Value’s time to shine?

Value-focused investment company managers on COVID, inflation, a potential growth-to-value rotation and attractively priced opportunities.

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The age-old investment debate about ‘cheap’ value stocks versus ‘expensive’ growth stocks shows no sign of going away. Whilst there is no doubt that growth strategies have been the winners over the past decade, predictions of a post-pandemic recovery and possible inflationary pressures could suit more value-orientated approaches.

But what does the future hold for value, will these types of stocks provide a hedge against inflation, and where are value-orientated managers finding opportunities? The Association of Investment Companies (AIC) has asked the managers of value-focused investment companies for their thoughts.

Value stocks and COVID-19

Ian Lance, Co-Manager of Temple Bar Investment Trust, said: “The portfolio suffered at the start of the pandemic but has recovered very strongly since the first news on vaccines. We had used the volatility in the market during 2020 to buy stocks that looked very undervalued if any sort of economic recovery occurred, and these stocks have done well during the last four months.”

James de Uphaugh, Manager of Edinburgh Investment Trust, said: “We are flexible investors and we have endeavoured to morph the portfolio as we have gone through the different chapters of the COVID crisis. For a brief gut-wrenching period it was all about ‘days of liquidity’ but quickly our team’s analysis pivoted to ensuring that we were invested in companies that had clear plans to emerge strongly on the front foot into radically changed competitive environments. So purchases included the likes of Greggs, Compass, Easyjet and Dunelm. These were funded by sales of the likes of Glaxo, Sage and Barrick Gold. Since taking on this prestigious mandate until the end of January 2021 we have outperformed and the discount has narrowed. Two encouraging initial proof points in what is a long-term project for the team at Majedie.”

Alex Wright, Manager of Fidelity Special Values, said: “While our portfolio was defensively positioned going into the pandemic, our holdings were not immune and a few, like aerospace equipment supplier Meggitt and alcoholic drink manufacturer and distributor C&C Group, two normally resilient businesses, have been severely impacted by the disruptions.

“But what we have also been finding is that the resulting recession is different from any other that we have seen previously. Unusually, consumers have not been able to spend as much as they would normally due to lockdowns and other containment measures still in place. So, they are spending considerably less on transport and travel, leisure activities and eating out – normally a substantial share of their spending – leaving them with more disposable income to spend on housing, DIY, electronics and sports equipment and clothing. This trend has benefited our holdings in specialist retailers such as Halfords, Dixons Carphone, Studio Retail Group and Frasers Group, which have been reporting stronger-than-anticipated trading.”

Inflation

Gary Moglione, Fund Manager of Seneca Global Income and Growth Trust (soon to be renamed Momentum Multi-Asset Value Trust), said: “Inflation expectations have been low for years with the main talking point being deflation. In that environment, investors seek growth businesses or dominant market players with a strong franchise and dependable cash flows. The consensus view has now changed significantly as markets start to reflect the expectation of inflation. The yield curve is steepening which indicates the market is expecting higher inflation and thus higher interest rates in the future and this view is difficult to argue against. We have had massive amounts of stimulus into the global economy, loose monetary policy and lots of pent-up consumer demand as people have been confined to their homes for the best part of a year. If the vaccine rollout is a success, then this should equate to a strong recovery and pressure on prices. I would point to research from Fama and French and William J Bernstein which has charted the correlation of inflation and the performance of value.”

Alasdair McKinnon, Manager of The Scottish Investment Trust, said: “Central banks are indicating their willingness to tolerate greater inflation. And while governments can’t say it out loud, they would secretly love to devalue the debt burdens that they have accumulated during the pandemic. Historically, ‘value’ fared well in inflationary conditions. This is when a ‘bird in the hand’ is suddenly worth more than ‘two in a bush’.”

James de Uphaugh, Manager of Edinburgh Investment Trust, said: “Growth stocks have outperformed since 2009. The result is that the valuation differential between growth and value is at extremes. If inflation increases and bond yields rise then the combination of a likely less accommodative Fed and higher discount rates is likely to impact the valuation of growth stocks more than value stocks. In that event value stocks would provide something of a hedge.”

Ian Lance, Co-Manager of Temple Bar Investment Trust, said: “There are many signs that economic recovery, combined with massive monetary and fiscal stimulus, could lead to inflation as newly created money finds its way into the real economy rather than just financial assets. Historically, value as a style has done well in this type of environment as sectors such as energy, mining and financials fare well during reflation/inflation.”

Growth-to-value rotation

Alex Wright, Manager of Fidelity Special Values, said: “The UK market – and in particular the value segment of the market – offers very attractive opportunities. While we have started to see a rotation into value in late 2020, the dispersion in returns between growth and value stocks since the 2008-2009 global financial crisis remains unprecedented. This leads us to believe that, should investors shift their focus for the reasons mentioned previously, the degree of outperformance could be very substantial, given how bifurcated the market currently is. We are particularly optimistic on the medium-term outlook not only due to the number of investment opportunities on offer and their upside potential, but also because we are not having to compromise on quality.”

Ian Lance, Co-Manager of Temple Bar Investment Trust, said: “Value as a style has significantly outpaced growth over the last few months but we believe that very few investors have started to reposition themselves and hence we believe that the rotation will continue, in particular in the face of an economic recovery or pick-up in inflation.”

