Dear Clients and Friends,
As a deeply committed value manager, we fervently believe the principles of value investing are as immutable as the laws of nature.
We hold that, at least in the short term, emotionally driven human behavior—not necessarily logic—moves stock prices. At times, the patient investor is therefore presented with opportunities to buy potentially undervalued stocks: we don’t think this pattern will change. Even with quicker access to increasing information, reasonable people will differ in its interpretation; after careful analysis, some will be sellers and some will be buyers.
A few years ago, a client observed to Charles Brandes (Trades, Portfolio) that investment information is much more widely available today than when the firm started in 1974. “Does it not follow,” this client asked, “that markets are more efficient and the opportunity to exploit the value premium has been eroded?” Said Charles in response: “Technology has created greater access to information for all market participants.” However, he added insightfully, “greater access to information simply allows people to panic more quickly.”
So, if the principles underpinning value investing are immutable and mispriced stocks will always exist, why has value as an investment style been out of favor for such a long period?
Value performance has been lagging its growth alternative for almost a decade for various reasons, including the tendency of many investors to seek companies with at least modest earnings growth in a low-growth economy, the gravitation to “low-volatility” companies and the growing popularity of index investing.
The long “dry spell” for value investing has caused many investors to reduce their allocations. Some traditional value managers have even changed their style to improve short-term performance metrics and asset gathering. However, when value has rebounded, the effect is dramatic. To see these patterns in chart form, click here.
Has something fundamentally changed and is it indeed different this time? At Brandes, we think not. Here are five reasons why we believe you should consider increasing the value allocation in your portfolio:
- Value has performed well when there is a reasonable amount of market volatility to create mispricing that reveals buying opportunities. However, asset-price correlations have been high for most of the past decade. Giving up on value implies we will never encounter volatility again: experience confirms this is not a sound assumption. In fact, investors may be becoming complacent. Because we have not had a major equity market pullback in years, there has been little reason to be fearful. However, markets have often experienced short-term turbulence that favors prudent, value-focused, long-term investors.
- Many investors have become accustomed to the availability of easy money endorsed by central banks in the past decade. As a result, they seem to assume that central banks will implement similar accommodative monetary policies in the future. This attention response bias (a natural tendency to overestimate the likelihood, frequency or impact of an event based on recent experience) potentially skews investment decisions.
- The strength of the markets (particularly in the United States) is causing many investors to ignore fundamentals. Despite serious geopolitical issues (North Korea, Brexit) and significant political divisions in the United States (the prospect of leaving the North American Free Trade Agreement, health care reform, etc.), markets have remained calm and have generally kept rising. Extrapolation—the tendency to view the future based on assuming that present events will continue or even accelerate—can lull us into thinking it will be “more of the same” and therefore into making poor investment decisions.
- Unless you think reversion to the mean cannot occur, the long run of growth outpacing value will eventually end. The valuation gap between growth and value is historically highfor markets worldwide—similar to when the tech bubble burst—and value rebounded strongly afterwards. We believe this pattern will likely recur.
- Unless all human beings become financially rational in the same way, at the same time, and at all times, there will always be mispricing that creates value investing opportunities.
If you agree that it truly isn’t different this time, what we’ve shared in this letter strongly favors another look at value. Because at Brandes, we do not believe the laws of nature change. We believe value investing will prove to be as successful in the future as it has proven to be in the past.
Regards,
Brandes Investment Partners
Past performance is not a guarantee of future results. No investment strategy can assure a profit or protect against loss. The information provided in this material should not be considered a recommendation to purchase or sell any particular security. It should not be assumed that any security transactions, holdings or sectors discussed were or will be profitable, or that the investment recommendations or decisions we make in the future will be profitable or will equal the investment performance discussed herein. Strategies discussed are subject to change at any time by the investment manager in its discretion due to market conditions or opportunities. The Brandes investment approach tends to result in portfolios that are materially different than their benchmarks with regard to characteristics such as risk, volatility, diversification, and concentration. Market conditions may impact performance. International and emerging markets investing is subject to certain risks such as currency fluctuation and social and political changesĂŤÂľ such risks may result in greater share price volatility.
The foregoing reflects the thoughts and opinions of Brandes Investment Partners® exclusively and is subject to change without notice.
