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Schroders takes long-term view on value

Not only do current levels of valuation dispersion suggest that value has plenty of upside – it can also offer protection in frothy markets, according to Schroders.
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Investors will continue to benefit from opportunities to find value in today’s market, despite previously unloved sectors already rallying since the vaccine rollouts began in late 2020.

“It’s important not to focus too much on short-term percentage price moves, because when you zoom out and look at the bigger picture, you can see that many shares are still trading on deeply depressed valuations,” said Liam Nunn, fund manager, equity value at Schroders.

This is based on the extreme levels of valuation dispersion within the market, defined as the gap in fundamental valuation between the most highly rated and the least highly rated shares globally. Against this backdrop, Nunn said the latest bounce in value performance is “barely visible”.

Simon Adler, another fund manager for equity value at the fund house, added: “The moves we’ve seen in recent months may feel dramatic, but we think we’re looking at a tremor of performance rather than a real earthquake.“

If valuation gaps in the market are to return to something more like normal in the context of long-term history, there seems to be a long way to go, he said.

Learning from the past

Value hunters will have already welcomed the comeback for value style investing during the past six months.

However, Nunn warned, the last couple of years has witnessed the sort of crazy market behaviour that typically occurs at the top of market cycles. “In fact, this is exactly the sort of behaviour that characterised the peak of the dotcom mania in 1999/2000.”

“This looks to us like the market has, once again, abandoned the idea that fundamental valuation is important.”

Last time, from the peak of the market cycle in March 2000, global equity indices entered a painful, drawn out bear market. “Even five years on from the peak, the MSCI World Index was still under water in absolute terms,” explained Adler.

During that same period, global value delivered a strong period of both absolute and relative performance.

“Systematically avoiding the most egregiously overvalued stocks in the years leading up to the peak had left value investors chastised and mocked by many in the investment community,” said Adler. “But in the fullness of time, sticking solely to the cheapest areas of the market stood them in good stead.”

He emphasised, however, that value as a style often underperforms into the tail end of a bull market. “Fashionable areas of the market soar and value investors are often left behind.”

Knowing where to look

While periods of irrational exuberance in markets will often create contrarian opportunities for investors, these are now appearing in more traditional sectors such as banking and energy.

”We think banks are very attractive, not least because they have record high levels of capital, have spent a decade reducing risk and are part of the solution to the current crisis – as opposed to the cause of it as was the case in the global financial crisis,” said Adler.

Energy companies, meanwhile, are another posterchild of value. “At last, they’re showing capital discipline, focusing on costs and returning capital to shareholders,” he explained. “This, in combination with exposure to potentially rising oil prices, makes for a compelling opportunity.”

Looking geographically, attractive pockets are emerging in Japan. Although many Japanese stocks might previously have been considered value traps, there is a current crop with appealing valuations that pose relatively low risk.

At the same time, added Nunn, there are still high-quality businesses unfairly sold off during the height of pandemic-led panic.

These include so-called “tortoise stocks” – those likely to be slow and steady winners such as food retail and telecoms. In addition, there are “turnaround stocks” – businesses that have endured a rough patch but are in the process of being turned around and recovering.

“We continue to think value should have a long-term place in every client portfolio,” added Nunn.

Part of the Mark Allen Group.