It has been a surreal year for fund managers in the City, with unprecedented volatility descending on practically every investment vehicle, asset manager or investor operating out of the Square Mile.
The unpredictability of the ongoing pandemic is one of the reasons why the age-old investment-driven debate about ‘cheap’ value stocks versus ‘expensive’ growth equities has never been more topical.
Whilst there is no doubt that growth strategies have been the winners over the past decade, predictions of a post-pandemic recovery and possible inflationary pressures may suit a more value-orientated approach.
City A.M. spoke to a number of Square Mile-based investment managers about the impact of the pandemic, inflation risks and opportunities and a potential growth-to-value rotation.
When Covid first hit
The portfolio of Ian Lance, co-manager of Temple Bar Investment Trust, suffered at the start of the pandemic but he has switched to recovery gear since the vaccine rollout kicked off in earnest.
“We had used the volatility in the market during 2020 to buy stocks that looked very undervalued [in case] any sort of economic recovery occurred, and these stocks have done well during the last four months,” Lance said.
It was a similar story for James de Uphaugh, manager of Edinburgh Investment Trust. When the pandemic first hit, for a “brief gut-wrenching period” it was all about “days of liquidity”, De Uphaugh said.
“We have endeavoured to morph the portfolio as we have gone through the different chapters of the Covid crisis,” he shared with City A.M.
“But we quickly ensured that we were invested in companies that had clear plans to emerge strongly on the front foot into radically changed competitive environments,” De Uphaugh added.
Purchases included the likes of Greggs, Compass, Easyjet and Dunelm, funded primarily by sales of the likes of Glaxo, Sage and Barrick Gold.
While Alex Wright, manager of Fidelity Special Values, stressed his portfolio was “defensively positioned” when the pandemic first hit, the vehicle’s holdings were not immune.
Several of the vehicle’s holdings, like aerospace equipment supplier Meggitt and alcoholic drink manufacturer and distributor C&C Group, “two normally resilient businesses,” have been severely impacted by the pandemic-related disruptions.
This recession is different from any other that we have seen previouslyAlex Wright
“Consumers have not been able to spend as much as they would normally due to lockdowns and other containment measures still in place. So, they are spending considerably less on transport and travel, leisure activities and eating out, normally a substantial share of their spending,” Wright said.
As a result, consumers were left with more disposable income to spend on housing, DIY, electronics and sports equipment and clothing.
“This trend has benefited our holdings in specialist retailers such as Halfords, Dixons Carphone, Studio Retail Group and Frasers Group, which have been reporting stronger-than-anticipated trading,” he added.
Turning the focus to inflation, Gary Moglione, fund manager of Seneca Global Income and Growth Trust, soon to be renamed Momentum Multi-Asset Value Trust, pointed out inflation expectations have been low for years, with the main talking point being deflation.
“In that environment, investors seek growth businesses or dominant market players with a strong franchise and dependable cash flows,” Moglione told City A.M.
“The consensus view has now changed significantly as markets start to reflect the expectation of inflation,” he said, pointing out that the yield curve is steepening which indicates the market is expecting higher inflation and thus higher interest rates in the future.
“This view is difficult to argue against,” Moglione continued, as he stressed markets have had massive amounts of stimulus into the global economy, loose monetary policy and pent-up consumer demand as people have been confined to their homes for the best part of a year.
“If the vaccine rollout is a success, then this should equate to a strong recovery and pressure on prices,” he added.
Alasdair McKinnon, manager of The Scottish Investment Trust, has noticed that central banks are indicating their willingness to tolerate greater inflation.
While governments can’t say it out loud, they would secretly love to devalue the debt burdens that they have accumulated during the pandemic.
Historically, ‘value’ fared well in inflationary conditions. “This is when a ‘bird in the hand’ is suddenly worth more than ‘two in a bush’,” McKinnon said.
There are signs that the economic recovery, combined with monetary and fiscal stimulus, may lead to inflation as newly created money finds its way into the real economy rather than just financial assets.
“Historically, value as a style has done well in this type of environment as sectors such as energy, mining and financials fare well during reflation and inflation,” Lance said.
The UK market, and in particular the value segment of the market, offers very attractive opportunities, Wright stressed.
“While we have started to see a rotation into value in late 2020, the dispersion in returns between growth and value stocks since the 2008-2009 global financial crisis remains unprecedented,” he said.
“This leads us to believe that, should investors shift their focus for the reasons mentioned previously, the degree of outperformance could be very substantial, given how bifurcated the market currently is.”
For Lance, value as a style has significantly outpaced growth over the last few months but he believes that few investors have started to reposition themselves so rotation will continue, in particular in the face of an economic recovery or pick-up in inflation.
Exceptionally long cycle
“History doesn’t repeat itself, but it often rhymes,” remarked Moglione “We are now over a decade into one of the strongest periods for growth stocks ever. Valuation spreads between value and growth reached extremes in 2020.”
Pointing out he has seen cycles like this before, with the Nifty Fifty in the 1970s and the Tech Boom in the 1990s.
“You can look through history and see that whenever we have a period of strong outperformance of growth the market eventually rotates to an exceptionally strong period of value performance.”
These cycles usually range from a couple of years to a decade, so for Moglione this period for growth has been exceptionally long, as he concludes that many investors aged under 35 have effectively only witnessed one market during their careers.