Value is safer than growth and outperforms more often and for longer despite the consensus suggesting otherwise, according to Neptune Investment Management’s Rob Burnett. 
The FE Alpha Manager, who oversees the £442.2m Neptune European Opportunities fund, said there are a numerous misconceptions he battles against when talking to clients.
The first, he said, is that value is inherently riskier than growth as a style – one of the most common mistakes investors make.
He said: “I feel there is a story to be told about value and risk perception and the fact [that because] value has had a 10-year bear market therefore it is high risk, when actually it is falling interest rates and falling inflation that is ‘kryptonite’ for value and once that stops value becomes safe.
“It is as simple as that. Now that that [falling interest rates and inflation] has stopped, value is a safe investment.”
Burnett (pictured) added: “We are seeing that now in the [Neptune] fund’s statistics, even though the fund’s holdings haven’t really changed over the last two years, suddenly the downside risk is disappearing and it is because the regime is changing.”
This is backed up by the Sortino ratio, explained Burnett, which measures risk-adjusted returns with a focus on deviation from a fund’s expected returns on the downside. The ratio therefore provides a gauge of negative volatility as opposed to general fluctuations.
As the below chart shows, in Europe value stocks as measured by the MSCI Europe ex UK Value index has a higher ratio than the MSCI Europe ex UK Growth index over the last 12 months.
The Neptune European Opportunities fund meanwhile has the highest score over the last 12 months in the IA Europe ex UK sector of 5.18.
Rolling Sortino ratio of fund and indices over 1yr
Source: FE Analytics
“That to me is a massive validation of how value pursued in the right way is a lower risk strategy than growth which is obviously the reverse of what everyone thinks,” the manager said.
“There are two risks to investors, the risk to the earnings and the risk to the price that people are willing to pay.
“Because of QE amongst other things, in the last 10 years the market has thought that earnings risk is the only risk. If earnings are solid then to hell with any other risks but actually over the last 100 years the price risk is just as important.”
Burnett added: “A lot of the pushback from our clients is that many people are nervous about value because of their perception of risk. They think that consumer staples are low risk when I am certain that the risks are incredibly high for that sector because of price and earnings.”
This leads onto the second misconception identified by Burnett, which is that over the longer term growth will outperform when in fact value has historically beaten growth styles.
“This is simply inadequate historical perspective but I am totally sympathetic to it,” he noted.
“We are conditioned by our experience but they are not old enough. If you were 100 you would have a totally different point of view. A century of returns shows you that quality growth is the anomaly.
“If you are 55 years old and you are a CIO who started their career in 1990 let’s say, value has had a very bad [time].”
However, this is because value styles have experienced two bear markets back-to-back, from 1989-1999 and from 2007-2016.
“So, if you started your career any time since 1990 you have only seen value work sustainably from 2000 to 2007,” he said.
“For all investors who started in the 90s that period is blindly dismissed as a dash for trash even though it is seven years. In the last 27 years growth has outperformed for 20 more or less.”
However, if investors go back to 1900 they will see that actually in seven out of 10 years value outperforms and growth has these ‘fleeting flashes’, the manager explained.
“Value has only underperformed from 1929 to 1939 and then you had wait 50 years [for the next one] from 1989 to 1999.
“So, it has only had three bear markets it is just that we have had two back-to-back ones in investors’ living memory.”
Value bear vs bull markets since the 1930s
Source: Neptune Investment Management
The common denominator between all three bear markets are falling interest rates, Burnett noted, which declined in all of the above periods.
“Price has become less relevant in a world where interest rates are declining because when interest rates decline discount rates go down and so the present value of the future earnings go up,” he said.
“All asset values go up when interest rates go down as it supports the values of your future earnings and what that means is companies with high stability and defensiveness always get more multiple expansion when rates fall.
“Value companies by definition are perceived by investors to be low quality – that is why they are cheap and so with that reduced visibility it means they don’t get that multiple expansion when interest rates fall.”
The third and final issue that investors believe affects value stocks more than it actually does, according to Burnett, is low volatility. In theory, low volatility means there are less pricing anomalies and therefore less stocks becoming cheap.
“At the market level volatility has been very low but I would actually say that low volatility is not a problem for value and it can be quite constructive,” the manager said.
As the below shows, volatility in Europe peaked in 2008 but has remained low since 2015, dropping to 10-year lows at the end of 2016.
Rolling volatility of index over 10yrs
Source: FE Analytics
“What tends to drive volatility is in my view a couple of things – volatility in economic momentum and/or in interest rates or inflation,” the FE Alpha Manager noted.
“To me the low volatility is totally justified because global economic momentum has quietly moved up and become quite solid and broad and yet inflationary pressures have not really sparked yet.
“The absolute sweet spot for value is when interest rates rise but steady economic growth with stable interest rates also works and that is what we are in now.
He added: “We’re confident that the next phase that will usher in more volatility is rising interest rates and that is when the afterburners will hopefully will kick into the fund. Right now, it is just operating reasonably well but we have extra power to kick in if interest rates rise.”