There is little doubt that investors have been rewarded for taking a growth approach to the equity market over recent years, as funds implementing such a strategy have tended to dominate their more value-orientated peers.
There have been a number of drivers behind this trend, of course. Firstly, the lasting effect of the financial crisis has meant most investors prefer to focus on the perceived safety of cash generative companies with clean balance sheets and reliable earnings, rather than more cyclical value stocks where earnings are more reliant on the state of the economy.
On top of that, given many of these high quality companies have also paid reliable dividends, they have attracted swathes of tourist fixed income investors who have been forced out of the bond market by central bank polices of quantitative easing and ultra-low interest rates to find an acceptable level of yield.
According to FE Analytics, growth stocks in the global, UK, US, Europe ex UK, Japan and global emerging markets space have all outperformed value stocks over the past five years.
Source: FE Analytics
Putting those six equity market indices together, on average, growth stocks have returned 51.43 per cent over five years compared to a gain of 33.51 per cent from value stocks.
Given that information, it is no surprise that some of the best and most consistent performers (not only from a total return, but capital preservation viewpoint) in the various Investment Association sectors have been those that focus on high quality names with strong franchises.
These include the likes of CF Lindsell Train UK Equity in the domestic peer group, Fundsmith Equity in the IA Global sector, the Stewart Investors funds in the emerging market space, Baillie Gifford Japanese in IA Japan and Jupiter European in the IA Europe ex UK sector.
Their performance has also led to a surge in assets, with many investors wanting to capitalise on their strong past returns.
However, is this trend coming to an end and should investors now be focusing on value funds for their equity exposure?
Simon Evan-Cook, fund manager at Premier, says he and his team have been debating this very subject within their own fund of funds range.
He points out that while growth-orientated funds have driven most of his five crown-rated Premier Multi Asset Global Growth portfolio’s outperformance over recent years, given how well they have performed and with the possibility of higher interest rates, now may be the time to shift his assets more towards ‘deep value’ funds.
Performance of fund versus sector and index under Evan-Cook
Source: FE Analytics
“Within the Global Growth fund, we have plenty of funds that do that job – Lindsell Train Japan, JOHCM UK Opportunities, Hermes US SMID, etc – so there are lots of really high quality funds in there,” Evan-Cook (pictured) said. 
“These ‘Fundsmith-type’ funds may have had the best conditions imaginable over the last few years, especially in the developed markets. There has been nowhere better to be than developed market, high quality stocks.”
“Should you be worried about that? I think if you are a 20-year investor, probably not. But, if we all held our hands up and say we know ourselves, many people aren’t prepared to sit there and watch their fund underperform over even a year, yet alone five or six years.”
“There is a risk that, having done so well, that – to use Nick Train’s terminology – these type of funds go to sleep for a while. I’m not suggesting that these is going to be some sort of cataclysm for these funds, but on the other side of that you have to think how badly value has done.”
The graph below plots the MSCI AC World Value index relative to the MSCI AC World Growth index over the past 10 years.
Relative performance of indices over 10yrs
Source: FE Analytics
As you can see, while value stocks considerably outperformed prior to and immediately after the global financial crisis, the style has consistently underperformed since September 2009 – with 2015 being a particularly bad year for them.
This trend has been clearly illustrated in the IA UK All Companies sector tables year to date, as value funds (which due to their style have held bombed-out mining, oil and financial companies) litter the bottom quartile.
These include the likes of Schroder Recovery, Standard life Investments UK Equity Recovery, M&G Recovery, Old Mutual UK Alpha and Investec UK Special Situations.
However, Evan-Cook says it is only a matter of time before this trend starts to reverse.
“The world goes through these swings and they can last for six, seven, eight years and the current one has lasted since the global financial crisis. There was a big value cycle before that and it has since been all about growth,” Evan-Cook said.
While Evan-Cook firmly believes that value will be the ‘new era’, he admits he has no idea when such a change in markets will occur. Therefore, he will continue to blend growth and value strategies within his portfolios to keep the bases covered.
However, Tilney Bestinvest’s Jason Hollands believes now is the time to be focusing on value in certain parts of the market, especially given where we are in the economic cycle.
“I’m inclined to agree with such a shift to a more value-focused approach when it comes to US equities where the bull rally in growth stocks appears to have lost momentum and stock prices look stretched at a time when a rate hikes will reduce liquidity flows. In such shift in environment, I believe the market will become more discerning about both valuation but also genuine top line sales growth,” Hollands said.
“A lot of the earnings expansion in the US in recent years has come from restructuring and refinancing, essentially disproportionately rewarding more indebted companies. With the cost of capital on the rise, the heyday for that type of activity has probably already passed by.”
Rob Morgan, pensions and investment analyst at Charles Stanley Direct, says investors should take a similar approach to Evan-Cook at this point in time.
He says that given the headwinds facing markets and the clear challenges presented to some of the deepest value areas of the market, now is a good time to incorporate value funds alongside more growth-orientated products.
Performance of indices over 3yrs
Source: FE Analytics
“I think a balanced portfolio of active funds should contain a mix of styles and both growth and value funds,” Morgan said.
“Now could indeed be an opportune time to add to value for the long term, whilst being aware of what value could mean – e.g. mining, energy, supermarkets and so on. These are areas that have appeared cheap for some time and it could take a while for a turnaround to happen.”
For those looking to add value funds to their portfolios, in the next article we look at five funds which investors may wish to consider.