Gary Moglione, Fund Manager of Seneca Global Income and Growth Trust (soon to be renamed Momentum Multi-Asset Value Trust), said: “History doesn’t repeat itself, but it often rhymes. We are now over a decade into one of the strongest periods for growth stocks ever. Valuation spreads between value and growth reached extremes in 2020. We have seen cycles like this before with the Nifty Fifty in the 1970s and the Tech Boom in the 1990s. You can look through history and see that whenever we have a period of strong outperformance of growth the market eventually rotates to an exceptionally strong period of value performance. These cycles usually range from a couple of years to a decade, so this period for growth has been exceptionally long. Many investors aged under 35 have effectively only witnessed one market during their careers. To evidence the belief that “this time it’s different” over the past year or two there have been many articles entitled “Is Value Dead?” This is the recency effect and a common behavioural bias that people weigh recent experience much more heavily than distant experiences. As value has had a poor decade, people question its validity more and more. You can google “Is Value Dead? 1999” and see that exactly the same articles, even with the same title, were being written in 1999 just before one of history’s strongest rotations from growth to value.”

Opportunities

James de Uphaugh, Manager of Edinburgh Investment Trust, said: “Our view that inflation expectations are on a probable upward trend leads to us holding banks such as NatWest and commodity companies such as Anglo American, which is pivoting to commodities such as copper, crucial for the electrification necessary if the world is to achieve environmentally sustainable growth. Elsewhere, we have supported equity raises in the likes of Polypipe, which is in the sweet spot of sustainability and is illustrative of how in each of our holdings we integrate ESG into the investment decision.

“A global risk we are concerned about is that the economy accelerates so strongly in late 2021 that it puts upward pressure on inflation and bond yields forcing central bankers’ hands. Then, just as declining bond yields were so important in powering stocks in 2020, the reverse could happen, as policy makers cut back on liquidity. This would put pressure on equity valuations.”

Alasdair McKinnon, Manager of The Scottish Investment Trust, said: “Going forward, we see stocks that are able to pass on price rises in a timely manner as best placed. Even better, these ‘value’ stocks are severely out of favour. Banks (Santander, Lloyds), energy (BP, Shell) and miners could all be beneficiaries of this. We have also added to some of the most impacted industries like the high street, where we find some restaurants and clothing retailers with good brands and balance sheets that we think will allow them to re-emerge from the pandemic as long-term winners. Some of our largest holdings are gold miners, including Newmont and Barrick Gold – you can’t print gold and we expect its value to increase in line with the ballooning money supply.”

Ian Lance, Co-Manager of Temple Bar Investment Trust, said: “We are finding opportunities in energy (BP), materials (Anglo American), financials (NatWest Group) and consumer cyclicals (Marks & Spencer). One of the greatest risks is the enormous over-valuation of the US stock market combined with signs of speculative behaviour that are often associated with a market peak. A second one is the risk that central banks will fail to react as inflation increases and that inflation may get out of control.”

Alex Wright, Manager of Fidelity Special Values, said: “We have significantly increased our exposure to specialist retailers (Halfords), car distributors (Inchcape), DIY stocks (Kingfisher) as well as housebuilders (Redrow and Vistry). These are all areas that are seeing increased demand as households reassess their priorities and, importantly, where we believe the changing dynamics caused by the virus are likely to be longer lasting than currently factored in. We continue to favour life insurers, which are well regulated companies with good risk management and which are seeing strong demand for bulk annuities and pension de-risking. The sector offers an attractive combination of cheap valuations, strong demand/supply fundamentals and growing earnings. Our largest holdings in the space are Legal & General and Aviva.

“Conversely, we are underweight mainstream banks. While cheap, they lack a medium-term catalyst to re-rate given the low interest rate environment. Instead, we have bought into UK-listed emerging market financials Bank of Georgia, TBC Bank and Kaspi, which are able to generate strong returns in the current interest rate environment but have been overlooked or lumped in with the mainstream banks. We are also underweight energy having sold down our exposure to UK oil majors Shell and BP, which have cut their dividends and are embarking on a complex and high-risk transition towards a more diverse energy mix.”

Gary Moglione, Fund Manager of Seneca Global Income and Growth Trust (soon to be renamed Momentum Multi-Asset Value Trust), said: “One stock which we think will do well is UK Mortgages (UKML). UKML had a difficult start after launch as market conditions meant they did not invest the initial capital very quickly which led to an uncovered dividend and a declining NAV. They took a new strategic direction last year and are now focusing on the higher yielding mortgage books whilst selling the lower yielding. They essentially buy or initiate mortgages and when the number of loans reaches a reasonable size they will securitise them, locking in returns and freeing up capital to initiate more mortgages. The trust has traded on a significant discount and the managers and board have worked hard to close that from a peak of 47% in April 2020 to less than 10% today with an aggressive buyback policy. The dividend, which at the current price is 6%, is now covered and they are also projecting NAV growth with their latest securitisation anticipated to generate mid-teen internal rates of return. A second value play is Ediston Property Investment Company (EPIC). This trust focuses on out-of-town retail parks. The property market has been ravaged by COVID as many retailers struggle and some use company voluntary arrangements to force landlords to accept lower rents.”

-ENDS-

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Notes to editors

  1. The Association of Investment Companies (AIC) was founded in 1932 to represent the interests of the investment trust industry – the oldest form of collective investment. Today, the AIC represents a broad range of closed-ended investment companies, incorporating investment trusts and other closed-ended investment companies and VCTs. The AIC’s members believe that the industry is best served if it is united and speaks with one voice. The AIC’s mission statement is to help members add value for shareholders over the longer term. The AIC has 360 members and the industry has total assets of approximately £234 billion.
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