The lines are blurred between the growth and value investment styles, according to the fund managers of Temple Bar.
Temple Bar (LSE:TMPL) investment trust has a long and respected heritage as being value-focused, but a recent letter to shareholders from the managers at asset manager RWC makes the case that labels such as ‘value’, ‘growth’ and ‘quality’ are actually unhelpful, if not misleading, for private investors.
Managers Ian Lance and Nick Purves took over from Investec’s Alastair Mundy last October, and enjoyed a strong recovery in the ‘value bounce’ that swiftly followed as the country saw its way through the pandemic.
Mundy was a ‘deep value’ investor, hunting out the cheapest UK shares, and had underperformed persistently for several years. In contrast, Lance and Purves aim for ‘sustainable value’, investing in relatively cheap businesses where they nonetheless see a robust business model and long-term financial strength.
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Value investing definition needs a rethink
So they are keen to dispel the idea that value investing is about holding “poor businesses which may have the odd bounce, but which are doomed to decline in the long run”, while growth investing involves focusing on “the disruptors who will be the survivors in this winner-takes-all world” and is therefore a surefire winning strategy.
They argue that their strategy for Temple Bar means they look at both quality metrics and growth projections, as well as valuations, for any firm they are considering, and that “all else being equal” they would rather buy high-quality and high-growth stocks than low growth and low quality. But, they stress, “one needs to acknowledge that there is a price which is too high for even a good-quality, high-growth business”.
They also make the point that while value investing has been widely demonstrated to deliver benchmark-beating returns over the long term, the same cannot be said for either growth or quality strategies that disregard valuation. That’s because value investors reap the benefit of holding stocks that other investors don’t want, and that are considered relatively risky; growth investors cannot expect to see a similar premium, because they are buying the popular, less-volatile stocks that everyone else wants.
Valuation is key for all investment styles
That argument is even flimsier these days, Lance and Purves add, because of the current huge gap in valuations between growth and value, as investors have sold the latter and bought the former.
“Anyone who believes that valuation is the best guide to future returns should be wary of owning such expensive stocks and yet expecting them to deliver strong future returns,” they comment.
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However, Gavin Haynes, investment consultant at Fairview Investing, suggests that the wide disparity of the past few years may be less pronounced in future. “In 2021, growth and value stocks have both performed well at different times throughout the year,” he says. “Going forward, I don’t believe we will see such a stark divergence between growth and value as we have seen over the past decade.”
What about the risk of value traps? Those who say value investing no longer works in a technologically driven world highlight the perceived risk of investing in low-valued businesses that have basically had their day and will continue to fall in value - so-called value traps. Conversely, the school of thought is that growth investors are in a strong position because the disruptors they target have so much potential that it doesn’t matter that shares are costly.
But as Lance and Purves argue, there’s little evidence of “an increased dispersion between the profitability of these two groups”.
Instead, the duo argue the evidence indicates that “the primary driver of value’s underperformance has simply been value getting cheaper and growth getting more expensive, as has been the case in every past cycle where value has underperformed (of which there have been many)”. Eventually the trend reverses, and value stocks start to outperform again.
There are ‘growth traps’ as well as ‘value traps’
Indeed, recent research from GMO finds there are more disappointing ‘growth traps’ that fail to realise their potential, than value traps that fail to recover. Moreover, the former tend to fall further because they attracted more interest in the first place and had high expectations baked into the share price.
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So one of the jobs of a value investor is to try to identify “misdiagnosed structural decliners” - which is harder than it sounds. As an example, Lance and Purves point to the unloved energy sector in the face of transition to a net-zero world. “We are obviously very mindful of the ESG issues surrounding the sector, but our approach to sustainable value investing favours engagement over divestment,” they say.
Haynes agrees: “It appears premature to write off oil majors such as BP (LSE:BP.) and Royal Dutch Shell (LSE:RDSB), which have seen a strong recovery in their share price and are adapting to the changing environment while continuing to offer attractive dividends to shareholders.”
The Temple Bar managers argue, unsurprisingly, that over the long term, investing on the basis of valuation will prove its worth - particularly given the low valuations currently available.
Haynes takes a more balanced position: “Having both value and growth funds makes sense,” he says. “But the key to investing in value is to find managers who avoid value traps.”
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