Style Council – revisited
For those of you who are regular readers of our articles, you may recall that back in December 2017 I wrote a piece about the dispersion of valuations between growth and value stocks. The argument went that the gap between growth and value stocks had become too great and we may see value stocks come back into fashion.
As is ever the case with predications, I was right for about five minutes! The first half of 2018 saw the growth style dominate once again and then suddenly, with the Federal Reserve talking about interest-rate rises, there was a major shift in sentiment back to value that persisted for the second half of the year. All was looking good until December last year, when the Federal Reserve unexpectedly performed their now famous ‘volte-face’ – with markets tumbling during Christmas – and announced a period of interest-rate cuts. This was the signal to the market to pile back into quality growth stocks and those bond proxies as yields came crashing back down again.
Why am I telling you this? Well, since late August, something interesting has been going on in the stock market and we have seen a pretty big reversal in sentiment. As is often the case when watching the stock market, there isn’t an obvious catalyst for this shift but clearly there are many major events going on in macro-economics at the moment from the US/China trade war, a recession in Germany to dear old Brexit if we look closer to home.
Focusing on the UK, there has certainly been a boost in sentiment in recent weeks as the Government has managed to renegotiate the Withdrawal Agreement with the EU as well as finally securing a General Election. This has seen sterling move from around 1.2 against the US dollar to closer to 1.3, representing an 8% shift.
Since the Brexit referendum, the clearest way investors have expressed a view on the UK market has been through the currency, and the FTSE All-Share Index has polarised into stocks benefiting from a weak currency and those that either get hit by it or are impacted little. Another way to think of this is simply internationally-focused companies or domestically-focused companies. This has brought about huge valuation dispersion with stocks such as Diageo, selling their premium sprits to connoisseurs around the world, being loved and sitting on a PE ratio of 24 times, while a domestic play like Aviva languishes on a PE ratio of just under 10 times. Those fund managers who have embraced the overseas earners like Diageo have been hugely rewarded while those managers who believe that the likes of Aviva has long-term value have been severely punished.
This had led to the likes of Lindsell Train and Fundsmith, to name but two, registering fantastic performances and raking in enormous assets as their investment style bias has been rewarded, while other highly regarded managers like the value teams at both Jupiter and Schroders have lagged the market and been largely ignored by investors. That is not to underestimate the high quality fund management delivered by Lindsell Train and Fundsmith, but it is important to recognise the style tailwind that they have had for a number of years.
However, in the past couple of months, with the shift in sentiment and large move in sterling, investors seemed to have turned their attention back onto the unloved part of the market. This has resulted in some big moves for value managers who have delivered some short-term outperformance of the market while those managers focused on the quality growth space have given back all of their gains for the year. The likes of Fundsmith Equity and Lindsell Train Global Equity have gone from being around 10% ahead of the MSCI World Index this year to being flat against the index year to date, which is a pretty big reversal.
While I’m not calling the end of the quality growth rally and suggesting that value investing is about to become the prevalent style again, it is a healthy reminder that markets change, sentiment moves and today’s winners may not be the winners of tomorrow. It also highlights the critical importance of understanding the style biases that you may have in your portfolio; after all, there is little diversification benefit from combining managers that have exposure to exactly the same style. It might have been great on the way up with managers performing well at the same time but that’s not much good when they both fall at the same time, taking back some of those returns.
So as 2019 comes to a close, take a look at your portfolio and think about what style you have exposure to. When recently interviewing Ben Whitmore, manager of the Jupiter UK Special Situations fund, he said he was more than happy to take advantage of severe market distortions even if it is meant sacrificing the quality of the companies in his portfolio. Few would probably argue that the likes of BT, WPP and Kingfisher are high quality businesses, with all having their own individual challenges, and they are valued accordingly by investors. But there comes a point when even troubled companies have a price worth paying and in recent weeks it seems investors have concluded that some unloved parts of the market may just have reached this point.