“Patience, young grasshopper.” —This quote from Master Po to Caine from the TV series Kung Fu, may strike a chord with value investors right now after the value factor turned positive in recent months.
At WARRHUNT, we pursue higher expected investment returns for our clients, through low-cost, well-diversified portfolios which tilt toward known factors of return.
In simple terms, equities (shares) have a higher expected return than fixed interest (bonds). In equity markets, Small Companies, as defined by market capitalisation, and Value Companies, as defined by relative price, have higher expected returns than Large Companies & Growth Companies respectively. These higher expected returns are known as ‘Factors’ of return.
It’s no secret that the value factor – the additional expected return of low relative price over high relative price or ‘growth’ stocks– has struggled in the past decade, testing the patience and resilience of many investors.
But we also know from history that stock returns are unpredictable and that there is a precedent for the value factor turning around quickly after a prolonged poor run. After the end of the ‘dot-com’ era in early 2000, for instance, a long period of outperformance by growth stocks ended abruptly and value came to prominence.
And even within the drought of the past decade, value has experienced strong run-ups in some years. In 2016, for example, value was the standout factor, particularly in Australia where value beat growth by about seven percentage points.
In fact, most of the underperformance of value in the past decade was concentrated in the three years of 2018-2020. Last year, amid the pandemic, growth was boosted by rallies in technology giants Apple, Microsoft, Amazon and others.
In the final quarter of 2020 and first quarter of 2021, however, stocks that had been beaten down during the pandemic – retailers, oil and gas explorers, airlines, media and financial stocks – have started to shine.
In the 12 months to 31 March, for instance, large value stocks in Australia have delivered a factor above growth of about 22 percentage points. Among small caps, the factor has been even more impressive at about 34 percentage points.
Some of the big name value outperformers have been big banks Westpac, ANZ and NAB, oil and gas producers Santos and Woodside Petroleum, and materials stocks Fletcher Building and South32.
Outside Australia, the value factor over the year to the end of March has been about 10 percentage points among both large caps and small caps.
To be fair, value still lags growth over the past 10 years, but it has made up significant ground. And while we don’t know whether this revival will continue, we do know there is sold empirical evidence for a long-term value factor.
That evidence is based on the theory that paying a lower price for a security relative to fundamentals means a higher expected return. However, as with the equity market itself, we know that realised returns are volatile. A 10-year negative factor, while not expected, is not unusual.
But history also tells us that changing course after a disappointing run for known factors can lead to you missing opportunities. When those drivers of outperformance have turned around in the past, investors who stuck to their plan have been rewarded.
Sometimes, the waiting is the hardest part.
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Any advice in this publication is of a general nature only and has not been tailored to your personal circumstances. Please seek personal advice from WARR HUNT prior to acting on this information. Before making a decision to acquire a financial product, you should obtain and read the Product Disclosure Statement (PDS) relating to that product. Past performance is often not indicative of future results.