Most investors should be 'value managers' or, in other words, they should look to exploit the difference between the current price of a stock and what they estimate its intrinsic worth is, according to Invesco Perpetual’s Simon Laing.
It has been a difficult time for value strategies over the past decade as the market rally has favoured growth strategies.
Indeed, as the below chart shows the MSCI The World Growth has risen by 245.68 per cent – in sterling terms – compared with a 168.79 per cent gain for the MSCI World Value index.
Performance of indices over 10yrs
Source: FE Analytics
However, Laing, who heads up the US Equity team at Invesco Perpetual and co-manages the Invesco Perpetual US Equity fund alongside Simon Clinch, said to assess potential returns on investment, all investors need to make an estimate of the real intrinsic value compared with the purchase price.
“Over time a stock price will be drawn like a magnet back to the intrinsic value of the company,” he explained.
“It may rise from being too cheap or fall from being too expensive – and it is anybody’s guess when that reversion will take place – but it will.
“Our fund may look a lot like a traditional value fund right now, but that will not always be the case,” said the Invesco manager. “It is merely a function of the fact that our valuation framework currently leads us to favour those areas of the market.
Yet, while the value headwind has been detrimental to the £485.8m fund’s performance, Laing said Invesco Perpetual US Equity is not a value fund.
“In fact, valuation is nearly always the last determination in our investment decision and more often than not it is the reason we have missed some opportunities. But, more importantly, it has helped to avoid some howlers.
“For us, valuation is most definitely not the sole reason an investment is made, and that is what distinguishes us from traditional value funds and indices where valuation is the key criteria for potential investment.”
According to Laing, many growth investors are also seeking value in the current investment climate. A great example, he noted, was Google’s IPO in August 2004.
Performance of stock since IPO
Source: Google Finance
“Back in 2004, the market’s expectation was for Google to earn circa $2.40 in 2006. At the IPO [initial public offering] price of $42.50 – split-adjusted – that was a P/E [price-to-earnings] ratio of 18x two years out, a rich multiple, compared to the market’s then circa 14x P/E.
“However, if you were prescient enough to appreciate Google’s growth opportunity you may have correctly predicted that Google would actually earn $5.30 in 2006.”
“That means at IPO, you were actually paying a P/E multiple of 8x for Google which is value in anyone’s book. Yet, Google was a growth stock by the market’s definition.”
In terms of the areas they are currently finding opportunities, Laing noted the team currently likes energy and healthcare and is also seeing warning signs in the technology sector.
Although the team acknowledge the opportunities within technology from a fundamental point of view, Laing said it questions the valuation of many of the companies in the sector.
“Good equity analysis requires a recognition that the only certainty in your forecast is that you will be wrong,” he explained. “Therefore, a proper appreciation of the downside risk is essential, and this is the main issue we have with many valuations in the technology sector right now.”
He added: “In many instances we can get to the current share price or somewhat higher. But the growth and margin assumptions we are making are often staggeringly aggressive.
“And when we attempt to sensitise our models to more normal assumptions, we often get considerable downside.
“As we look at all our investment opportunities on a risk-adjusted basis, we often decide to pass on such a stock, full in the knowledge that we could be wrong if the company hits those aggressive assumptions or stock market momentum continues to feed on itself.”
As such, the fund currently has an 11.61 per cent in information technology.
According to Laing, the US sectors currently offering favourable risk-reward characteristics include energy and healthcare.
With almost a 50 per cent allocation, the two sectors have the highest weighting in the portfolio.
“The oil & gas sector fell by over 60 per cent from 2014 to 2016 as the oil price fell circa 70 per cent,” said the Invesco manager.
“From the $30 bottom, oil prices have recovered to circa $70, yet many stocks in the energy sector have barely recovered, lagging the oil price recovery markedly.
“Importantly we don’t see a lot of downside to many of these stocks given the lack of investment in future oil supply and a continued backdrop of decent demand, he said.
The manager noted that they have also seen dramatic change in behaviour from oil executives, who now increasingly commit to spend within their cash flow generation and return cash to shareholders.
“ROIC [return on invested capital], which now forms a large part of compensation structures, is now improving for many of these companies after years of decline,” he said, adding that this is the exact opposite of what is happening in the technology sector.
As the below chart shows, since launch in 2012, Invesco Perpetual US Equity has delivered a 332.55 per cent total return compared with a 684. 24 per cent gain for the average fund in the IA North America sector fund.
Performance of fund since launch
Source: FE Analytics
Invesco Perpetual US Equity has an ongoing charges figure (OCF) of 0.91 per cent.