May 31, 2022

Value and Growth Through the Looking Glass

by Dewi John.

Oscillations between value and growth can provide those hand-waving explanations that actually don’t explain very much. Value is outperforming now where growth was before because…well, just because.

The individual elements of what’s producing these high-order effects can tell us a lot more than a heavily generalised summation, however—as can how this is mediated through specific portfolios.

A recent blog from FTSE Russell indices notes that Value and Dividend Yield factors have strongly outperformed the growth-focused Quality factor over the first quarter of this year (chart 1).

 

Chart 1: Factor relative returns (%) – First Quarter 2022

Source: FTSE Russell, March 31, 2022. The Value active industry weights are based on the GEIS indices: the UK is represented by the FTSE UK; US is by the FTSE USA and Europe on the FTSE Developed Europe ex UK

 

This has been driven by two factors: first, value stocks tend to belong to outperforming sectors such as oil & gas, miners, and consumer staples. These have benefited hugely from supply chain disruptions, whether from the disjointed post-COVID not-so-normal ‘normalisation’ or war in Ukraine.

Second, rising interest rates favour value relative to growth, as the former are shorter duration and therefore suffer less from the discounted value of future earnings—unlike, say, the tech sector, where companies often have valuations premised on earnings with a strong emphasis on “future”.

These two have combined over recent months to catalyse a third: the dumping of expensive new economy stocks, the valuations of which ballooned during the low interest rate environment since the global financial crisis.

 

OK for UK

The UK has been a particular beneficiary of this, outperforming many other equity indices year to date. The FTSE 100’s Oil & Gas weight is about 12%, as compared to the S&P 500’s 4.4% and nothing for the Dax. Energy, basic materials, and consumer staples make up nearly 40% of the FTSE All Share (chart 2). That said, the performance you get depends very much on where you are on the cap scale, as the mid-cap FTSE 250 has only about 2% in oil & gas and has performed in lockstep with Germany’s Dax so far this year.

 

Chart 2: Value active industry weights (%) – as of March 31, 2022

Source: FTSE Russell. March 31, 2022.

 

What the UK large-cap index lacks has served it almost as much as what it has, as there are no home-grown equivalents of the BATs or FAANGs. That hurt it until the tail-end of 2020, since when it’s been a boon.

Style exposure is not necessarily a straightforward effect, however—hence my scepticism about generalised over value and growth effects. Take, for example, financials, which have a heavy value tilt. Consequently, they suffered smaller losses than the broad market in the US and Europe and rose in line with the benchmark in the UK. Banks do well as rates rise, as higher rates allow for higher margins. However, they’re also heavily procyclical. So, as recessionary fears grow, and UK GDP fell over Q1, the shine has come off this sector, banks have sold off and valuations suffered.

Nevertheless (and please excuse my generalisation, having slated it), in the round value has outperformed since the “vaccine rally” kicked in, in November 2020 (chart 3).

 

Chart 3: US and UK Value v Growth Indices

Source: Refinitiv Lipper, to April 30 2022

 

While the FTSE UK Growth and Value indices’ history doesn’t stretch back to 2009, you can clearly see the effect with the US large-cap Russell 1000 and small-cap Russell 2000 indices. The growth premium until the end of 2019 was considerable, particularly among large caps. For more than a decade, you couldn’t put a foot wrong throwing your money at big tech beasts such as Amazon or Facebook. Things are more mixed from the start of 2020 to April 2022, with UK growth and US large-cap growth still outperforming, while value edged it elsewhere. But from November 2020, when global markets bounced hard on expectation of a viable vaccine rollout, it’s much clearer: it has been value all the way, by a massive degree—almost 50 percentage points with US small-caps. And the highest return has been from UK value.

 

Through the Fund Lens

The next thing I did was to see how this index performance panned out for UK equity funds, taking the two periods—until end 2019 and from November 2020—from chart 3 and applying them to Lipper’s Equity UK group of funds.

Unsurprisingly, over the first 10-year period, the top of the table is dominated by growth funds and the bottom value (though there are exceptions). Returns ran from 422% to -19%. The top-performing growth-orientated UK fund therefore still lagged the 430% return of the US large-cap growth index, the Russell 1000 Growth.

From November 2020, there’s a complete style reversal. Returns run from 76% to -12% over the period, with a general pattern running from value to growth—though, again, not without exceptions.

The three top-performing funds between 2009 and 2019 rank 146, 170, and 220 out of 257 from November 2020. Conversely, the top three performers since November 202 with histories stretching back far enough ranked 96, 63, and 41 out of a universe of 164 funds.[1]

What this final (admittedly back-of-an-envelope) calculation indicates is that while style matters, so too does manager skill. The top-performing UK equity manager between November 2020 and April 2022 still beat the FTSE UK Value index by 76.2% to 54.4%, while the top-performing fund over 2009 to 2019 has nevertheless managed to deliver 32.2%—almost double that of the UK Growth index over the same period.

The best UK manager didn’t beat the index for US large-cap growth over a decade. Calling the prevalent macro drivers correctly, and knowing what markets to place your bets, is therefore important—though, as ever, that’s easier in hindsight than sitting in your foxhole as it all goes off around you, as now. But identifying a manager able to adapt, even when those drivers are against them, can help a lot, even if you misjudge the former.

[1] Funds UK registered for sale, currency of record GBP, primary share class.

 

 

This article was originally published in Portfolio Adviser.

Refinitiv Lipper delivers data on more than 330,000 collective investments in 113 countries. Find out more.

The views expressed are the views of the author and not necessarily those of Refinitiv. This material is provided as market commentary and for educational purposes only and does not constitute investment research or advice. Refinitiv cannot be held responsible for any direct or incidental loss resulting from applying any of the information provided in this publication or from any other source mentioned. Please consult with a qualified professional for financial advice.

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