Investors concerned about the dizzying heights in stock markets should consider challenging their preconceptions over value investing and increasing their allocation to this style, according to Neptune Investment Management’s Rob Burnett. 
Burnett (pictured), Neptune’s head of European equities and manager of the £446.8m, four FE Crown-rated Neptune European Opportunities fund, said value investing has developed a reputation for being more risky than the growth style.
As the chart below shows, the MSCI Europe ex UK Growth index delivered a 16.28 per cent total return last year compared with a gain of 10.87 per cent from its value counterpart.
Performance of indices in 2017
Source: FE Analytics
Despite the more challenging environment, however, the Neptune European Opportunities fund delivered a total return of 21.68 per cent, compared with a 17.29 per cent gain for the average IA Europe Excluding UK sector fund and a 15.84 per cent return for the MSCI Europe ex UK benchmark.
The FE Alpha Manager said: “Value didn’t perform particularly well in 2017, so was quite a tough year for the style. We actually did pretty well in the context of that headwind.
“Our strong conviction is that the conditions are in place for a sustainable period of value outperformance.
“So, we would hope that we would be able to deliver more alpha than the 5 per cent of the outperformance we delivered last year.”
He added: “In the event value starts performing a little more strongly, we ought to get a tailwind from value this year and a tailwind for the alpha contribution to performance.”
Burnett said one of the misconceptions about value investing is that it is a riskier investment style than growth, but this is more of a recent phenomenon.
“A lot of investors think that value increases the risk of your portfolio,” he explained. “That was true from 2007 to 2016 and, because that was a very long period, investors perceive that to be the marker of the long-term characteristics of value.
“But actually over the last century value has exhibited a lot more defensiveness than growth and that has been shown again over the past 18 months.”
The Neptune manager said that “over the last 100 years” the value style has exhibited a superior Sortino ratio – which measures risk-adjusted returns using downside risk as its denominator – indicating lower risk.
“It’s been showing that again since the second quarter of 2016, value is returning to a superior defensive profile,” he said.
“It is not a high-risk strategy – you can actually lower your risk profile by taking a value bias over the very long-term.”
Burnett added: “Don’t think by having a value bias in any of your portfolios that in of itself you’re increasing your risk profile, it’s actually reducing your risk profile.”
Sortino ratios since 1999
Source: FE Analytics
The Neptune manager said that with valuations at high levels, investors should be looking at adding value to their portfolios to offset some of the price risk.
“The last time this happened… in 1999/2000 it was a historic entry point for value,” he explained. “What happened from the market peak in March 2000 through to 2007 was a phenomenal period of alpha for value.
“Discount rates are rising, even if you have a company with incredibly high earnings visibility, if prices are high it won’t protect your portfolio.”
With concerns over inflation having been raised since the start of the year, Burnett said that further growth may be more difficult to come by.
“When headline inflation gets north of 4 per cent, stock markets are meaningfully impacted in terms of multiples so we’re still in an okay scenario at the moment,” the FE Alpha Manager said.
“But it is worth saying that the prospects for multiple expansion no longer exist. Since 2009 we’ve had very strong equity market returns driven by two things: earnings growth and higher multiples.
“That leads us to be a bit more susceptible to the vagaries of the world economy and volatility so should be anticipating the high volatility regime that we have already experienced this year should last. We’re still in a sweet spot but no more expansion is likely.”
As such, Burnett continues to favour banks which he said are the “most defensive part of the market” currently, noting their relative outperformance of “supposedly safe haven-style areas” such as healthcare and consumer staples.
“That’s because when regimes change, risk profiles change,” he said. “So, in a deflationary world where interest rates are falling, clearly banks are not in a great position to be in whereas bonds or bond proxies are a good place.
“But in a world where deflation comes to an end and some inflation is returning, that means interest rates will eventually rise, discount rates will rise, banks can profit from that raising interest rate environment, they can protect you.”
Another area that Burnett likes is the automobile sector where he has a number of investments such as Commerzbank, Daimler, Volkswagen and Renault in his top-10 holdings.
“The sector is at the highest discount to market that we’ve [ever] seen,” he said. “Historically autos always traded at a discount to the market of about 20 per cent, but right now it’s 50 per cent and more.”
The Neptune European Opportunities manager said the sector faces both medium-term and long-term headwinds that have led to the opportunities in the sector.
Over the very long-term, autonomous driving is a headwind for the industry, although it remains unclear yet how that theme will play out.
More immediately is the “death of diesel” and how this may affect European firms. While there are concerns about fines by the EU for missing carbon dioxide targets or the value of lease fleets, Burnett said the industry has made great strides in producing greener cars while limiting capital expenditure.
“We have a very good outlook for the next three, four and five years and with valuations this low we think there’s an opportunity here,” he said. “Earnings resilience is underestimated and underpriced.”
Concerns over the prospect of a trade war may also be overdone, after US president Donald Trump announced tariffs on steel and aluminium, stoking fears of further escalation.
“If we’re going to get a global trade war… it is going to decimate global equities, there are going to be very few hiding places whether you’re in Nestle or Daimler,” he said.
“This is absolutely not our base case, this is part of Trump being a tough but probably, maybe, a sensible negotiator.
Burnett added: “This is just a signal that they want to engage in global trade but in a pro-American, somewhat more hostile way than we should be expecting.”
Under Burnett the Neptune European Opportunities fund has delivered a total return of 304.60 per cent compared with a gain of 192.47 per cent from its average peer and a 169.59 per cent rise for the benchmark.
Performance of fund vs sector & benchmark under Burnett
Source: FE Analytics
The fund has an ongoing charges figure of 0.97 per cent.