Value investing has had a poor run over the last decade and it’s done especially badly in 2018. But there are some very early sings that we may be at a turning point. That’s according to Andrew Ang, Head of Factor Investing Strategies at BlackRock.
If the trend really is changing, it’s well worth noting. Value is probably the best known investment strategy out there, and it’s certainly the one with the longest history. It was first developed by Ben Graham and David Dodd back in the 1920s, and in essence, it’s about buying cheap shares that the market has been avoiding. Over the long-term, it’s often been a lucrative approach.
Earlier this week, Ang told journalists that the fall we’ve seen over the last year or so has been one of the worst we’ve ever seen for value. That follows a mainly poor performance since the financial crisis. And if you look at the world purely through a cyclical lens, you wouldn’t expect value to pick up yet. That’s because value usually doesn’t perform strongly in the late stage of the business cycle or in a recession, and that’s where we are now.
Instead value normally does best in the early stage of a recovery which is definitely not the current environment. Ang explained that value stocks normally perform in this way because these kind of companies often have fairly inflexible businesses with large factories, warehouses or the like. As we go into a recession, it’s hard for these businesses to adjust. But once the economy is in the recovery stage, these inflexible assets give value businesses ‘scale and operational leverage.’
Of course, the economic cycle isn’t the only thing that drives share prices. Valuation is also important and Ang admits that ‘value has gotten quite cheap’ this year. The strategy was ‘fairly flat’ in 2017 and ‘losses started to accelerate in the first quarter of this year.’
Then in the last fortnight ‘we’ve seen some pick-up in value, but it’s still too early to see if that will be sustained.’
Any value fans looking for good news can also take comfort from the fact that value had one of its worst years in 1999 and then had one of its best years in 2000. Ang reckons that the 1999 market was quite similar to 2018, so there’s a chance that history could repeat itself next year.
Nobody knows for sure….
Regardless of where we are in the economic cycle or valuation, some commentators think that value investing faces a fresh challenge.
Value investors have often focused on a company’s physical assets such as property or equipment. If you can find a company where the share price is lower than the value of its assets, value investors normally get excited. But that ignores a change in capitalism where intellectual capital and brands are becoming ever more important. David Stevenson discusses this in more detail in Value is broken, but a new generation of ETFs could fix it.
If you buy this argument, it’s at least possible that traditional value investors will never prosper again. Perhaps they can only make money if they follow an updated value strategy. Instead of using traditional metrics such as price-to-book and the price/earnings ratio, perhaps they need to focus on things like free cashflow as well as non-physical assets.
Most value ETFs – smart beta ETFs that follow a value strategy – are following the traditional approach, but one US provider, Distillate Capital, has launched a new ETF that looks at free cashflow. Unfortunately, the company hasn’t yet launched a UCITS version of this ETF for the European market.
One thing’s for sure, traditional value investing has had a rotten run and arguably looks cheap. Maybe that’s enough reason to invest.