Is this the end of value?

Photo by Artem Beliaikin on Unsplash

Value investing is dead.

That’s what we keep hearing from the newspapers, who have a habit of writing obituaries for things that have not yet expired. 

According to a widely-repeated legend (who knows if it’s actually true), an American newspaper printed Mark Twain’s obituary when he was still alive. He later quipped, “Reports of my death are greatly exaggerated.” The same might be said of value investing, and we use “might” with great emphasis, because we simply don’t know what is going to happen. 

We’re interested in value. We would certainly never describe ourselves as “value investors” in the Benjamin Graham mould, and we wouldn’t call ourselves steadfast “growth” acolytes either. The concept of value is actually quite fluid. We’ve seen it described as an, “age-old investment strategy that involves buying securities that appear cheap relative to some fundamental anchor”, which pretty much sums up the craft of investing in general – there are many anchors at our disposal, of which fundamental analysis is just one. 

Let’s face it, no ambitious young fund manager enters the business intending to buy high and sell low. In that sense, we are all seekers of value, with different ways of looking at the world and different ways of getting at the good stuff.

Third level thinking.

Here’s something we do know – despite what some economic theorists would have us believe, markets are complex beasts and certainly don’t function as hyper-efficient weighing scales in the short term. In fact, the prevailing perception of how they operate (which differs decade to decade, year to year, and lately it seems, day to day) impacts asset prices themselves. 

This is the “third level thinking” that Keynes famously invoked when characterising the beautiful complexity of investing in markets composed of sentient beings, many of which have now been swapped out for robots (it’s worth noting at this point that Keynes was also a fan of buying stocks based on what he called “intrinsic value”). 

What we are driving at here is that a shift in the discourse around the dominant style of investing can have profound effects on individual stocks and entire sectors. That is what seems to be occurring right now, and we are watching it unfold with great attention and caution.

Screaming signals.

Josh Wolfe recently tweeted that, “Articles on the death of “value investing”, as in ‘99/‘00 are screaming signals.” The question is, screaming signals of what? The media cycle is never perfectly aligned with reality, and the ensuing lag effects create interesting spaces for investors to explore and exploit. As ever, it’s a question of timing. 

It’s worth noting that during the Wall Street Crash of 1929, renowned newspaper the New York Daily Investment News inked a headline on Friday 25th October (the day after Black Thursday) that proclaimed, “Stock Market Crisis Over”, after stocks gained 1% on the day. Soon the same publication was reporting, “It is over. We have seen the worst.” But they had not seen the worst. Continued selling heralded billions of dollars of value wiped from the Dow and the onset of the Great Depression.

We are not ancient enough to have read that newspaper in print, but we are old and wizened enough to remember over-exuberant headlines that have misjudged underlying economic realities. As The Economist perceptively pointed out in a recent article on the economic fallout from Coronavirus, “Financial markets look forward. Yesterday’s news is stale.” For this reason, we try not to read too much into headlines, preferring to sift through the big stories to find the little ones that are less obvious but so much more rewarding.

Demographic shifts and robots.

Right now a massive debate is raging about the relevance of value investing. Warren Buffett has always personified the value school, and the recent fallout from his exiting of US airlines stocks (it sold more than $6bn of airline stock last month) has delivered a deep blow to the prestige of value as an investment style, undermining the rhetoric of thousands of managers and advisors who have grown up idolising and repurposing (or lamely copying) the Berkshire ideology.

The decade-long underperformance of value since the last financial crisis has led some to question whether systematic value strategies are now irreparably broken. So it was interesting to read AQR’s recent thoughts on the subject. Having assessed many of these criticisms (ranging from increased share repurchase activity, the changing nature of firm activities, the rise of ‘intangibles’ and the impact of conservative accounting systems, the changing nature of monetary policy and value measures are too simple to work), researchers found find little empirical evidence to support them. It seems there is another reason why value has broken down; a beast lurking in the shadows. And that beast is the passive movement.

Logica has lent credence to this view, observing that more than 100% of gross flows into the stock market are now passive, thanks to regulatory changes brought about as a result of lobbying from the likes of Vanguard and Blackrock. Since the mid 90s, momentum has outperformed value by an astonishing 73% of all three-year periods. Logica points out that value hasn’t really performed for decades due to structural change in the market. 

The future arrived quicker than anyone thought, and we have moved from a market dominated by momentum. We can thank demographic shifts and robots for that, both simple and systematic.

Knowing you don’t know.

