Value and growth are essentially different styles of investing. Compared to some of the other stock market jargon, the concept of value and growth investing styles are refreshingly clear, writes Scott Spencer, investment manager in the multi-manager team at Columbia Threadneedle Investments.
There’s a difference between buying cheaper value shares with higher dividends as opposed to investing in more expensive growth shares that should repay you with future profits due to the company perceived high growth. The styles of investing look at how a company is being valued by the stock market and how that might change.
We invest in both styles but currently, see a clear advantage to leaning towards the value style of investing. However, that doesn’t mean excluding technology and AI-linked shares from portfolios just because they’re traditionally associated with growth, especially after they’ve been such rewarding investments over the past six months.
It’s more recognising that, with inflation still sticky and interest rates higher for longer, and value being historically cheap a bias towards a Value-style investing approach is likely to be more rewarding in the current environment.
Performance linked to the economic background
The growth style of investing outperformed overall from 2007 to 2020, linked to the low cost of capital and low interest rates, success of technology-driven companies and the disruptive shift of many businesses online over that period. However, last year when their share prices slumped, value outperformed.
Global rising interest rates and the potential for a global recession impacted all companies but many value names already reflected a global slowdown. It is crucial to understand the economic background to that period of outperformance of the growth investment-style over value.
This was a period when profits growth was hard to come by and when interest rates and inflation were low, in the aftermath of the global financial crisis. Previously value-style investing had outperformed over the period 1970 to 2006, with a few breaks such as the dot.com bubble.
This period of value outperformance was during a period with higher average growth, inflation, and interest rates. It is essential to look at all these factors when deciding whether to shift an investment style towards growth or value.
Factors favouring value
New emerging technology is disrupting existing business models and opening new opportunities for companies, as such the market focused on a long-term theme, currently AI, which favours growth.
Aside from this, there are many market factors which point to value looking more attractive this year. For example, interest rates historically determine the value of future versus current profits. Higher interest rates favour value and lower interest rates are better for growth.
As short-term interest rates remain high and central banks seem keen to continue to increase, this favours value, and bond yields indicate interest rates will remain above the level of the previous decade.
In addition, higher inflation drives interest rates and gives opportunities for many companies to raise profits. Inflation has remained stubbornly high and the market forecasts that it will remain above, rather than below, central bank targets, which favours value.
Higher economic growth means companies growing profits are more common and therefore less highly prized. More common GDP growth favours value, but economic recessions are not necessary a bad environment for value investors. The bond market is forecasting a US recession this year, with the yield on US Treasury bonds less than short-term interest rates.
The covid lockdown and recession saw value underperform growth, however previous, non-covid lockdown recessions were more neutral for style performance and mainly saw value outperform.
Taking all this into consideration, all indicators point to value-style investing being the most fruitful against the current economic background this year. However, whilst a lean towards a value style approach in a portfolio might be rewarding, a diversified portfolio is crucial so continuing to hold good quality growth managers is also key.
An investment style bias can impact a fund’s performance relative to its benchmark in a positive or negative way. No investment style performs well in all market conditions. When one style is in favour another may be out of favour. Such conditions may persist for short or long periods.
This article was written for International Adviser by Scott Spencer, investment manager in the multi-manager team at Columbia Threadneedle Investments.
