Christopher Jenks: Is value dead? As you can imagine, we’ve heard this question a lot. While it’s true that value has underperformed expectations in recent years, the simple answer is no – value is not dead. Remember the underlying principle of the style is that the price you pay for a stock matters. Academic research supports this principle, showing there are clear benefits from buying cheaper stocks over full market cycles. But like all styles of investing, there are down cycles. Our data shows that investors have continued buying into the highest priced equities on the market. In fact, research dating to the start of 2018 shows a majority of returns across the US equity market have been led by the most expensive 10% of companies. So, we don’t believe that value is dead, it’s simply in the midst of a down cycle.
Luke Casey: It’s easy to see why. A decade of low interest rates prolonged the bull market in which momentum and growth were dominating returns. Within that particular universe, you typically find high-flying companies with great stories behind them, which investors sometimes find so attractive that they forget they are overpaying for earnings or relying on future earnings growth to justify today’s high prices. There is also misperception that value focused managers are all looking for beaten up, turnaround projects, but that is not our niche at all. We look for high-quality companies, that is companies with low leverage and iron-clad fundamentals, which are trading at attractive valuations.
CJ: Exactly. What we’ve experienced is a cyclical issue that appears structural. Central banks explicitly cut interest rates after the 2008 financial crisis in order to stimulate growth and investment in the economy. However, the unintended consequence was spread compression across the risk spectrum, which caused investors to unconsciously extrapolate current growth into far-fetched valuations. It’s textbook behavioral bias, amplified by the unique existence of a decade-long rally in equities, which has resulted in dislocations in equity markets that should provide an opportunity for alpha generation.
LC: At the end of 2019, virtually all quality stocks with sustainable earnings and achievable dividend targets were expensive. Only deep value was cheap, but that meant going toward financials and consumer discretionary – sectors where it would be challenging to find companies with solid earnings profiles. Since there were few names that could pair strong fundamentals with affordable valuations, we had to accept the majority of value plays were outside our mandate. At those times, you have to be patient in the knowledge that markets will ultimately correct – as they invariably do – even if you cannot accurately guess which economic drivers will drive valuations back on course.