It’s natural that people are questioning the future of value. After all, it’s underperformed for decades, and at a time when a ghastly pandemic is overshadowing markets and you might expect it to come back charging, it has been pummelled. Berkshire has taken a loss of nearly $50bn in the first three months of the year, driven by massive hits on its stock portfolio. And more broadly speaking, the value index has disappointed and dismayed its fans. As the FT points out:

“The Russell 3000 Value index – the broadest measure of value stocks in the US – is down more than 20 percent so far this year, and over the past decade it has only climbed 80 per cent. In contrast, the S&P 500 index is down 9 per cent in 2020, and has returned over 150 per cent over the past 10 years. Racier “growth” stocks of faster-expanding companies have returned over 240 per cent over the same period.”

But markets move in mysterious ways. We think it’s foolish to say without ambiguity or humility that value is dead forever. If there’s one thing we’ve learned from 14 years of investing, it’s that trends are cyclical, memories are short, and markets have an uncanny way of reinventing themselves over and over again, much to the chagrin of those who believe they have them pegged. 

We don’t know what’s going to happen, but at least we know we don’t know. In fact, knowing that you don’t know is a powerful way of preparing yourself for new possibilities, protecting against big threats and maximising the opportunity set.

The fragile structure of markets. 

From where we’re standing, our base case (lightly held) is that value won’t be making a major comeback any time soon. But it’s also possible that value can make a sensational return to prominence. 

What are the things that could cause this to happen? Political and economic black swans are always a possibility (although the Coronavirus pandemic hasn’t seemed to help), but value investing’s best hope for a resurgence is tied to the fate of passive investing. 

Value investing is, of course, synonymous with active management. Should the passive movement stall – perhaps due to macroeconomic factors damaging the ability of millennials to save, regulatory intervention designed to clamp down on the somewhat dubious marketing strategies of some robo-advisors, wholesale loss of confidence in the efficient market hypothesis, or a general loss of confidence in markets generally – value could return. The King of Value himself has said, “Fear is the most contagious disease you can imagine”.

Reading comments on FT articles is a favourite past time of ours, and we couldn’t resist reproducing this little beauty from an FT subscriber who goes by the name of “Hollow Man” (his thinking is the opposite of hollow):

“Perhaps one day someone will write the definitive thesis on the artificial shortening of time by the US central bank that has obliterated our assessment of the future. As investors, we have felt our way forward. The future is more uncertain and more treacherous than the present, the distant future even more so than the near. That is our baseline and upward sloping curve of uncertainty. On that baseline we add different layers of risk: credit is better than equity, publicly traded equity is better than illiquid and non- transparent  private. But value outperforms not on the vertical layering of risk but in the horizontal continuum of uncertainty. Only if the future feels uncertain, will value flourish. Conversely, by removing uncertainty, where the future is murkier than the present, we collapse into the familiar categories of risk. But the Fed has flattened and shrunk the uncertainty curve. In short, value will not outperform until the central banks are seen to have failed.”

As lovers of uncertainty and studiers of market narratives, we are always mindful about the possibility of value staging a comeback. Indeed, we saw a brief glimpse of what might happen at the beginning of 2016, a significant inflection point where value surged for a good few months. Since then, the structural reformation of the market has accelerated, with passive investing (not to mention systematic approaches) gaining greater ground and driving many active managers with high fees and low alpha into new careers as life coaches and organic coffee roasters. 

Against clubs.

Given the fragile structure of contemporary markets, the increasingly extreme actions of policy markets and the dominance of passive flows, a reversal could be extremely violent – biblical in ferocity and scale, a tsunami of funds flowing out of passive managed portfolios. The investment landscape would suddenly look very different; mostly underwater, with some islands of sanctuary poking up above the waves. To extend the metaphor to the limits of what is acceptable in a thought piece, the challenge for us as managers is to avoid building portfolios at sea level. Those that take the necessary precautions could see massive opportunities after the flood subsides (or even during), as a deep value style returns with a vengeance (for some time at least). 

Nobody can consistently time the market perfectly. But we can read the signs and prepare for a wide range of divergent scenarios. To do so requires an open mind and a refusal to subscribe to clubs. 

Value investing incites strong opinions and cult-like tendencies amongst its adherents, perhaps more so than growth investing. But humans have an irrefutable need to belong, to identify with a larger community. In truth, the “growth club” is just as appealing as the “value club”, and just as irrelevant and dangerous in today’s markets, which, much to everyone’s continued frustration, refuse to join clubs or pick sides.