Since the emergence of “Modern Portfolio Theory” and the “Capital Asset Pricing Model” in the late 1960s, institutional investors have taken a quantitatively driven approach to portfolio construction, looking to create portfolio diversification and obtain better risk-adjusted returns by balancing their asset-class exposures. This journey has seen several important advancements in thinking about how to optimally achieve desired results.
Funds that want to take the total portfolio approach first need to get the total portfolio view. To do that they not only need data – and lots of it – but a rock-solid understanding of exactly how they’re going to use it.
Second big quarter in value rotation
Value managers are hopeful that, following the second consecutive quarter of the factor’s outperformance, their world has returned to normal. Value may well be back.
For the March quarter, for Australian shares, the S&P/ASX 200 value factor index was up 8.50 per cent, making a 12-month return of 42.71 per cent. The S&P/ASX 200 growth index was down 0.17 per cent, but growth was still satisfying its customers over the year, with a 12-month return of 31.99 per cent.
In fact, one of the many strange aspects to do with current market behaviour, including the record-breaking 12-year outperformance of growth over value styles, is that much of value’s gains of the past six months has not been at growth’s expense.
As Garth Rossler, the CIO of value manager Maple-Brown Abbott, said last week (April 7): “A lot of the recovery has come from the bounce in value stocks; not as much as you may have thought from a decline in growth stocks. At the really pointy end of the growth names, they have generally still done better than the market as a whole.”
The better-performing stocks have included tech disrupters, such as Afterpay, whereas some of the more established growth stocks, such as CSL, have lagged recently. Rossler believes that “we are at the start of a sustainable value cycle”.
But not one to get too excited by short-term performance, he points that that overall one-year numbers are helped by the big market correction in the March quarter last year, dropping out. “So, [for Maple-Brown Abbott] that’s 400bps that has dropped off,” he says. In the March quarter this year, preliminary comparative figures put Maple-Brown Abbott’s Aussie shares trust in the top quartile for performance with a return of approximately 8.4 per cent, compared with an ASX 300 index return of 4.1 per cent.
The US market (in US dollars) tells a similar relative story. The S&P 500 ‘pure value’ index was up 21.0 per cent for the quarter compared with 2.1 per cent for the S&P 500 growth index.
In its Australian commentary, S&P said: “Financials led amongst Australia’s sectors, rising 12 per cent in the first quarter, closely followed by Communication Services and Consumer Discretionary, both with 9 per cent. In contrast, Information Technology lagged, weighing down Australia’s benchmark with its decline of 11 per cent.
“With the largest stocks leading the way, few of our Australian factor indices beat the cap-weighted S&P/ASX 200 [in the March] quarter, but value shone through to a table-topping 9 per cent total return. Despite turning a corner in March, momentum and quality weren’t able to claw back their losses; both slid 4 per cent in the quarter.”
Maple-Brown’s Rossler points out, as do other value managers, that the economic tailwinds seem to be with value for the foreseeable future. These include inflationary expectations, increasing interest rate pressure and global economic recovery.
Australia tends to be a value market, because of the weightings to the banks and energy and resources stocks. Rossler says: “When value’s doing well, we find that about two-thirds of the top-40 stocks, which are the largest contributors to our performance (either up or down), turn positive for us. A lot of value stocks tend to run together.”
In a recent global assessment, Research Affiliates, a factor manager which has a value bias for most of its range of smart-beta strategies, including the flagship RAFI index, pointed out that momentum – itself a factor – was currently pushing behind value, which it had not done for some time.
Stephen Bruce, senior portfolio manager for Perennial Value’s Australian shares trust, says that despite the two consecutive quarters of strong outperformance by value stocks, the level of dispersion in valuations between value and growth is still even greater than it was during the last tech boom of 1998-2000.
“When I think about mean reversion, we’re still at record levels of dispersion,” he says. “How much dispersion can there be? What’s been driving it? For the last five years the world economy has had weak growth, low inflation and declining interest rates. Policy makers addressed it with monetary policy but now they see this is having less and less effect…
“The inequality and misallocation of capital is becoming a negative. It’s what led to Trump etc. But COVID forced the hand of policy makers. They had to step in on the fiscal side, which has been more effective as a stimulus than the trickle-down approach of monetary policy,” he says.
“We think this has led to broad-based economic growth and increasing inflation expectations. Inflation will start coming through – not immediately – and it will put upward pressure on bond rates. We argue that this is a paradigm shift for markets.”
Most managers for which their fund strategies span institutional and wholesale markets have seen net redemptions over the past few years, but value managers have tended to suffer more than their growth-orientated counterparts. Over the past five years, for example, Perennial Value’s Aussie shares trust has gone from managing $1.3 billion to $730 million. Perennial has about $1.4 billion under management, though, in the strategy in total.
A good example of the impact on manager returns of the continued wide dispersion is that Perennial, also a top-quartile performer, has a return of 68.3 per cent since the market bottom of March 23 last year, which is 10.8 percentage points above the ASX 300. But its five-year number of 7.9 per cent, which is 13.6 percentage points above the benchmark, still lags that index by 2.4 percentage points.
Coincidentally, the last time value beat growth for two consecutive quarters was five years ago, in 2016, perhaps tempering the enthusiasm of value managers, given what happened subsequently.
“But what is ‘normal’?” Bruce asks himself. He says that the share market will be back to normal when “the long-term outperformance of the value style re-emerges, as it has done throughout history”.
A study of recessions and other periods when there has been a significant style rotation throughout global markets should comfort investors who are, perhaps tentatively, reallocating to value.
David Taylor, director of business development and client services, and Australian country head, of US-based global manager Pzena Investment Management, says that it has become evident that some clients have been adding more to their value portfolios and there are some new value searches happening.
But, he says: “It doesn’t seem like there’s a 100 per cent consensus yet that value is where it should be.” The continued strong performance of big tech stocks and some thematic plays, such as electric and autonomous vehicles is muddying the waters.
He says: “The big sustained rises in value, those periods which last five or more years, are generally from the low points of recessions. And the rises are generally faster and more pronounced in the early parts of those periods.”
Similar to Australia, the global story for the March quarter is a continuation of that for the December quarter. For Pzena’s flagship ‘focused’ portfolio, with a concentration of about 50 stocks, the December quarter delivered a record 24.5 per cent return, against the MSCI’s All Countries World Index’s 6.5 per cent and ACWI Value’s 8.3 per cent. The fund returned 16.5 per cent for the March quarter against the ACWI’s 5.9 per cent and the ACWI Value index’s 10.3 per cent.
Taylor says that the consensus view from broking analysts is that there is superior potential for the earnings per share (EPS) of value stocks worldwide to come off their 2020 lows.
“The street analysts are looking for EPS growth of 20-30 per cent per year for at least the next two years,” he says. “Pzena’s company-by-company estimates for the cheapest quintile in our global equity universe, which look out five years, support this and we don’t believe this earnings growth is priced into value stocks by any means as yet.”
