Why do you persevere with value exposures?
The question whether we should persevere with value exposures is one which we are often asked by clients, and it’s certainly reasonable. After all, value factors and value-oriented active strategies have continued their multi-year underperformance.
Cycle, value and sentiment
Over the last six months, the global equity team has outlined how value exposures have become increasingly attractive, using our cycle, value and sentiment process (CVS). Suffice it to say:
- Through various valuation lenses, we see value as highly attractive, versus history and other styles
- Cycle conditions remain supportive, albeit much more nuanced with COVID-19
- We believe that evidence abounds that sentiment conditions warrant a contrarian buy
Cycle - Recessionary conditions in the short-term are counterbalanced by vast monetary and fiscal stimulus. Our work suggests that value tends to outperform with high confidence following fiscal stimulus and as high yield spreads1 normalize and yield curves steepen. With powerful, opposing forces colliding, the specific timing of their impact on the real economy is a watchpoint but, overall, we think the cycle is still on our side, especially as we look out beyond the immediate future.
Analyzing the bigger picture
Strategic role - The role of value as a long-term strategic factor exposure in Russell Investments' equity portfolios still stands today. Of course, the role of a portfolio manager is to dynamically adjust that positioning as our CVS signals dictate. At Russell Investments, we may be neutral or even underweight value, as shorter-term conditions warrant. Even then, however, value exposure is never far from our thoughts.
Scale and perspective - As much as value exposure in funds has struggled, it is worth noting that small-cap and volatility factor risks have been broadly as significant a performance headwind as the value factor itself. In fact, these are all related, as an expression of the type of stocks held particularly by value managers in the current environment. Disentangling these effects is complex but it is helpful to consider the issue in multiple dimensions.
Style performance comes and goes - Why is it different this time? This is a big topic, as the definition of the economic cycle has been somewhat redefined since the Global Financial Crisis. There isn’t a particularly comparable period in history. So profound was the damage in 2008 that economic growth has remained firmly below trend and any signs of further dips have been met with powerful stimulus measures. Even mild recessions have not been tolerated. Interest rates (low to zero) and inflation (non-existent) tell you all you need to know. Furthermore, it is growth stocks that typically benefit more from low-interest rates than value stocks. This is because more of the former’s cashflows are further in the future, due to the longer duration nature of the asset. Without the typical ebb and flow of the business cycle and its policy drivers, like falling/rising interest rates, the resurgence of value in a typical pattern has stalled. Note, though, that all this context sets the scene for the opportunity we have been increasingly highlighting.
Growth/quality stocks are riskier than they seem - The factor tailwind supporting this style is well understood. We would argue it has the feel of a carry-like or momentum trade—all bar the ending, that is. Carry trades are characterized by a continual stream of small rewards followed by explosive reversal. They feel comfortable for investors, ironically more so the longer the trend continues. Then, the music stops. That attribute—comfort—is really what the global equity team is pushing against. It seems unlikely that maintaining significant exposure, let alone adding, to a space that has become so popular and crowded is a smart forward-looking decision. However, this doesn’t mean eliminating growth, just treading carefully and using the right specialists in the space.
Outperforming is never easy
A central tenet of skillful active management is implementing differentiated views, at the right time. This inevitably means putting money to work in less than comfortable areas, exploiting price volatility and investors’ behavioral biases. We believe that our investment process provides the framework and guard rails to do so effectively. We are continuously on the look-out for reasons why this could be wrong (indeed, we document some in our materials) and, in any case, have no intention of narrowing the existing broad range of return drivers and styles which characterize Russell Investments portfolios. Tilting is just that.
1The difference in current yields of high-yield bonds versus investment-grade corporate bonds, government bonds or another benchmark.