Asset prices continued to trade mostly to the upside during the reporting period, driven by ongoing monetary and fiscal stimulus programs the world over. As a result, we perceive worrying signs of excess optimism in certain pockets of the financial markets. More relevant and decisive is the fact, however, that at the same time there are still plenty of overlooked and unfashionable equities available on a global scale that may be taken advantage of by discerning, price-to-value conscious investors like we are.
Over the last few months, after the first positive Covid vaccine news appeared in November 2020, the topic of value investing has gained renewed attention within the financial community at large. Since then, seemingly everybody is talking about the pros and cons of the “value trade.” Therefore, we think it will be an opportune moment for us to discuss some misperceptions about what value is, and what it is not, in our mind. The reader should note that these thoughts specifically refer to our vantage point in the context of our craft as deep value investors. We do not in any shape or form attempt to criticize, negate or refute other approaches that make use to the term value, such as quantitative, smart-beta, blue-chip, or index-driven value strategies.
We detect two main misperceptions, each one deserving a quick commentary. First, contrary to what has often been propagated recently, value is not a transient macroeconomic, yield curve or government policy trade. Nor can it conveniently be bundled into broad-based trading patterns according to popular market moods. As the Covid pandemic has kept dragging on, for example, the market began to follow simplistic yet catchily-named daily trading schemes for “lockdown stocks” and “reopening stocks” (the latter where “value” apparently has been lumped into). But true value, according to our understanding, is not “on or off.” Rather, it “is or it is not” as defined by the analytical assessment of a particular company and its stand-alone valuation with all its unique attributes in terms of product and/or services offered, competitive positioning, operations management and corporate finance.
Second, value does not automatically imply “higher risk,” nor does it connote “low quality.” Especially the former claim has been made by frequently-cited empirical studies where so-called performance anomalies were investigated. Basically, the theory implies that the observed excess performance of value over long periods of time should be attributed to higher risk, such as more volatile periodic results, lower operating margins or higher debt levels in contrast to other firms. As practicing value investors doing bottom-up research, we have reason to question this generalized conclusion. For example, just because cyclically sensitive firms or big project businesses with lumpy revenue streams may report highly variable period-to-period accounting figures does not per se mean that they are also higher risk. It merely represents a different type of risk in comparison to, say, seemingly stable consumer goods companies reporting readily predictable financial results.
The bottom-line for us in any case is that the valuation and the consequent estimation of the intrinsic worth of a firm must be conducted based on a long-term, normalized, multi-business-cycle view. Hence, we draw two main conclusions from the above discussion. First, we sound like a broken record, but it cannot be stressed often and emphatically enough: Success in deep value investing comes with time, not with timing. This is true for both parties involved, the portfolio manager on the one hand and the client on the other. That is, as managers we don’t get in and out portfolio positions based on the whims and moods of the market or the variability of quarterly earnings reports. And likewise, the client is not advised to subscribe or redeem the fund based on short-term performance or market sentiment. The second conclusion follows accordingly: For us, it is all about a continuous process of applying the same philosophy and implementing it with iron discipline, which in the end leads to a solid net compound rate of return for our clients over time. And for the saver and his adviser, deep value should not be used as a tactical asset allocation tool but instead should build a steady component in his or her overall investment program.
Chief Investment Officer SG Value Partners AG