The author of this article examines the "conventional" wisdom that value investing beats growth investing, and finds that claim is not backed up by evidence.

Investors and their advisors are figuring out what asset classes and components of them will fare well, or not, from the kind of world thrown up by COVID-19. We continue to run selective commentaries from wealth managers on this question. An example here is from Owen Moore, investment manager at Bowmore Asset Management, a UK-based firm. The editors at this news service are pleased to share these views; the usual editorial disclaimers apply. Email tom.burroughes@wealthbriefing.com and jackie.bennion@clearviewpublishing.com

A very small minority of investors are in the enviable position of having their investable assets forming part of a much wider estate. While these individuals or families may need to call upon their investments from time to time, often the main objective for these pots of money is to serve generations to come and guarantee a certain level of lifestyle. 

For those with circumstances aligned with those just alluded to, their investment mindset tends to be fundamentally different. Rather than worrying about when the money might run out, they are more concerned about the investment strategy that will deliver the best absolute returns in order to continue to build their overall wealth and, in turn, a “safety net” that will sustain multiple future generations indefinitely. 

These types of client usually have various pots of money managed by different investment managers, all with different strategies. However, the pandemic has caused seismic shifts in the investment universe and many investment managers, and even their clients, are now debating which style of investment is likely to provide the best outcomes moving forward. Value or growth?

Many managers claim to specialise in one or the other and are reticent to adopt both styles of investment. Neil Woodford is an example of a fund manager who switched from growth investing to value investing, and ultimately this was the start of his downfall.

Conventional wisdom suggests that value investing (buying companies at prices lower than their intrinsic value with a view to realising that value in the future) outperforms growth investing (buying companies looking to grow their revenue and market share, and therefore grow their overall value). That is, it had been conventional wisdom until recently.

Based on the MSCI World Growth and Value indices (US dollar), growth investing has outperformed value over the last 13 years, with growth up +90 per cent on a relative basis since the end of 2007. This rotation of fortunes has sparked an ongoing dialogue regarding the merits of these investing styles in a modern context. But how has the coronavirus pandemic affected the growth vs value story?

2020 has sparked levels of market volatility not seen since the global financial crisis in 2008. On average, equity markets fell by -21.8 per cent in Q1. During the first three months of 2020 the growth index fell by -15.4 per cent, whilst its value-focused opposite fell by -27.5 per cent. Clearly, investing for growth has been the winner, in spite of a reputation for carrying more risk. The April relief rally told a similar story, with growth up by +12.7 per cent vs value at +8.6 per cent.

If we dig a little deeper, the underlying sector returns are a mixed bag. As you may expect, more defensive sectors such as utilities, healthcare and consumer staples fared well, relatively speaking. This is no surprise. These sectors provide services that remain in high demand during a downturn. 

More cyclical sectors, such as financials, real estate and materials fell much further. When global growth slows property markets contract, banks’ profitability stalls and manufacturing diminishes. The energy sector also fell by -45 per cent, due largely to a collapse in the oil price.

This selloff is fundamentally different from many of those that preceded. It hasn’t been caused by flaws in the financial system (albeit some may well be exposed as a result), rather a global pandemic. A health crisis has precipitated a financial crisis, the severity and extent of which is still to unfold. Whilst the overall outcome is still unknown, there are certainly some sectors that will ultimately be long-term beneficiaries as a result of the unique and unprecedented circumstances that we find ourselves in (on the other hand some sectors will find the next 12-18 months extremely challenging). 

What has been interesting to note is how defensive some of the more growth-oriented sectors have been. Higher valuations suggest that in periods of market stress, lofty growth stock prices fall further. Despite this, the likes of communication services and information tech have held up well. Technology is clearly one that has the potential to be a long-term winner. Prior to the health crisis, tech has provided stellar performance for investors, returning +87.8 per cent over five years to the end of March 2020 and falling by only -13.0 per cent over Q1.

It is true, valuations on tech stocks are some of the highest around. At the beginning of the year, the sector had a P/E multiple of 27.6x, (i.e. a company would need to generate 27 years’ worth of earnings to justify its share price). Although this fell to 23.3x in Q1, it has been argued that tech companies still look expensive compared with sector peers.

Are tech stocks therefore looking expensive and, if so, where else can you look for growth?

Firstly, it must be considered that tech looks expensive because of the opportunities it offers. Investors are paying a premium for potential future growth and outperformance. Growth investing as a concept defines that these companies must carry higher valuations.

There are, though, other growth-heavy sectors that provide an opportunity to invest at lower valuations. The consumer discretionary sector, with a P/E valuation of 18.7x, and communication services at 19.9x, look less expensive than tech but still provide exposure to a growth recovery when the global economy gets back to business as usual.

Although the leg down for markets has provided opportunities to invest at lower levels across the board, the question remains of how similar this recession will be to those that came before and therefore how reliable previous experience may be. Can history and economic theory be used as a reliable indicator of what the future investment environment is likely to look like post COVID-19?

Perhaps not if we take the global financial crisis as a comparison.

In the two years through 2008 and 2009 not only did growth outperform value, but protection in the downturn was provided by healthcare, consumer staples and information tech. Financials were once again hit hard (unsurprising given the cause of the recession), but utilities (defensive value) fell significantly.

Perhaps more important is what happened over the next four years as markets recovered. During this time growth outperformed value, tech outperformed utilities and consumer staples led the way as economies restarted and spending resumed.

Recent history, therefore, tells us that growth has outperformed value consistently. Whilst some growth stocks may look expensive, they have protected assets in the downturn and provide opportunities to invest at lower valuations and participate in the growth story when markets begin a recovery in earnest.

Therefore, the “conventional wisdom” we referred to at the beginning of this article, “value investing outperforms growth investing” no longer appears to be relevant or accurate. 

At Bowmore Asset Management, in recent months and weeks our portfolio activity has been greater than usual to reflect the “new world”, seizing the opportunities that we are convinced will provide stellar returns in the future. For investors, now is not the time to sit still and rest on your laurels. 

Disclaimer

*Bowmore Asset Management Ltd is authorised and regulated by the FCA. Past performance is not a guide to future performance.