It will take something drastic to happen to markets before value stocks become “sexy” again, according to Investec Asset Management’s Alastair Mundy.
The value investment style has been out-of-favour for much of the post-crisis period as low rates, low economic growth and quantitative easing have driven investors into growth stocks in search of strong returns.
As the below chart shows, the MSCI UK Growth index has risen by 153.98 per cent over the past 10 years while its value counterpart is up by just 95.51 per cent.
Performance of style indices over 10yrs
Source: FE Analytics
On a fund level it has been the quality growth managers that have won the plaudits over the past decade, while the backdrop has been more of a challenge for their value counterparts.
“Even though it’s strong, we’re very much looking at a bifurcated market and for stocks that are very much in-favour, that’s where all the sexy fund managers are,” said Mundy, manager of the Temple Bar Investment Trust.
He added that the best value to be had in the UK market is in stocks most at risk from two factors: Brexit and a decline in global growth.
The manager said that some investors have recently become “paralysed” with Brexit fear and as a result, the stocks that have the most to lose from a disorderly departure from the EU are becoming ever cheaper.
“It’s one step worse than paralysing, they’re actually selling those stocks – they certainly aren’t willing to embrace any positive news on Brexit. So, the valuation of domestic stocks has really taken a hit,” he said. “At the same time, the UK economy is clearly struggling and there’s nothing, profitability-wise, to support those domestic stocks.”
Meanwhile, concerns over global growth have been fuelled by the Federal Reserve’s rate normalisation programme last year and a deterioration in relations between the US and China.
Recession fears have built over the past month, with the Bank of America Merrill Lynch Global Fund Manager Survey noting a net 34 per cent of respondents believe a technical recession within the next 12 months is likely, an eight-year high.
“Worldwide, investors have become more aware of economic growth,” said Mundy (pictured). “There’s been an effort by investors to price-in a recession and that has led to cyclical stocks really taking it on the chin, a lot of which are already under pressure because they were value stocks that many investors were already doing their best to avoid.” 
This has contributed to a much tougher decade for value stocks, with the “wheels coming off in the last 18 months”.
“We have to accept that economic growth hasn’t been great for the last decade, which hasn’t proved much of a help to value stocks,” he continued. “And neither has inflation.
“Finally, interest rates have been so low, that’s been a great backdrop for growth stocks and a pain for value stocks.”
He added that it is likely to take something drastic before the value style swings back into favour.
“For value to do particularly well, you really have to believe that the yield curve is going to change shape significantly and bond yields are going to rise,” he explained.
While the recent inversion of the yield curve has raised fears of recession, Mundy said there are several developments that could be positive for value stocks.
The move towards populism and support for increased government expenditure in the form of ‘modern monetary theory’ and growing tolerance of inflation could help push yields higher, for example.
“If you look at the yield curve, investors have regrettably given up on inflation ever moving higher in a significant way again, which we think is a little bit backward-looking,” he said.
“Perhaps people aren’t necessarily focusing on why that has been cyclical rather than structural and, therefore, we wonder if investors have got a portfolio which is future-proof, or whether it’s actually history-proof.”
Nevertheless, Mundy said there are currently some interesting opportunities to be found in markets.
“To us, it looks like valuations are just about as compelling as they were in the late 1990s, in the technology boom, certainly in absolute terms,” he explained.
“In the late 1990s, everyone was effectively saying, ‘no one wants the old economy stocks because new economies are going to destroy them’. And that is sort of where we are again now.”
Mundy added: “Even if there are correct reasons for value stocks being sold down aggressively, we still would argue there are some babies that have been thrown out with the bathwater.
“When value is most out of favour is when we would expect the most irrational behaviour on an individual stock basis.
“The point is that both value and growth have had their periods in the sun over the years and when either of them is doing very well, that performance tends to get extrapolated.
“Unfortunately, that often means when investors fall in love with any sort of investment style, they seem to take their eye off the ball in terms of the valuations they’ll pay.”
Mundy added: “We would argue that there’s less emphasis on valuations at the moment than there has been for some time. And we think that that can often lead to sub-optimal decision-making.”
Asked whether it has been one of the most challenging times for the style in his career, the manager was a bit more philosophical.
“Has this been the most terrible period for value stocks or being a value manager? There are two sides to every coin,” he concluded. “All value investors will feel rather beaten up at the moment, but at the same time rather excited about their opportunities.”
Performance of trust vs sector & benchmark under Mundy
Source: FE Analytics
Since October 2002, when Mundy took over management of Temple Bar, the trust has delivered a total return of 390.62 per cent compared with 301.22 per cent for its IT UK Equity Income sector and 285.60 per cent return for its FTSE All Share benchmark.
The £938.9m trust is currently trading at a discount of 4.5 per cent to net asset value (NAV), is 8 per cent geared and has a dividend yield of 4.6 per cent. It has ongoing charges of 0.47 per cent, according to data from the Association of Investment Companies (AIC).