While it is generally accepted that the value style of investing tends to trump its growth counterpart over the long term, this depends upon your definition of long term.
The MSCI IMI USA Growth index, for example, is now up by 1,327 per cent over the past 25 years, compared with 855 per cent from its MSCI IMI USA Value counterpart.
However, Schroders’ Simon Adler said that if you go back 147 years – the longest data series available in investment markets – what is clear is that the lower the cyclically adjusted price/earnings (CAPE) ratio, the better the long-term returns.
And while growth stalwarts will claim the technological advances and associated disruption of the past quarter of a century have been a game-changer, Adler pointed out the 122 years before then saw its fair share of disruption as well.
“During that period you had the Boer War, two world wars, the invention of the motorcar, the invention of the commercial plane, the invention of the internet, the space age and the Cuban missile crisis where we nearly went to a nuclear war,” he said.
“And throughout all of that, value has still prevailed over the long term.”
Another reason Adler, a manager on Schroders’ equity value team, thinks value will come back into favour is that despite the enormous upheaval over the past 147 years, there is one thing that hasn’t changed: us.
“We’re all just as greedy, just as fearful and just as emotional as we ever were and that’s what drives markets,” he continued.
“It’s greed that drives it up: ‘My next-door neighbour owns Facebook and has a much nicer kitchen than me, so I’d better buy some Facebook.’ Or it’s fear: ‘I can’t possibly own a bank or a miner, they’re disasters,’ – that just makes the spring go further.
“In Holland, in the Dutch tulip boom, what did it take to stop that boom, one of the biggest the world has ever seen? An auction failed. One day, someone just said, ‘I am not going to pay that much for a tulip bulb’. And people suddenly got fearful and the whole thing fell apart.”
This is not to say that Adler ignores the threat of technological disruption. Schroders’ equity value team begins its process with a screen highlighting the cheapest 20 per cent of stocks in the market, before creating a long-term model of how each business has performed at every stage of the economic cycle.
Next, the team applies a checklist of seven different questions to each stock, to determine whether it is a value trap – the first of which is “what is the structural threat?” And finally, it distils this analysis into two numbers – the risk of the business going bust and the potential upside, by which point it will be able to reject 98 per cent of the companies highlighted by the initial value screen.
Adler said this process gives the team confidence to invest in out-of-favour areas such as high-street retail.
“Should you own a retailer? Many people say 'no, value retail is totally dead',” the manager continued. “My wife orders 10 pairs of jeans online and sends back 10. Everyone shops online.
“Our view is very different. Our view is you can own a retailer, but you have to be incredibly selective.”
Part of assessing the structural threat to a retailer involves instantly reducing its sales forecasts at the business-modelling stage by 20 per cent – this is not a random number, but the fall from peak sales experienced by Abercrombie & Fitch, which had the worst experience of the major listed retailers.
In a list of 30 shops the screen highlighted last summer, the business-modelling process and seven value-trap questions whittled the list down to two: Dillard’s, a department store, and Buckle, a jeans retailer, both in the US.
“These are two things you think ‘I am not going to buy’,” Adler continued. “But because we distil the work and remove the emotion, we bought both of those across some of our funds. And what happened to the shares? Buckle doubled and Dillard’s was up about 80 per cent. That was in a time where online shopping kept increasing, where Sears was on the way to going bust.”
However, Adler admits that the team can get it wrong and end up in value traps, which can happen for one of two reasons. The first is that they are unlucky and the company directors do stupid things, while the second is that they sometimes get the risk/reward score wrong.
He said this is best illustrated in one of the team’s biggest mistakes of recent years, a company that “when you hear what it was, you will say ‘are you total idiots? Anyone could have told you that was going to be a disaster’.”
That stock was Debenhams.
“If you look back, you ask ‘why would anyone buy Debenhams?’,” he said. “But Debenhams is a totally leased estate, it leases all of its stores from private equity, and we thought there was enough upside for the risk.
“It turns out we just got the risk score wrong: we thought the risk was somewhere between five and 10, but it was 10. We thought the upside was more than 100 per cent and we still think the upside is huge, but the risks outweigh it. So, we try and strip out all the value traps, but sometimes we just make mistakes.
“Sometimes we are just idiots, which happens more often than we would like.”
Data from FE Analytics shows that despite the occasional mistake, the strategy has been very effective.
In a decade in which the value style has been out of favour, the £1.2bn Schroder Recovery and £2.3bn Schroder Income funds – the asset manager’s flagship value vehicles – have made 309.92 per cent and 262.13 per cent respectively, compared with a 171.64 per cent total return from the FTSE All Share.
Performance of funds vs index over 10yrs
Source: FE Analytics
Both funds have an ongoing charges figure (OCF) of 0.91 per cent. Schroder Income has a yield of 3.49 per cent, while Recovery’s stands at 2.44 per cent.