There has been a good deal of press lately about the renaissance in the performances of value-orientated funds.  Is this a passing phase, or we are finally seeing the beginning of more rewarding time for value managers, after the longest ever period of underperformance from the style?

Alastair Mundy of Investec Asset Management, a rare champion of long-term value in an industry that is increasingly short-term in its perspectives, pointed us to an interesting piece that was written by US investment manager, Kopernik Global Investors.

As value investors, Kopernik has been sharing in the heartache of their compatriots in this lonely land.  As the underperformance of their style became more extended, so their clients were more inclined to ask, “when will this end?”.  Their response, much to the frustration of weary investors in value funds no doubt, is that “when” is not the question to ask. It is far more effective to ask, “why?” and, “how?”.  Good equity analysts are able to determine why a company makes for a good investment and they are also able to calculate how much they expect to make.  But as for when it is going to work, well, that is Mystic Meg’s territory.

All-time highs….and a bear market

The S&P 500 may be close to its all-time highs, but Kopernik argues that the US is already in a bear market.  The enthusiasm for “quality growth” stocks over the past few years has masked a bear market that has been moving stealthily through other, less glamorous sectors.  They see parallels to 1972, when the outstanding performance of the “nifty-fifty” stocks obscured devastation elsewhere in the market.  Eventually, they couldn’t defy gravity and late in 1973, they capitulated too.

In the current era, it has been the FANGs (Facebook, Amazon, Netflix and Google, or more correctly, Alphabet - how pesky of Google to ruin an entertaining acronym), biotech companies and consumer super-brands that have camouflaged a good deal of pain taking place elsewhere.

This means that in their value world, the US is in the latter stages of a long and deep bear market.  This is, of course, cause for optimism, as money-making opportunities have become more plentiful for them.  They see much of the value in the US market in the resources, emerging markets, transportation and infrastructure areas.

Where is the value in the UK market?

Of course, the largest companies in the UK market don’t whet investors’ appetites quite as much as the glamour of the FANGs.  While our home market is not as richly priced as the US, it is nevertheless trading above its long-term average valuation and like the US, is experiencing declining earnings.

Alastair Mundy, well known for courting danger (within the safety of balance sheet strength), is less enamoured with the scale of opportunities in his market than Kopernik, but highlights two main areas of interest.  Food retailing is one, where he argues that the major players are fighting back against the upstarts, Aldi and Lidl.  The banking sector is the second –  even more so after Mark Carney indicated recently that the peak of the regulatory burden was near.  He argues that underlying profitability for banks is healthy and assuming this can be maintained, it represents a relatively attractive profit stream.  If this doesn’t sound like a resounding shout from the rooftops, it’s not meant to.  He argues that banks look attractive compared to other value plays in the market because unlike some others, they do not need core profits to increase to validate current valuations.  In an ideal world, value investors seek stocks that look cheap based upon current depressed earnings, not based upon a hope for earnings improvement in the future.  For him, opportunities in “ideal” value names are limited.

Managers of the Schroder Recovery fund, Kevin Murphy and Nick Kirrage, have similar areas of focus at the present time.  In spite of a turnaround in the relative performances of their funds so far this year, they are not inclined to signal the dawn of a new, value-driven phase quite yet.  This is because the “safety-first/hunt for yield” trade, which has been in place since the financial crisis, has not yet lost its appeal.  On this subject, they are vocal in warning investors of the valuation dangers inherent in stocks that are perceived to be safe and stable.  They remind us that there is no such thing as an asset that is always safe, or one that is always risky - your risk is determined by the price you pay for it.

So, are we there yet?

The value-orientated managers we speak to remain cautious and are having to work hard to make the combined valuation and investment case stack up.  Cash and gold continue to be favoured by those who can hold them, hardly a ringing endorsement for risk assets.

Overall, equity markets remain richly valued compared to history and are supported primarily by low bond yields, rather than a rosy outlook for corporate profits.  The cost-cutting / declining debt servicing era is over – these positive influences upon earnings cannot happen twice from here.  The market knows that central bankers are close to being out of bullets and investors are eyeing the myriad of risks that lurk on the sidelines.

So, the answer to the question in an absolute sense is certainly not a resounding, “yes”.  In a relative sense, the picture is more mixed.  Splitting the true bargains from the possible value traps is critical, unless you can see a booming cyclical recovery on the horizon which will drag the marginal players out of trouble.  Managers who do this successfully and are holding cheap, unloved stocks, which have priced in a lot of the bad news, should be in relatively good shape, notwithstanding the usual bumps in the road.   They are certainly better placed to take the blows, from whichever direction they come.  Commonly-owned, loftily-valued quality growth/income stocks are arguably not so well placed, as Mr Murphy and Mr Kirrage vocalise.

As a closing comment, Richard Colwell, manager of Threadneedle UK Equity Income, referred to Jeremy Grantham of GMO in a recent presentation, as follows, “Although value is a weak force in any single year, it becomes a monster over several years.  Like gravity, it slowly wears down the opposition.”.