Investors wonder if value can recover amid tech stock boom

Institutional investors and money managers are looking to add value stocks back into portfolios to bring more balance and counter overweights to growth exposures.

Market participants had expected value to follow history — outperforming in a recovery. But in the recent bounce back from the coronavirus-induced depths of March, value continued to underperform. Returns looked better than previous months, at 12.85% for the three months through June 30, but global stocks gained 19.54% and growth stocks gained 25.64%.

"We're getting a lot of questions from our clients and interested parties, quite naturally saying, 'If it does not work in this situation, is it ever going to work?' The standard argument is that it's not just value underperforming growth, but specifically that a number of tech stocks are shooting the lights out," said Koray Yesildag, principal, asset allocation specialist at Aon PLC in London.

Exponential returns by growth stocks have left portfolios overweight to the investment style at the expense of value. However, that's starting to play on investors' minds.

"I think people are worried a little about growth exposure," said Laurence Bensafi, deputy head, emerging markets equities and senior portfolio manager at RBC Global Asset Management (U.K.) Ltd., based in London. The firm's value assets under management were not available.

Growth and value exposures in equity portfolios were previously more balanced, especially in the U.S., she said. "And value has been so out of favor it has added concentration to growth."

But "this year has been the most interest I've seen for seven years in value, in that when the growth trend reverses it will be quite violent," Ms. Bensafi said.

J.P. Morgan Asset Management's value team is also "watching tech closely" for signs of the growth style having "a more difficult time," said Ian Butler, executive director and a portfolio manager in London. "For value to outperform growth, it doesn't necessarily have to go up exponentially."

Hugh Gimber, a global market strategist also based in London for J.P. Morgan Asset Management, said the COVID-19-related recession has been unusual in that some of the largest growth names have produced strong earnings even as U.S. GDP has collapsed.

"You do not expect these growth names to be as defensive. But ... (clients) need to be cognizant now that a lot of the story around the resilience of online (stocks, for example,) is now factored into the price. ... We're starting to think about just bringing a bit more balance back into portfolios, ensuring we are not overly overweight the winners. Growth vs. value comes up on pretty much every client call I do at the moment." Clients "are not ready to say now is the right time to be explicitly overweight value, but certainly (to be) balancing out exposures given how extreme moves have been," Mr. Gimber said.

And Schroders PLC's value team is also seeing interest. "There are a number of people knocking on the door, looking to gain exposure (to value) given how extreme the move in growth has been," said Kevin Murphy, fund manager, equity value, in London.

The MSCI World Value index annual returns have underperformed growth and global markets nine times since 2006. In 2019, value gained 22.74%, compared with 28.4% for the MSCI World index and 34.14% for the MSCI World Growth index. The most recent outperformance for value was in 2016, with a 13.23% return vs. 8.15% for world markets and 3.21% for growth.

And over the shorter term, performance was particularly poor, with an annualized -10.61% return for the year through June 30, compared with 3.4% for the world index and 17.85% for growth.

Right now, money managers and consultants think value is not only performing poorly, but continued gains by growth stocks are making things look relatively worse.

"At the moment, value seems to be stuck in the middle of a historic tech revolution, and the ongoing seismic effects of the GFC that are still reverberating through very low interest rates and flat yield curves," Aon's Mr. Yesildag said.

Growth stocks have dominated the COVID-19 recovery, said Damian Handzy, Boston-based chief commercial officer at analytics provider Style Analytics Ltd. "You couldn't have designed a worldwide event to benefit one company better than COVID benefits Amazon."

Mr. Handzy said U.S.-based growth stocks have an "additional phenomenon" helping them out — a regulatory environment over the past decade or so allowing "these large tech companies … to gobble up small competitors and really create monopolies for themselves. Combine that with the low-interest-rates environment and there's good reason for these tech giants to continue growing and increasing their market share and stock prices."

But market participants are still looking for the silver bullet that will facilitate value's comeback in its own right — although managers warned that may be hard to find.

"It won't surprise you that people are trying to find a catalyst to make value return to greatness. While we can devise a nice-sounding story … around what has happened and why, the reality is when you try and test whether that story holds true in the past, that doesn't work," Mr. Murphy said.

Take the argument that higher inflation should bring value to the fore. "One market where there is significant deflation is Japan ... (where) value investing has worked," he said.

"Markets defy easy stories — simple stories that people tell themselves are just that. Fairy tales. The market doesn't listen to your stories," Mr. Murphy added.

A hot topic in the investment industry right now is whether value should be redefined in order to help facilitate a comeback. The argument largely focuses on the use of price-to-book as the main measure of a stock for value investing.

"It's an area that requires further research, but one of my arguments for price-to-book not working very well is that book value is the value of a company on a balance sheet. But intangibles have grown on the balance sheet," Aon's Mr. Yesildag said.

While it's easy to value a building, machinery or equipment, intellectual property and brand are increasingly important parts of a company's worth, he said. "These things matter much more and are subject to very different accounting treatments."

Free cash flow yields may be a better measure. "Our analysis shows that over the last 30 years, the increasing impact of the intangibles on the balance sheet really does make (price-to-book) less of a strong indicator for values than cash-flow yields," Style Analytics' Mr. Handzy said.

A combination of metrics is a better approach, sources said.

Schroders' value team uses cash flows for investing rather than price-to-book. Until early 2019, the team outperformed the market, but in 2019 and 2020, performance has been "poor and that has put a dent into the long-term performance," Mr. Murphy said. Schroders runs about £9 billion ($11.5 billion) in assets across global value strategies.

And J.P. Morgan Asset Management has found "extreme dislocations, almost historically unprecedented in the market," with value spreads wider today than at the height of the tech bubble and present across sectors, Mr. Butler said. The international equity group had $2.2 billion in value equities across international, Europe and U.K. strategies as of June 30.

JPMAM, which looks at a composite value metric and uses price-to-book as a secondary check, has also had a challenging period in terms of performance, particularly over the past 12 to 18 months.

But when value does make a comeback, investors need to be ready. "A big proportion of returns to value are often in the first few weeks (of a rally). That's when you can make a big bang for your buck," Mr. Butler said.

Schroders' Mr. Murphy agreed: "The elastic band can only stretch so far, and when it snaps back it will be huge."