ONE of the greatest debates in the investment management world is that of quality growth versus value-based investing. It is important to note, however, that every investor is ultimately a value seeking investor. When an investor buys a share, they are looking to make a return primarily from a combination of mispricing, capital appreciation and dividends.
The first implies buying a share at a price that is trading below its true value, in anticipation that the market will correct this over time. In reality, there are two sources of mispricing; the market’s mispricing of the share and the investor’s own mispricing of the same share.
If the investor’s mispricing is less than the market’s mispricing, then you would expect the investor to make above-market returns. Where these two styles of investment primarily differ is in their approach to valuing shares and the stocks they pick.
Value stocks are typically characterised by low levels of price-to-earnings (PE) multiples, price-to-book value or any other valuation metrics that the investor uses. These stocks essentially seen as cheap are out of favour thus trading at a “discount” – are considered good value for money.
Quality growth stocks on the other hand are typically characterised by strong earnings growth, high levels of return on equity and typically have some competitive advantage that they are able to maintain and use to protect their market share. In contrast to their value counterparts, quality growth stocks tend to have high levels of PE multiples and are typically seen as “expensive” by value-based investors.
Over the past 10 months, value stocks have outperformed quality growth stocks globally. Over this period, the MSCI World Value index delivered a total return of 29.3% while the MSCI World Quality index delivered a total return of 22.5% in USD denominated terms.
If we go back further in time, amidst the 2008 financial crisis, the US Federal Reserve alongside most major reserve banks, embarked on quantitative easing in order to provide support for their respective economies and markets. The US Fed cut interest rates by 5.0 percentage points and increased their balance sheet by over 3 trillion USD.
The unprecedented quantitative easing regimes by the reserve banks, although supporting markets overall, significantly benefited quality growth stocks more than their value counterparts. This saw quality growth stocks outperforming value stocks over the past 13 years. The MSCI World Quality index delivered a dollar return of about 15% per year from the start of 2009 to the end of 2020, compared to a return of around 9% per year for the MSCI World Value index.
This is the reason the recent out performance of value is seen as significant. Part of this performance could be attributable to a potential market repricing of stocks in the current economic recovery and the nervousness of markets around the US Fed’s potential policy normalisation.
In their previous attempt at policy normalisation, the US Fed only managed to reverse half of their interest rate cuts and marginally reduced their balance sheet. Shortly after, they were forced to cut rates back to their post-2008 financial crises level of 0.25% and increase their balance sheet by a further 4 trillion USD to counter the economic effects of the Covid-19 pandemic recently. In our view, 10 months is too short a period to make any bold proclamations. If history is anything to go by, policy normalisation is a difficult and lengthy process.
In practice, most investment management styles lie within a continuous spectrum of quality growth and value, as opposed to being strictly one or the other. What is important from an investment strategy perspective, is to maintain a well-diversified portfolio that has sufficient exposure to each of the investment styles in order to withstand and participate positively under various market conditions, as and when they occur.
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