Back in the 1990s there was a clear binary division of the stock market between growth and value shares. It was often as crude as calling all shares with a below average price-earnings (p:e) ratio value shares, and those with an above average p:e growth shares. Yet today’s p:es are a meaningless snapshot at an arbitrary moment in time. Long-term investors should be concerned about what the shares will be worth in 10, 20 or 100 years, not today.
One disagreement that will never go away is on the concept of reversion to the mean. This, put simply, suggests that what is cheap today will go up to at least its historic average, and expensive shares will go down to their averages. A staunch value manager such as Rowan Williams-Short of Vunani believes this to be a truism, like the sun rising in the morning. Growth managers believe there are decadent companies that are on the road to permanent decline. They are badly run companies in the wrong place. For example, the SA textile companies were never going to prosper after tariffs on imports were lifted.
More recently we have seen the growth of many more factors to allow for a systematic approach to equity investing. Rob Arnott of Research Affiliates built on the rather crude approach of most value managers through the Fundamental Index, which uses a much more sophisticated approach to measuring economic footprint.
Meanwhile, growth investing has been overshadowed by the much sexier “quality” investing. Who doesn’t want quality shares managed by quality fund managers? Quality is arguably a less speculative approach as it focuses primarily on brands; there is more than enough proof that shares such as Coca-Cola, LVMH and Reckitt Benckiser outperform over time. This isn’t just because they have cool logos. They are all strong capital managers and cash generators.
Momentum is the factor many fund managers don’t like to talk about as it is the antithesis of buy-and-hold management. Instead of buying low and selling high, momentum investors buy the shares that are going up and sell the ones that are going down. But there is proof that this style can work.
Fund managers should take note of the words of the famous economist John Maynard Keynes: “If the facts change I change my mind. What do you do sir?” I also note the phrase first quoted to me by Jeremy Hosking, then at Marathon asset managers in London. I asked him if he saw himself as a true blue value manager. He answered with Deng Xiaoping’s famous phrase: “It doesn’t matter if a cat is black or white as long as it catches mice.” Fund managers can’t afford to be too rigid.
I was intrigued to get a release from Kyle Wales on why the value versus growth debate is defunct. Wales is a portfolio manager at Flagship Asset Management. It is a small niche manager so maybe it should change its name from Flagship to Mine Sweeper. But it has a highly respectable track record. He says as growth stocks have outperformed value for several years many are expecting markets to enter a period where value stocks play catch-up. But there are a number of structural factors that explain why growth stocks have outperformed value stocks. The growth of disrupters means many established businesses face shrinking profit pools. In these circumstances “reversion to the mean” seems unlikely.
And as global GDP growth is low the emphasis has moved to talking market share: emerging markets, which will show higher growth, will be kinder to average companies and show a less stark distinction between winners and losers than in the West. Wales says proponents of mean reversion 100 years ago would have invested in horse and carriage businesses, not car manufacturers. He believes it is time to ditch the value/growth distinction. Right now the MSCI Value Index includes shares as diverse as Intel on a 10 p:e (with its history that is surely underpriced), Johnson & Johnson on 25 and Disney on 132. These businesses are deemed not to be growing fast enough to be included in the growth index. But what else do they have in common?
My biggest disappointment is that Flagship describes itself as valuation-based, a meaningless term that could describe any fund manager. But it does mean using both black and white cats.
• Cranston is a Financial Mail associate editor.
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