Ian Lance, portfolio manager of the RWC Income & Value fund, unpicks some of the myths swirling around the current growth vs value debate.
Myth 1: Value investors have simply spent a decade riding companies on low multiples, but which are in terminal decline
Truth: This is a common narrative we have seen repeated over recent years. Although there are some examples where this may be true, such as Amazon vs HMV, there aren't many (or any that I know of) value investors who buy low multiple structural decliners.
The question we must ask is not whether this has happened in isolated examples, but the extent to which it has happened in aggregate.
Studies have emerged on this particular narrative, such as the notable studies from Cliff Asness and Rob Arnott, which have investigated this claim and found that, contrary to popular belief, there has been no degradation in returns on capital or earnings for value quintiles.
But rather, value portions of the market have done slightly better.
Myth 2: Disruption is a new issue, which has caused value to perform poorly in the past decade
Truth: As investors, we face the possibility of companies being disrupted. This is not just a risk relative to value investors but arguably to growth investors too.
The first reason being an underlying desire to disrupt the incumbent that growth companies attract due to their high growth rates and returns on capital.
Secondly, the risk they pose is not priced into stocks. When the market believes a business does not have a viable future, it will price it accordingly and those that defy those expectations produce strong returns. Some examples of this include tobacco stocks from 2000 or Microsoft in 2010.
Stocks which have proven to the market that they are resilient to competitors may also be priced for high growth to perpetuity and face the possibility of significant downside if they disappoint the market or if there is a shift to value.
It has been a recurring theme that investors have the habit of overpricing stocks that offer stability and predictability, and under-price those with poor prospects.
Myth 3: The outperformance of growth in the last decade is proof enough that value investing is dead
Truth: The recent period of growth’s outperformance, whilst although significant, has been by no means unprecedented. This has, in fact, occurred three times in the past 50 years with the Nifty Fifty Bubble, the dotcom bubble, and finally in the past decade.
With all three occasions, there are similarities in what has caused these periods of growth, creating a narrative about certain stocks that represent a new paradigm that allows these stocks to become highly priced.
The second common theme is a background of excess liquidity, inflating the bubble and causing some investors to believe the liquidity-fuelled bubble to be investment brilliance.
As investors move in to buy growth celebrities at their peak, they dismiss value investing with the belief that the style 'will never work again' due to it not having worked recently.
This thought process does a disservice to value investors as their stocks become neglected, regardless of how cheap they are.
When the bubble pops, starry eyed investors are left with significant losses as the growth celebrities begin to de-rate to more amenable levels.
Myth 4: This cycle is different as the winners are 'real companies' with huger impenetrable franchises unlike the dotcom era
Truth: This is a common claim, often accompanied by examples that attempt to prove the point but instead make unfair comparison, including ones as obscure as "Amazon is not like Pets.com".
We have seen examples in the previous growth bubbles of companies that appeared to have a certain future. During the height of the Nifty Fifty period, we witnessed the growth of Xerox and IBM which investors were fanatical about.
In 2000, Cisco, Dell, Nokia or Intel all appeared to dominate the market, and to investors there was no way they could ever be caught by competitors.
In today’s world, we could say the exact same things towards Facebook and Google, that investors will remain invested in them and they will never be caught by competitors.
These past examples have ended up losing investors significant amounts of money, begging the ultimate question, what will happen when this bubble goes pop?
Is value investing dead? Are we about to see another bubble grow? And is this financial cycle any different to that of the dotcom era?
Is value investing dead? Are we about to see another bubble grow? And is this financial cycle any different to that of the dotcom era? With the economy enduring a rollercoaster ride over the past year,...