This way of investing, as Schroders’ Kevin Murphy claimed in an article earlier today, has been proven over time to outperform growth investing over the long-term.
Backing a company to keep expanding is historically very difficult to do, as shown by the table below.
Schroders research shows that the higher the starting price-to-earnings [P/E] ratio – the traditional measure of how expensive a stock or index is – of the S&P 500 since 1880, the less money investors have made over time.
10yr annualised return of the S&P 500 index by starting P/E ratio
| Starting P/E ratio | 10yr annualised returns (%) |
|---|---|
| 5-10 | 11 |
| 10-15 | 8 |
| 15-20 | 6.5 |
| 20-25 | 3.8 |
| 25-30 | 3 |
| 30+ | 0 |
Source: Schroders
On average, a starting P/E ratio of between five and 10 has resulted in 11 per cent annualised returns from the S&P 500 over a 10-year period.
This compares with 8 per cent when the P/E has been between 10 and 15, 6.5 per cent when the P/E has been between 15 and 20 and 3.8 per cent when it has been between 20 and 25.
When the P/E has been above 30, on average the index has failed to make any gains at all.
"What you pay, not the growth you get, is the biggest driver of future returns. You can be the best stockpicker in the world, but if you buy expensive stocks you’ve got less of a chance of them growing," said Murphy.
This style brings with it substantial risks however, as Rob Morgan, analyst at Charles Stanley, explains.
"A value investor follows the approach of picking up unloved companies that are off the radar and possibly even basket-cases that people have decided to ignore, but where they think there’s a catalyst for change, like where there’s a new management team or another catalyst," he said.
"They have to be somewhat of a visionary really, as they may not have the evidence to go on in terms of figures."
"They also have to be a good judge of the downside risk and have an idea of what the sell-off value of a company is."
"There will be some that go bust as well; it’s inevitable with this style of investing."
Some funds have been very successful in using this strategy, however, delivering excellent returns to investors over the long-term.
Here, FE Trustnet highlights five that are highly rated by experts.
Investec UK Special Situations
Morgan rates this £776m fund – run by Alastair Mundy with a contrarian, value style – very highly.
"He has shown a good eye for stock-picking," Morgan said. "I would say though, it’s a fund that will have periods when it does very well and it will also have periods when it doesn’t."
"Investors can expect performance to be 'lumpy'; quite often things do not come at a steady pace."
Data from FE Analytics shows that the fund sits in the top quartile of its sector over five and 10 years, although it slips into the second quartile over three.
Performance of fund vs sector and benchmark over 5yrs
Source: FE Analytics
Morgan says this is thanks to its outstanding performance during the stock market crash that began the financial crisis.
"It did extremely well in 2007 and 2008 and a large part of its relative performance comes from those years," he said.
"He had a reasonably high weighting to cash and turned very defensive, so where he was seeing value was the safe, defensive type of stocks, the ones that nobody was invested in at the time."
Mundy runs a highly concentrated portfolio, with more than 7 per cent of the fund in his two largest positions – GlaxoSmithKline and HSBC.
He also invests in the mid cap spectrum as well as FTSE 100 companies.
The fund requires a minimum initial investment of £1,000 and has ongoing charges of 1.6 per cent.
Jupiter UK Special Situations
Ben Whitmore has run this £1bn fund, which has five FE Crowns, since 2000.
Its performance has been more consistent than the Investec fund and it is a top-quartile performer over one-, three-, five- and 10-year periods.
"He’s got that same value mentality and also, although not to the same extent as Alastair Mundy, he holds up on the downside," Morgan said.
"The fund’s holdings are more mainstream too; he tends to be more large cap than Mundy, who is happy to hold more mid and small cap companies."
GlaxoSmithKline is also a top-10 holding on this fund, as are BP, Vodafone and AstraZeneca, all large companies engaged in recovering from difficulties or turning around their business.
The fund is available with a minimum initial investment of £500 and has ongoing charges of 1.76 per cent.
Fidelity Special Situations
This £2.6bn fund has recovered strongly over the past year after suffering badly during the years following the financial crash of 2008.
Sanjeev Shah stuck to his strict contrarian, value-oriented style during a period when the market was less interested in fundamentals but more concerned about safety.
Diminishing macro-economic headwinds explain his recent success, the manager told FE Trustnet.
The fund is a top-quartile performer over one year, having made 27.43 per cent while the FTSE All Share returned 16.96 per cent.
Performance of fund vs sector and benchmark over 1yr
Source: FE Analytics
Shah is sticking to his big positions in UK banks, which many investors avoid thanks to the reputational and balance sheet issues they have struggled with.
The manager continues to see value in their depressed share prices.
The fund is available with a minimum initial investment of £1,000 and has ongoing charges of 1.7 per cent.
Aberforth Smaller Companies Trust
Simon Elliott, head of investment company research at Winterflood, says that this £753m investment trust, team-managed by Aberforth, is a solid value-based portfolio.
Performance has started to pick up after a few tough years, and it has outperformed its benchmark and sector over the past 12 months.
Performance of trust vs sector and benchmark over 1yr
Source: FE Analytics
"It had a tough period because the thing is with the value approach, when the market is rising strongly it can be difficult for those managers," Elliott said.
"So in ’06 and ’07 they struggled, then in '08 they added gearing because they saw value, and then the market crashed, then they were left behind in the rally in ’09."
"They have increased their resources on the team; it’s a specialist team, that’s all they do."
Elliott says that NAV has performed in line with the benchmark over one year and is slightly behind over three, suggesting that performance is improving.
However, thanks to its earlier struggles the performance in share price terms is only marginally over the Numis Smaller Companies ex IT benchmark over three years, at 51.02 per cent rather than 49.63 per cent.
Ongoing charges are 0.81 per cent, according to the AIC.
British Empire
"The other obvious value fund is British Empire. The manager is a team, Asset Value Investors, led by John Pennick," Elliott said.
"It has a global value remit, so the kind of companies he likes to buy are holding companies that you can analyse the component parts of and say where the NAV should be and where it trades. It struggled in 2008, but lots of managers did."
"The interesting thing is its own discount has widened to 12 per cent now compared with an average of 10 per cent, and we think that’s a value opportunity in itself."
"With a 30 per cent discount on the underlying portfolio and being on its own discount of 12 per cent you are effectively getting a double discount."
"John took a big bet on Europe last year which came off and it’s had listed private equity companies which have done well like Electra Private Equity as well as holding company Jardine Mathieson."
The ongoing charges on the fund are 0.75 per cent, according to the AIC.