Market conditions once again in favour of value managers over growth

Local and overseas data suggests that value investing of any kind – index based or active is having a very good run this year.

After a lost decade, value managers have moved back to the top of market performance tables, according to new research from the Morningstar group.

In reality, that generally means value managers have been losing less money than everyone else. But in a woeful year for sharemarket investors, relative outperformance is still a win.

Moreover, the signs are strong that the value brigade will stay on top for many months to come.

“As long as interest rates and inflation continue to rise then the wind is clearly in their favour,” says Ross MacMillian, research manager at Morningstar.

Value managers concentrate on traditional investment factors such as quality of earnings and potential discounts to intrinsic value. Growth managers concentrate on the potential of rising revenue to underpin future profit and are willing to take more risks to capture future outperformance.

As the Morningstar report explains: “Rising inflation, an interest-rate-tightening cycle, and concerns about a possible recession are weighing on the share market and are the perfect elements for the rotation to value stocks (mature businesses with pricing power, balance sheet strength, and positive cash flow).”

Value managers will also more regularly invest in large and medium cap stocks where there is a greater certainty of earnings and less exposure to individual company founders.

The perfect conditions for value managers has also meant a rebound in fortunes for some leading names in the value sector such as Investors Mutual, Allan Gray and Tyndall.

In fact, Perpetual – the fund manager which is now a takeover target of the Regal Group – is among the top performers over the year to September. Perpetual’s SHARE-PLUS fund managed a positive 2.4 per cent over the reporting period, ranking second to the outright winner Lazard Select Australian Equity, which romped home with a 14.3 per cent return.

While the average Australian equity value fund lost 5.1 per cent over the reporting period, the average growth fund did three times worse. In the 12 months to September, the average Australian equity growth manager is down by 15.6 per cent.

Perpetual chief executive Rob Adams. Perpetual is among the top-performing fund managers over the year to September. Picture: John Feder

The ASX Accumulation (which measures both price performance and dividends) lost around 9.6 per cent over the same period.

So what’s the message for investors? Certainly the outstanding takeaway is that value does well when the market is in a deep sell-off.

But does that mean you need an active fund manager to get the relatively better returns offered by value? No.

Local and overseas data suggests that value investing of any kind – index based or active (where the manager actively picks selected stocks) is having a very good run this year.

As Scott Opsal, director of research and equities at the US based Leuthold Group wrote recently: “Active managers tend to have more of a value and quality bias, so a year like this is a tailwind for them.”

John Dyall, head of investment strategy at the Rainmaker group, says: “I think you’ll find that it’s not so much that ‘active’ funds are beating the benchmark of late. It’s more that value-oriented managers are beating the market capitalisation benchmark. On the flip side, pretty much all growth managers will be underperforming. A lot of returns from active funds are actually style returns.”

At Morningstar, Mr MacMillan suggests that over the longer term all share market investing ‘styles’ have their day in the sun.

He says: “For investors I would suggest making sure you have access to a very good value manager and a very good growth manager to capture the best performance from both sets over the longer term. Don’t forget that over the last decade growth managers enjoyed wonderful conditions.”

Over the last decade the ASX accumulation index managed an improvement of 8.4 per cent per annum. Even against those high returns, leading growth funds such as Ausbil, Greencape and First Sentier managed annual returns across the entire decade that beat the index. The Ausbil 130/30 Focus fund managed an annualised return of 10 per cent.

As Mr MacMillan says: “The best course of action is to select a fund manager who rigorously maintains the same investment style over the long term for researching, selecting stocks and constructing a portfolio despite any changes to economic conditions or geopolitical events.”