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.
Pro-value chorus getting louder and louder
One of the great unanswerable questions for investors over the past 10 years is why value investing, the tried-and-true performer since it was identified in the 1930s but probably used innately well before, has stayed out of whack for so long. The chorus bemoaning value’s plight just gets louder and louder.
But there are signs the market is starting to listen and react, at last. For instance, as reported last edition from a session at the Morningstar Investment Conference, at least one global growth manager, Capital Group’s mark Casey, has started to trim the growth sails and Australia’s Magellan told its investors last week (October 13) that it had recently sold Apple because of valuation concerns.
Realindex (First Sentier Investors Realindex) which is a part of the First Sentier funds management group, has produced a paper titled ‘Value is Dead, Long Live Value!’ The firm has about $26 billion under management in mainly value-orientated smart beta strategies. The paper’s author, quant analyst Wang Chun Wei, takes aim at criticisms of value-style investing.
“We don’t believe that value investing is dead, just because it has underperformed growth in recent years. In fact, it’s to be expected in an environment where a handful of outlier stocks have inflated the index, fuelled by investor sentiment and easy monetary policy,” he said. “There is no magic factor that consistently delivers alpha month in, month out. Value, like other styles, is known to have long periods of underperformance, followed by outperformance. Over the long run, value investing works, and a plethora of empirical evidence supports the value premium.”
The paper points out that current circumstances have led some to conclude that value is synonymous with poor quality and growth stocks with high quality, even though the whole buoyancy of global equity markets, particularly that of the US, has depended on the massive outperformance by big tech stocks.
Wei said: “There is an assumption that in a continued low growth world, there is little hope for poor quality names to outperform, and thus value is as good as dead. However, our empirical analysis shows it’s not this simple. When we plot the relationship between quality and value for all MSCI World stocks, we see that it is possible to have value stocks with earnings certainty and low leverage, and vice versa, for growth names.”
The paper also points to the impact of monetary stimulus on “exuberant” pricing of growth stocks. “It’s true that growth stocks have done well in the recent past. This is not only due to the rise of intangibles, but also to favourable macroeconomic conditions,” Wei said.
“Growth stocks have more room to accommodate investors’ imaginations, and it is easier for them to get bid up in a market flooded with cheap cash. Their cash flows are more likely to be long dated, and they have taken advantage of this low interest rate environment.”
When analysing price-to-book ratios, it became apparent that expansion of the most expensive stocks was attributable to growth stocks becoming “pricier” as opposed to value stocks becoming “cheaper”. This effect was compounded by the stellar growth of a handful of names which distorted the market, according to the paper.
Wei said: “In essence, the recent outperformance of growth has been driven by a very narrow set of technology stocks, and we think this is unsustainable. Isolating five stocks, including Tesla, Amazon and Apple, our paper shows that the value underperformance, relative to the market capitalization benchmark, largely disappears once we exclude these names. To us, the outperformance of growth looks quite unstable. If we take out a handful of US tech darlings, value has actually kept pace with the broad market.”
– G.B.
