Noise around Brexit has hidden investors from the real impact to their portfolios – a landmark shift from growth and quality to valuations and fundamentals, according to Aberdeen Standard’s Thomas Moore. 
The manager of the £1.5bn Standard Life Investments UK Equity Income Unconstrained fund said the last few weeks have been the start of a great rotation that could catch some investors unawares.
“The big thing people should have been on edge about three months ago was growth stocks: people have been fretting about the wrong macro issue,” he said.
Over the last decade, growth and quality stocks have performed exceptionally well, leaving their value-based peers behind.
Indeed, the MSCI United Kingdom Growth index has outpaced the MSCI United Kingdom Value benchmark by 19.82 percentage points over the past decade.
Performance of indices over 10yrs
Source: FE Analytics
“You can directly link that to quantitative easing [QE] and bond yields falling because that has helped stocks the bulk of whose value lies in the outer years because it has lowered the discount rate you have to put on those future earnings,” Moore (pictured) said.
This has been a very helpful backdrop for stocks that look a bit like bonds – otherwise known as ‘bond proxies’ – such as consumer staples, as investors have sought refuge in an uncertain macroeconomic environment.
It has also benefited companies with high growth potential, such as the giant technology names in the US as well as other sectors such as biotechnology.
As such, the funds that have outperformed for much of the last decade have largely been those that have played into either the high growth or quality styles.
“That was never going to last forever but it is reflected in the top of the Investment Association sales tables,” the fund manager said.
“The managers that have style factor as their key have performed the best and the ones who are most concentrated in that style have been rewarded with strong flows.”
However, he caveated that this is a very risky strategy for investors to take, as it means they are taking on a lot of style-specific risk.
“If you are right for a little while you will be rewarded but unless you are flexible enough to shift into new style factors it is very unlikely you are going to perform over a prolonged period of time,” he said.
The manager said he believes that this rotation has already started to happen, following the big changes to the UK market last month, which saw the FTSE All Share index fall 5.12 per cent.
Performance of indices in October 2018
Source: FE Analytics
Value stocks outperformed growth over the course of the month with UK domestic names, in particular, holding up well.
“They have been more resilient than many of the global industrial stocks for example which have sold-off aggressively, which were perceived by many fund managers to be safe havens because of their overseas exposure,” Moore said.
The fund manager said there is an idea that value is a 20th century phenomenon but that type of talk is typically heard towards the end of a style cycle.
“The idea that it is all about narratives – in this case tech and consumer staples – sounds great when it is working and can sound very hollow when it stops working,” he said. “Implicitly, it is an admission that you are sitting on a whole bunch of stocks that are overvalued.”
But Moore noted that, over the long term, value as a style will work as it has done for the last two centuries.
“You buy stocks when there is nothing priced in and there is a huge wall of worry to be climbed. As it is climbed the valuation moves up and you get exit opportunities because it becomes self-fulfilling and the momentum investors start to buy,” he said.
As such, this rotation was expected to happen at some point. With growth stocks looking fully-valued and Moore said now is the time that they are being subsequently de-rated following their peak.
“We are seeing a big, healthy rotation under the surface out of these growth names into the value and income names,” the Standard Life Investments UK Equity Income Unconstrained fund manager added.
“What is critical is what priced in. If you think about share prices there are two core beliefs that all managers should think about – first is focusing on fundamentals and the belief in understanding the companies. The second thing you need to look at is valuation.”
What is different this time around – as opposed to 2016 when value appeared to be making a comeback only to be derailed – is that the market is much more discerning.
Companies whose market positioning are strengthening are outperforming and overvalued stocks – partially growth stocks – are underperforming.
Take sofa-maker DFS and Primark-owner Associated British Foods as an example. The former was a ‘bombed out cyclical’ while the latter was a ‘high-value growth stock’.
“If you asked 10 investors which one would have performed better 12 months ago I reckon eight or nine would have said AB Foods,” Moore said.
However, over the last year, DFS has comfortable outperformed, returning 14.94 per cent to investors while AB Foods has lost 25.33 per cent.
Performance of stocks over 1yr
Source: FE Analytics
“One of the stocks had lots of good news priced in because there are a lot of momentum investors chasing the growth who wanted to flee UK domestic earnings and ended up pushing the valuation to unsustainably high levels,” the manager said.
On the other side, a year ago DFS was trading on a price-to-earnings multiple of 10x with a dividend yield of 6 per cent.
He said: “The stock had been sold-off aggressively despite the evidence coming through that they were building market share as some of their competitors are falling by the wayside.
“In the end these things do correct. We could go through every sector and find these anomalies.”
Moore has managed the Standard Life Investments UK Equity Income Unconstrained fund since 2009, during which time it has returned 248.42 per cent, outperforming both the IA UK Equity Income sector and FTSE All Share index.
The manager focuses on dividends when analysing companies, aiming to estimate the future cash generation before comparing this with the market’s expectations.
His fund has a portfolio dividend yield of 4.21 per cent and a clean ongoing charges figure (OCF) of 1.15 per cent.