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Market conditions prompt increased focus on value

Rising interest rates, waning growth cycle shift investor emphasis

Eoin Murray said the period of worldwide growth ‘appears to be well and truly over.’

The changing rates environment is paving the way for value-driven investments to be back in vogue, consultants and money managers said.

For the better part of the current cycle — the past seven to eight years — strategies emphasizing growth held sway in portfolios, sources said. Now that might be changing, with opportunities germinating in Europe and Asia.

"The success of the growth-driven strategies hinged on the performance of the technology sector globally," said Tapan Datta, head of global asset allocation at Aon PLC in London. "With rates increasing, the focus is shifting to more cyclical stocks like financials."

Eoin Murray, head of investment at Hermes Investment Management in London, added: "The period of global synchronized growth that we were enjoying in 2017 appears to be well and truly over, with Europe and China clearly slowing down (and) that gives a clue as to what geographic biases an investor might consider. A value investor would typically look to sectors such as basic materials and consumer staples, both of which have lagged technology for the recent past."

According to data provider eVestment LLC, aggregate returns of pan-European all-cap value equities in 2017 returned to their 2013 levels, and were up 26.24% compared to -0.27% in 2016. Aggregate returns for Japanese all-cap value equities were significantly higher in 2017 at 30.41%, compared to 6.49% in 2016.

By comparison, U.S. all-cap value equities returned 15.76% in 2017 and 17.11% in 2016.

In the first quarter of 2018, institutional outflows from global all-cap value equity have been the lowest in three years, falling to $438 million compared to $3.7 billion in the fourth quarter of 2017. MSCI ACWI-ex U.S. all-cap value equity strategies saw outflows of $606 million compared to $2.1 billion in the previous quarter, also according to eVestment.

Andrew Koch, senior fund manager, active equities at Legal & General Investment Management in London said, "In our strategy, we hold French and Swedish banks as stocks of these companies are trading at discounts compared to the rest of the market. And we expect the trend to continue in the next three to five years."

"Value investments is a natural place to be as we are getting closer to the end of the cycle and investors aren't getting great yield anywhere else," Mr. Koch said. "(Our) active value fund could add 4.5% yield," Mr. Koch added.

LGIM's value fund launched in December last year, attracting 260 million ($345 million) since.

Ian Vose, portfolio manager, who runs the $6 billion international dynamic equity strategy ex-U.S. for Investec Asset Management in London, said the strategy has done a good job in a tough operating environment, attracting U.S. clients. "There aren't a lot of cheap stocks out there so you have to be discriminating." But Mr. Vose said "tobacco, pharmaceuticals, energy and automobile producers' stocks in addition to financials present opportunities." More than $4 billion has flowed into the strategy over the past three years.

T. Rowe Price Investment Management has been overweight global value equity excluding U.S., underweight global growth stocks ex-U.S. and neutral U.S. growth stocks in its $299 billion multiasset portfolios as of June 30. Andrew Clifton, London-based portfolio specialist European equities, said: "We can find out-of-favor companies that are undervalued on a free cash-flow basis in the consumer space in Europe and Asia. For example, we are holding electrical retailers in both France and the U.K. Good quality companies approach 50% in our portfolio and deep value companies constitute between 15% and 25%."

Tactical adjustments

Plan executives and target-date fund managers are making plans to take advantage of the expected shift to value, too.

Money managers running defined contribution portfolios have started to tactically adjust exposure to benefit from value and deep value — extremely discounted — stocks.

David Hutchins, senior vice president and head of the multiasset solutions business in Europe, the Middle East and Africa at AllianceBernstein (AB) LP (AB) in London, said the firm's target-date funds have about 50% of their equity holdings in value stocks.

"In the last 12 months, we have been overweighting deep value, which constitute now some 14% to 15% of the portfolio," Mr. Hutchins said. "Opportunities in value stocks are available in markets such as Europe but ... we are underweight the U.K."

"We are focusing on current value, but deep value is good in certain market conditions; however, you need a balance of value (and other factors)," Mr. Hutchins added. "Deep value makes sense in some stages of the cycle, and it is essential at this stage."

But for others it is not a clear-cut case that now is the time for a pure value approach.

Lode Devlaminck, managing director, equities at DuPont Capital Management Corp., Wilmington, Del., which runs $28 billion in assets, added: "At the moment, we think value management with a quality tilt is the best-performing strategy. You need to combine both."

Mr. Devlaminck said, "We think that beta of value (investments) has gone up, and it is now a more risky strategy than 10 years ago."

"There are more value traps around," he added. "So deep value has become much more of a tactical bet."

And Garrett Harbron, head of investment research at The Vanguard Group Inc. in London, said the firm doesn't "overweight deep value in our target-date fund portfolios. They do contain deep value stocks at market cap weight. (But) we don't incorporate a deep value tilt in our target-date funds (as it) incorporates another dimension of risk in the portfolio — active risk."

Mr. Harbron added that Vanguard's target-date funds are widely used as default investment options by "unengaged investors (so) we question whether incorporating (more) active risk in our target-date funds is appropriate. We feel (deep value) incorporates the necessary market risk without taking on additional risks the participants may not be aware of."