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.
Growth managers check value as FANMAGs soar
As it turned out, the Morningstar-organised discussion between a value and a growth manager became a lot more conciliatory than would have been expected. Many investors had been wondering whether value would ever make a comeback. They need not have worried.
The conference session (see other reports this edition) on global equities, “Can Value Beat Growth Again?”, involved value manager Brad Kinkelaar from Orange County, California, representing Barrow, Hanley, Mewhinney and Strauss, and growth manager Mark Casey, from San Francisco, California, representing Capital Group.
An investor poll this year by Morningstar showed that there was a lot of interest in global equities in terms of investment intentions, according to moderator Aman Ramrakha, but this had not translated into fund flows. He said global equities had incurred outflows this year, while multi-asset and fixed income had both had inflows.
Kinklelaar said that, as a value manager in the discussion, he felt like the underdog. “In the short term, the market is a voting machine, but in the long term it’s a weighing machine,” he said. Value had underperformed for more than 10 years. In the past 12 months alone, the growth index was up 36 per cent and the value index was flat. The top 10 stocks in the US accounted for 60 per cent of the market performance. Those stocks were trading at an average of 63 x earnings as at August 31.
“For growth to continue to outperform it would have to at least maintain its valuations and maintain its fundamentals. The market caps of the FANMAGs are almost double the entire market cap of the combined equity markets in Europe. Does that make sense?” he said. “They are great companies but two things got them there: solid fundamentals and a [P:E] multiple expansion.”
The FANMAGs are: Facebook, Apple, Netflix, Microsoft, Amazon and Google. Sentiment might get you there, but it changes over time, he said, as do fundamentals. “Shorting the top 10 stocks in any market is a very viable investment strategy over the long term,” he said, “not just what we are seeing today… It’s the same as it was in the run-up to the dot-com bubble. We all know what we should do but it’s very hard to do it.”
Capital Group’s Casey, said his firm did not believe there was a dichotomy between growth and value. It believed that growth prospects were a part of the value proposition. “You can have a good investment return from any kind of stock. Sometimes high multiples can also mean value. In the case of Google, the market profoundly underestimated how much the company would grow.”
But even a growth manager starts to question valuations at some stage. He said that three years ago he loved every one of the FANMAG stocks. “Today, in all honesty, there are only two that I can make a real case for – Facebook and Netflix.
Casey, who has been at Capital for about 20 years as both an analyst and then portfolio manager, said there were certain types of companies which could grow more than you’d expect. An example was Amazon. When it floated in 1997, at $1.50 a share, its prospectus focused on the company’s aim to replace physical bookstores with an online version. Its growth had been “miraculous”, with the stock currently trading at about $3,300 a share.
“On Amazon, I have pencilled it out. My most recent transactions have been to trim our FANMAG holdings and buy some of the most hated stocks in the market.”
In the spirit of appeasement, Kinkelaar agreed. “We don’t distinguish between growth stocks and value stocks. But we are looking for value today. A growth investor can have a longer time horizon.” In their sales pitch books, growth managers may turn this on its head, saying time is on their side whereas it is working against value managers.
With respect to lessons from history, Kinkelaar said; “Markets rhyme but don’t repeat.” Casey added that one thing that history did tell us was that everything traded at 15 x earnings one day. That’s the US 100-year average. “You can also look at history to see what the unstoppable trends are,” he said. These currently included:
- the shift from physical cash to digital cash
- the move from offline retailers to online shopping
- moving from on-premises computing to cloud computing, and
- move from an advertising-supported television industry sector to paid subscriptions.
– G.B.
