The great rotation – Cover story


since November 2020, easily beating the 23% gain for its ‘momentum’ counterpart.


“Investors now seem a little wary of jam tomorrow growth stocks and seem to be preferring jam today companies,” is how Russ Mould, investment director at AJ Bell, puts the rotation from growth to value.


Offering another interpretation, global market strategist Michael Bell says: “The underperformance of value relative to growth since 2007 is now approaching levels only seen during the 1930s and the dotcom bubble. After such significant peri- ods of value underperformance, the snap back in favour of val- ue has historically been large and quick.” Investors be warned.


Superior longer-term returns A key point for institutional investors, and pension funds in particular, is that value stocks should see superior returns over the longer term. Making them the natural bedfellow of pen- sion schemes. To support this, data compiled by economic sciences Nobel lau- reate Eugene Fama and Ivy league Dartmouth College profes- sor of finance Kenneth French revealed that from 1927 through to 2019, value stocks outperformed growth stocks 93% of the time during rolling 15-year periods. The value premium – the excess return over growth stocks – was 3% per annum. This seems to settle any debate between value and growth. The founder of value investing Benjamin Graham was looking for stocks of companies that were trading below a conservative estimate of their liquidation value – that is, less than their book value. Warren Buffet then took the idea of value investing further by looking for stocks that traded below their ‘intrinsic value’ – including high-quality companies that could reinvest large amounts of capital at high returns. Buffet’s famous adage on his approach remains: “It’s far better to buy a wonderful com- pany at a fair price than a fair company at a wonderful price.”


You can’t touch this But there is a modern twist to these impressive numbers. Phys- ical assets, such as factories, were the foundation of business value and recorded as assets on the balance sheet when Benja- min Graham founded value investing in the 1930s. Now, according to Michael Mauboussin, a professor of finance at Columbia Business School, earnings and book value no longer means what they used to. Professor Mauboussin’s assertion has real implications for the value versus growth argument. It means that if the worldwide economy continues on its trajectory of being more knowledge- based and increasingly reliant on new technologies – as it is clearly developing on these lines – then growth will outper- form, because of the weighting in the dominant industries.


It’s far better to buy a wonderful company at a fair price than a fair company at


a wonderful price. Warren Buffett, Berkshire Hathaway


Pointing to this trend, last year growth stocks outdid value by more than 30%, with the technology sector accounting for almost 40% of the S&P500 – so it is the actual dominance of growth here that appears to a major factor.


In addition, the information age has ushered in the age of the stock picker, and the differentiation between growth and value is truly blurring – growth, but at a fair value price. The very suggestion would have Warren Buffett shaking his head.


Zero-sum game Yet the current investment environment is shaping up to indi- cate a rotation into value, meaning institutional investors big on growth need to potentially readjust.


“Investors with a big bias towards growth stocks over value stocks are vulnerable to recession, reflation and regulation,” warns Michael Bell. “Therefore, it may be time to consider rebalancing portfolios to a more neutral balance between growth and value stocks after such a long period of growth out- performance,” he adds. Although does it have to be an “either value or growth” situa- tion for investor? Rob Morgan, investment analyst at Charles Stanley Direct, thinks not. “The question shouldn’t be whether value or growth is best, but how to find the best opportunities in each camp to populate a portfolio for the best returns.” Although Graham notes a rotation to value will not, or should not, necessarily mean a readjustment for growth. “The likelihood that the performance of value stocks in 2021 will revert closer to their historical mean – which is a good thing – should not begrudge the possibility that growth stocks will continue their trend up – which is also a good thing: it’s not a zero-sum game.”


Issue 103 | May 2021 | portfolio institutional | 21


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