Canaccord Genuity Wealth Management. “Financials is probably the biggest area in value that looks interesting – banks have been hit in the past and they’re in a better position than others to weather this downturn."
And James Yardley, senior research analyst at Chelsea Financial Services, says that some areas of value “don’t look that cheap” and will be vulnerable if the economy rolls over into a recession as a result of higher rates. “Some mega cap tech is compelling,” he explains. “The likes of Alphabet (US:GOOGL) and Meta Platforms (US:FB) are now becoming value stocks but have fortress balance sheets.”
Finding the value
You still have to pay a premium for US-listed value stocks relative to those listed in the UK, Japan and many other countries. Champion says that there is good reason for this as “US companies are inherently more profitable than other areas – they make a 2 per cent higher return on capital than [those listed in] other countries”.
But even taking that into account the UK still looks cheap, partly because it has been under owned by international investors following the Brexit vote and currency volatility.
“Relative to the US and global markets, the UK is probably as cheap as it has ever been,” says Peter Sleep, senior investment manager at Seven Investment Management. “Comparing similar companies in the US and the UK, American companies can appear relatively expensive because they enjoy high degrees of political and legal certainty, and easy access to cheap financing, and have an exceptionally large domestic economy to operate in.”
Japan is another market that value investors single out as it has some high-quality businesses trading on low valuation ratios. For example, the P/B ratio of the MSCI Japan Index was 1.36 times at the end of April compared with 1.84 times for the MSCI UK Index. However, Sleep cautions that “Japanese corporate governance is very conservative and the companies tend to hoard cash and non productive assets on their balance sheets which can result in very low returns on capital”.
Across sectors, the jury is out on where the best opportunities are. Gilligan thinks that natural resources still look attractive with the MSCI Metals & Mining Index trading on a price/sales ratio of 1.2 times, compared with a 2010 peak of 1.8 times. “BlackRock World Mining Trust's (BRWM) portfolio trades on a price/sales ratio of 1.3 times,” he says. “I could see this valuation moving higher from here given the supply tightness in several key commodity markets.”
While energy has been one of the best-performing sectors recently because of a supply crunch and being under owned, Yardley questions its long-term sustainability and is “nervous of some of the cyclical value sectors such as energy, financials and mining because their valuations have already increased and they are likely to struggle if we go into recession”.
He thinks that cheap industrials or consumer discretionary stocks which have been beaten up and are already pricing in a recession might be interesting, but I “would probably wait before buying them”.
Given steep share price falls, more than one investor thinks some growth stocks are now entering value territory. Mark Ellis, manager of Nutshell Growth Fund (IE00BLP46Q11), thinks that the quality growth premium has evaporated and his fund's five largest holdings include Adobe (US:ADBE), Microsoft (US:MSFT) and Alphabet.
He has been increasing exposure to information technology stocks during the recent sell-off and reducing healthcare. "We especially think that large-cap US tech is very compelling," he says.
Biotech companies, especially small caps, look particularly oversold. The Nasdaq Junior Biotech Index trades on a P/B of 2.4 times, close to its all time low of 2.3 times and compared to a long term average of 4.5 times, points out Gilligan. A tightening of monetary policy will make it harder for these companies to raise money which is critical for their success, but for patient investors it could be an attractive entry point into the companies which survive.
Fund for exploiting value
A natural consequence of how markets work is that investors disagree on where the best investment opportunities lie, so it's crucial to have a diversified, global equity portfolio. And given some sharp share price swings you should monitor your asset allocation to ensure that it doesn’t slip too far from your target weights.
Most US funds have a growth bias but there are some value focused options such as M&G North American Value (GB00B61S4242). This fund has risen by 12 per cent over the past 12 months during which time the S&P 500 Index has fallen almost 4 per cent. Its top holdings include Johnson & Johnson (US:JNJ), Meta Platforms and JPMorgan Chase (US:JPM).
If you’re looking for a pure value fund, Yardley suggests the UK and Japan. Options include Schroder Recovery (GB00B3VVG600) and Jupiter UK Special Situations (GB00B4KL9F89), which are relatively concentrated with just under 50 holdings each. Their managers invest in UK companies that they believe are materially undervalued. Schroder Recovery's managers, for example, specifically seek companies which have suffered a severe setback in their share prices or profitability, but have promising longer-term prospects. For more information on UK value funds read Reassess UK value funds to get the best returns (IC, 25.03.22).
Man GLG Japan Core Alpha's (GB00B0119B50) managers, Jeff Atherton and Adrian Edwards, invest via a value style selecting stocks that they consider to be undervalued based on their P/B ratio. The fund is relatively large with assets of over £1bn and has significantly outperformed its peers in recent months, rising 11 per cent over the 12 months to 13 May compared with the Investment Association Japan sector's 5 per cent fall.
Gilligan likes the look of Nippon Active Value Fund (NAVF) which was trading at a 10 per cent discount to net asset value (NAV) on 12 May. This investment trust takes positions in smaller Japanese companies, many of which are trading below cash, and looks to constructively engage with their managements to unlock value.
For a European value equities exposure, Sleep suggests LF Lightman European (GB00BGPFJN79). It is run by Lightman Investment Management, a small boutique which invests in companies with low P/B and price-earnings ratios, and a high free cash flow yield. “The [fund's investment] team is unafraid to back its judgement and make large investments in out-of-favour sectors like financials, materials, autos and utilities,” Sleep says.
Most biotech investment trusts are trading at a discount to their NAVs as these have recently fallen substantially. International Biotechnology Trust's (IBT) and Biotech Growth Trust's (BIOG) NAVs have fallen by 21 per cent and 38 per cent, respectively, over the six months to 13 May. Syncona (SYNC) might be particularly attractively priced as it was recently trading at a discount of 13 per cent despite its underlying portfolio of unquoted companies holding up well.
Gilligan’s favoured global value play is Murray International Trust (MYI), the largest global equity income investment trust with assets of over £1.7bn. While the vehicle has struggled relative to peers over the past five years, over the past 12 months it has been the top-performing investment trust in its sector.
“It holds a really interesting portfolio of stocks that are well placed to benefit from a number of long-term trends such as semiconductor chip demand and an increase in cryptocurrency trading,” says Gilligan.
|Performance (cumulative total returns %)|
|Murray International Trust||10.05||9.56||26.3||25.54|
|Jupiter UK Special Situations||0.86||3.12||12.44|
|Man GLG Japan Core Alpha||3.48||11.39||16.53||16.46|
|Nippon Active Value Fund||-22.89||2.1|
|M&G North American Value||3.04||11.9||36.34||51.25|
|LF Lightman European||-1.41||3.06||30.41|
|MSCI United Kingdom index||2.85||10.05||13.05||18.33|
|MSCI Japan index||-11.89||-1.72||16.64||22.52|
|MSCI USA index||-9.67||10.62||49.99||83.91|
|MSCI Europe index||-10.71||-0.18||18.51||21.74|
|Source: FE Analytics, 13.05.22|