Sure about your investment strategy? Here’s the case for value investing

In late 2015, no one wanted to be in emerging-market value stocks but since then they have been the best place to invest

It ain’t what you don’t know that gets you into trouble. It’s what you know for sure that just ain’t so.” – Mark Twain

This quote is particularly relevant in stock markets.

For years, investors were handsomely rewarded when they allocated money to growth, momentum or quality strategies; preferred developed markets over emerging markets; and chose large caps over small caps. This outperformance lasted longer than usual and caused value managers many sleepless nights.

The longer it lasted, the more certain they were that the trend would persist. It’s amusing that whenever market pundits are absolutely sure of a theme, it’s usually time to do the exact opposite. This anomaly has once again played out. In late 2015, the last place anyone wanted to be was emerging-market value stocks – and since then they have been the best place to invest.

The case for value investing is good when one looks back over time. The Financial Times recently ran a story on value investing. The author made the following observation: “This year’s Credit Suisse Global Investment Returns Yearbook, which draws on a wealth of market data dating back to 1900, once again pointed to the strength of the value premium.
“A dollar invested in US growth stocks (those with a high price-to-book-value ratio) in 1926 would have turned into $3,061 by the end of 2016, according to number crunching by Kenneth French, professor of finance at the Tuck School of Business at Dartmouth College. In contrast, $1 invested in value stocks (those with low price-to-book-value ratios) would have morphed into $56,247, thanks to an annualised value premium of 3.6 percentage points.”
What is even more interesting for us South Africans is the outperformance of our value stocks against the global average outperformance of value stocks. So, while value has outperformed growth by 2.1% per year over the past 41 years, South African value stocks have outperformed by an even great margin of 2.8% per year.
We should also note the extent to which small caps outperform large caps over time. All these observations tie into the Fama–French three-factor model, which expanded on the capital asset pricing model and stated that by adding size and value factors, one was better able to explain market returns.

 

Growth has outperformed value on a relative basis since 2007. Value/growth has been well explained by changes in US 10-year Treasury yields with an adjusted R squared of 83%. If we believe we have reached an inflection point in US interest rates and inflation, then the outlook for value is now particularly attractive.

While one does risk underperformance for long periods of time and high volatility, the historic data makes a compelling case for having exposure to value shares in one’s equity portfolio and particularly small caps (bearing in mind that past results are no guarantee of future performance).
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Barry Shamley is a portfolio manager at Investec Wealth & Investment. He would like to thank his colleagues, Peter Vogel and Michael Maxwell, for their invaluable contributions to this article.

Article  by Investec.