Equity Outlook  |  Q3 2019

What happened to value?

Darren A. Jaroch, CFA, Portfolio Manager

What happened to value?

As a value investor for over 20 years, I have a few observations about the asset class today. The past decade has often been painful for value investors. The approaches that worked best 10 years ago aren't likely to work as well today. But there are always opportunities for those who know where to look.

Why has value underperformed?

Looking at the past decade, the core of the problem has been the response by central banks to the global financial crisis. The market was flooded with liquidity, which encouraged investors to move higher on the risk curve, sending them out of value and into growth. As growth became a scarce commodity, investors were willing to pay up for it, even when multiples reached extreme highs.

Sector biases and the shortcomings of indexes

The value investing environment has changed dramatically, but some measurements of value, such as benchmark indexes, have not caught up. Most indexes are only rebalanced once a year, and index performance is affected greatly by sector concentration. The financials sector, for example, makes up a considerable portion of value indexes. This is largely because financials have historically had low price-to-book values.

Indexes place a heavy emphasis on price-to-book value, which we believe is less relevant today. Relying solely on price-to-book as a measure of value is a sure way to miss opportunities elsewhere. Intangible assets, which are often overlooked, can be more important in analyzing value. Looking back 10 or 20 years ago, value stocks were more easily classified by sector, and tangible assets such as factories, land, and equipment, were an important, and relatively static, measure of value.

"We differentiate between cheap and undervalued, and our strategy brings us to places beyond traditional value sectors."

Don't confuse cheapness with value

Cheap stocks are easy to identify. And in many cases, they are cheap for a reason. In our view, a passive benchmark is not the way to target value in the market. Our strategy is to differentiate between cheap and undervalued. To do this, we assess the equity universe daily — across both growth and value styles. We combine a six-factor quantitative model with classic fundamental research. Defining value in this way helps keep us on top of the changing market and brings us to places beyond traditional value sectors.

Fertile ground: Potential great finds in what's left behind

Over the past three years, so many stocks have been left behind by investors who were only attracted to a select group of high-multiple growth stocks. Until very recently, it was challenging to find value in those “left behind” names. While some of these businesses are permanently impaired, many others were unfairly punished in the 2018 fourth-quarter downturn. Today, for the first time in a while, we view the equity universe as fertile ground for attractive, undervalued companies.

Across this landscape, we look for relative value. This means identifying companies that are attractively valued relative to businesses within the same sector. The most attractively priced technology stock, for example, could be considerably more expensive than most utility stocks. That doesn't preclude it from being an attractive value opportunity, in our view. This is how our portfolio can differ from the benchmark and, ideally, outperform it.

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