With markets seeing a recent shift into value, what does this mean for growth-dominant, sustainable portfolios?
These moves were triggered by investors anticipating a recovery period in markets following the Covid-19 vaccine rollout, as a reflationary environment typically favours value and cyclical companies.
Indeed, since the coronavirus vaccine was announced last November value stocks have rallied in anticipation of this recovery and economic resurgence. The MSCI ACWI Value index has outperformed its growth counterpart over the past six months, returning 12.38 per cent versus 3.65 per cent respectively.
Performance of value vs growth over six months
Source: FE Analytics
So, if the value rally continued could it hurt sustainable investment portfolios – which tend to have a natural bias away from cyclical areas like energy?
According to Simon Holmes, manager of the BMO Sustainable Universal MAP range, sustainable equity funds do tend to have a bias towards quality and growth assets.
He argued that this can build a strong equity portfolio over the long term, but might be susceptible to more medium-term risk if inflation picks up.
Holmes (pictured) said: “I think you end up with a very good equity portfolio for the long term. But it has that sort of fractal style tilt towards quality and growth and away from value. 
“And you also end up with something of a sector tilt towards. It's not as obvious as one might think, but you're away from traditional energy and there's not necessarily enough renewable energies to go and completely close that.”
He added that there are sustainable investment plays in the more cyclical areas of the market but typically “you still end up with a bit of a bias”.
“Long term I think it’s okay, but if we're in a year like we're in - where people are talking about inflation and value having a resurgence, even if it's only for a medium-term period - that's a slight risk,” Holmes said.
Ryan Hughes, head of AJ Bell’s active portfolios, agreed with the idea that a value rally could pose some shorter-term risk to the performance of sustainable portfolios, but wouldn’t necessarily change the long-term investment case.
“The valuation gap between growth and value had reached extreme levels when the vaccine news was announced late last year so it’s little surprise to see money flow back into these unloved stocks in recent months,” he said.
“Areas such as oils and miners have been big winners and naturally these sectors are not often found in funds with a strong sustainable focus. Therefore, this has definitely been a headwind over the last few months.
“Given the UK has a strong tilt towards value sectors and investors are underweight the UK, I think it possible that money will continue to flow into these areas as investors look to adjust their portfolios away from the heavy bias towards growth stocks.
“This certainly has the potential to cause short-term headwinds for sustainable strategies but with many investors focusing on the long term, I suspect it won’t trouble them too much, particularly given the emotional element that comes with many sustainable investors.”
Indeed, Holmes explained that part of the reason he has increased the BMO Sustainable Universal MAP range’s UK allocation recently was to alleviate some of this medium-term risk of a value rally.
In the BMO Sustainable Universal MAP Balanced portfolio, the UK allocation has increased from 16.3 per cent in September to 19.2 per cent at the end of February, peaking at 22.1 per cent in December.
He said: “What we've done to try to alleviate that [risk] is to have a bit more in the UK. A UK sustainable strategy against a global venture will still have a bit more of the value tilt, even if compared to the UK it’s a bit more of quality and growth-esqe.”
While the value rally going on in markets might pose an immediate threat to the performance of sustainability, FE fundinfo Alpha Manager Hamish Chamberlayne argued that “it provides a fantastic buying opportunity for people who want to get into a decades-long trend”.
Chamberlayne, manager of the £1.4bn Janus Henderson Global Sustainable Equity fund, pointed out style rotations come and go in markets, but this doesn’t change his belief that “growth will always outperform”.
“I think actually it's axiomatic that growth will always outperform [and] you want to invest in the companies that are growing and succeeding,” he argued. “And if you've got a suitable investment time horizon, that will produce the best investment results.”
Like Holmes, Chamberlayne said that he structured his portfolio to ensure that his sustainable growth fund stands up even when value is dominant.
He explained that the Janus Henderson Global Sustainable Equity fund invests in two ‘buckets’ of companies, defensive secular growth and more pro-cyclical secular growth stocks. 
So, despite not having direct exposure to the value or reflationary parts of the market such as oil and miners, by investing in pro-cyclical secular growth companies this provides the fund with “indirect exposure to reinflation”, Chamberlayne (pictured) said.
“And we would expect the portfolio to perform well over time as that sort of second derivative feeds through,” he added.
Chamberlayne said increased the fund’s allocation to pro-cyclical names at the start of 2020 and this majorly benefitted it during the March sell-off.
He increased this further afterwards to help the fund outperform during the recovery periods, when banks, airlines and typical value stocks rallied.
“Last year, we outperformed every single quarter. So we outperformed through the market rotations last year,” Chamberlayne said.
“Now, to be very clear, on the particular days in the market where you get things such as airlines and cruise liners, oil companies and investment banks going up a lot, obviously those are more difficult days for us in terms of relative performance.
“[But] we're not worried about those types of particular rotational days because we think these things wash out over time. But certainly, when the market started becoming a bit more focused on reflation and recovery our pro-cyclical names performed very well,” he said.
Chamberlayne concluded with: “And while we may not be outperforming every single day, every single week, when you're getting these market gyrations we're pretty confident that we've got some very good investment ideas in the portfolio.”