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Has the value investing fightback begun?

Value investing is sometimes called the 'granddaddy' of investment styles, tracing its lineage back to Benjamin Graham and David Dodd's seminal work in the 1930s and 1940s.

Article originally published by The Financial Times. Hargreaves Lansdown is not responsible for its content or accuracy and may not share the author's views. News and research are not personal recommendations to deal. All investments can fall in value so you could get back less than you invest.

Like an ageing, unfancied boxer dusting themselves off for another fight, the most beaten-up school of money management is enjoying a comeback this autumn. The question is whether “value investing” is merely landing a few punches, or has started a fightback that will see it wrest the belt back from its opponents.

Value investing is sometimes called the “granddaddy” of investment styles, tracing its lineage back to Benjamin Graham and David Dodd’s seminal work in the 1930s and 1940s. In the wake of the Great Depression they laid the groundwork for a more rigorous, conservative approach to investing that continues to resonate today.

Baupost’s Seth Klarman, Oaktree’s Howard Marks and Berkshire Hathaway’s Warren Buffett are among Graham and Dodd’s best-known acolytes, but the precepts of value investing are foundational to a large part of the global asset management industry.

There are many ways of measuring value and approaches to value investing, but simply put it involves unearthing under-appreciated securities trading at unfairly low prices.

Academics have found that stocks trading with low price-to-earnings or price-to-book ratios can, over time, beat the broader market.

The problem is that strategies such as this — usually termed “factors” by the investment industry — do not always work, and value investing has now been in a deep funk for more than a decade.

Since the eve of the financial crisis in August 2007, the S&P 500 index has returned 175 per cent, compared with the 120 per cent total return of US value stocks. So-called “growth stocks” of fast-expanding, often more glamorous companies have delivered a thumping 235 per cent return.

This divergence is not just an American phenomenon, even though US equities have dominated the global post-crisis bull run. The MSCI World Growth Index has returned nearly 140 per cent over the same time period, almost twice the MSCI World Value Index’s gains.

As a result, value stocks, by most measures, are now trading at their lowest prices relative to the broad market, excepting the frenzied height of the late 1990s dotcom boom. Compared with “momentum” stocks — those already on the up — value is at its most beaten-up level in history, according to Bank of America.

However, the length and extent of the underperformance — coupled with signs that global economic growth is stabilising — is now spurring a rethink. US value stocks have gained almost 10 per cent since the beginning of September, more than three times the total return of US growth stocks.

AQR Capital Management’s Clifford Asness is among those who thinks this may be the start of a durable renaissance. Most of AQR’s funds invest on autopilot, but those that have some discretion are now tilting more heavily towards value stocks, despite Mr Asness often describing trying to time markets as an “investing sin”.

“To the [value stock] sceptics we would ask: if not now, when?” Mr Asness said in a note to clients last week. “If the answer is ‘only when it’s as bad as the tech bubble’ we just think you’re making the wrong call.”

Some academics and analysts have argued that investment factors such as value are simply less effective than in the past, given how widely known and heavily mined they are. But Mr Asness insists the evidence indicates instead that it simply fell out of favour, as it did during the 1990s internet craze.

And while the first eight years of underperformance relative to growth stocks might have been justified based on the latter’s stellar results — which more than compensated investors for the lofty prices they had to pay for them — the past two years of value’s unpopularity was “irrational” and unjustified by the fundamentals, Mr Asness reckons.

AQR’s founder isn’t the only one who thinks this is the time to dive back into value stocks. Both JPMorgan and Morgan Stanley analysts predict the upswing has further to run, and a net 34 per cent of fund managers surveyed by Bank of America this month think they will outperform growth stocks, up 21 percentage points in the month and the third-biggest month-on-month swing in opinion.

Nonetheless, the value comeback looks very dependent on a global economic acceleration and a continuation of the bond market sell-off.

Companies in cyclical sectors such as banking and industrials at present make up most of the value stock universe, and need the tentative signs of an economic bounce to come true to see their gains extended further. It is telling that the value bounce correlates almost perfectly with the global bond market reversal.

After suffering for their strategy over the past decade, value investors understandably grasp at any signs that the outlook is brightening. But if economic optimism fizzles out, they will probably have to dig in against the tide once more.


This article was written by Robin Wigglesworth from The Financial Times and was legally licensed through the NewsCred publisher network. Please direct all licensing questions to legal@newscred.com.

Article originally published by The Financial Times. Hargreaves Lansdown is not responsible for its content or accuracy and may not share the author's views. News and research are not personal recommendations to deal. All investments can fall in value so you could get back less than you invest.

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