At its core, ‘value investing’ implies buying stocks at relatively low valuations with the goal of achieving high returns over a long-term horizon. On the other hand, growth stocks are companies that demonstrate better-than-average earnings growth over the years with the expectations of still higher earnings in the future as well. value strategies have been the fundamental tenets of many legendary investors, with numerous academic and professional studies showing value strategies outperforming benchmark indices over long time periods.
Value lags behind growth
However, the performance of the value style after the Global Financial Crisis has significantly lagged growth – or quality investing. From the official end of the global financial crisis (GFC) in May 2009 till the early 2020, growth stocks (MSCI India Growth index) outperformed value stocks (MSCI India value index) by an average of 2.6 percentage points annually. The sharp underperformance over such a long period has driven an extreme divergence in valuations, with value stocks looking extremely cheap versus growth picks on various valuation metrics.
Hence, after many years of underperformance, 2020 saw value stocks bouncing back, rising 26 percent, as compared to an 11 percent rise for growth stocks.
Also read | Why value funds aren’t strictly going by valuations?
Though history shows that such periodic rallies in value stocks are likely, they have often deceived as they tend to be short-lived. So, the question arises: how do you determine whether this is a more sustainable trend going ahead. We believe that a few long-term fundamental drivers are close to a tipping point, which could result in a sustained improvement for the value style.
Drivers for value outperformance
First, value style generally outperforms during periods of strong economic growth. We expect the Indian and global economy to recover strongly from last year’s recession, as the ambitious vaccination programme would enable a faster return to normalcy amid policy support. This is already evident as GDP forecast revisions improve, helped by the ongoing recovery as indicated by high frequency indicators and business surveys. Further, the positive fiscal boost in the budget through higher capital expenditure, a greater thrust on privatisation and steps to improve credit flow are likely to hasten India’s economic recovery.
Also read: Why fund houses are keenly watching value funds? Moneycontrol’s review of DSP value Fund
Second, improving inflation expectations tend to benefit value stocks as they represents a large portion of cyclical sectors such as financials and commodity-related segments. India’s inflation has remained above the RBI medium-term target of 4 percent over the last year, which has been a positive tailwind for value stocks driving their relative outperformance in 2020. Currently, high consumer savings rates in India and other major economies (i.e., an indication of pent-up demand) and the unprecedented amount of liquidity from easy monetary policy could keep inflation expectations high in the future, thus supporting value stocks.
Third, value stocks have a strong positive correlation with nominal bond yields – i.e., when yields rise, value-style strategies generally outperform. The secular decline in bond yields has boosted the valuations of longer-duration growth companies (as they typically derive a large part of their cashflows in the distant future). However, a higher fiscal deficit and partial normalisation of some liquidity measures taken by the RBI have resulted in bond yields moving higher since the start of 2021. Further, history shows that bond yields typically follow higher economic growth. Nevertheless, with the RBI, US Fed and other global central banks likely to keep policy accommodative for longer to support economic growth, a significantly higher jump in bond yields is unlikely.
Fourth, current sector positioning tends to favour value. At present, the largest sectors within MSCI India value index are segments such as Information Technology, Financials, Consumer Discretionary and Materials, while for growth it is retail-focused Financials, Energy, and Consumer staples. In our view, the fiscal boost in the budget and efforts by the government to revive investments are likely to drive a strong cyclical rebound. Further, monetary policy, both local and global, remains benign. Overall, both these macro drivers could result in better performance for cyclically oriented sectors and value strategies.
Fifth, investor positioning is still light. Despite, investor sentiment seemingly turning more constructive on value style, positioning still seems light given years of underperformance. value and contra funds registered the largest outflows (Rs 62bn) in 2020 among major equity mutual fund categories. An analysis of mutual fund strategies across major categories – large-cap, multi-cap, mid-cap and small-cap – shows a near total dominance of growth style of investing. Hence, despite the current strong rally, value stocks are still broadly under-owned compared to Growth.
On balance, the above factors could act as strong tailwinds for value outperformance in 2021. Investors need to be cognizant of the risks. If COVID continues to linger, economic growth disappoints and bond yields continue to decline, then value could continue its trend of underperformance. Therefore, it would be prudent for investors to raise allocation to value strategies within a diversified equity allocation.
(Samrat Khosla is Managing Director & Head, and Vinay Joseph is Chief Investment Strategist, Standard Chartered Wealth, India)
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