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Can value finally emerge from growth's shadow?

Growth stocks have led the way for most of the rally since the financial crisis, but some fund managers are positioning for a reversal.

 
Can value finally emerge from growth's shadow?
 

Growth stocks have long held the edge over value investments, but as the prospect of interest rate rises sparks investor nerves, could the tables finally turn?

Proponents of value investing like to point to the historically stronger return from these sorts of 'cheaper' stocks, but the investment style has been enduring one of its periodic spells in the doldrums.

In the near nine-year stock market rally that has followed the financial crisis, growth and quality stocks have been in the ascendant, barring a few hiccups.

Stocks like Google owner Alphabet (GOOGL.O) and Amazon (AMZN.O) have been at the forefront of a spectacular rally in technology stocks.

'Quality' consumer staples stocks like Unilever (ULVR) and Diageo (DGE) have meanwhile been boosted by the search for a decent yield no longer on offer in some parts of the bond markets, thanks to the impact of quantitative easing.

Some fund managers are now positioning for a resurgence of value investing as the quantitative easing taps are turned off and interest rates start to rise.

Stephen Message (pictured), who took charge of the Legal & General UK Equity Income fund in October last year after joining from Old Mutual, has wasted little time in responding to the threat of rising inflation and interest rates.

He has sold stakes in consumer staples stocks Unilever, Diageo, Reckitt Benckiser (RB) and utility National Grid (NG), worried about how they would fare in that environment. 

‘Monetary policy has been incredibly accommodative. The direction is starting to change and, in that environment, a number of companies that have performed well in falling bond yields, that display bond-like characteristics, namely in the consumer goods space, that have enjoyed fantastic rerating, suggest to me ratings might come under pressure,' he said.

Message has used some of those proceeds to build 'overweight' positions in banks, such as HSBC (HSBA), Lloyds (LLOY) and Barclays (BARC).

He pointed to their tendency to perform well when interest rates rise, as it boosts the margins they are able to make.

‘If you think of the environment when interest rates start to rise, that will be supportive to bank earnings as well,' he said.

‘Sitting here a year ago, the general view around the prospect of interest rate rises in the UK would have been negligible. Going back to November, the general consensus was that the rate rise there was “one and done”. The process of normalisation is going to take some time but it is coming through, so I’m happy to hold bank shares.'

Jeremy Podger (pictured), manager of the Fidelity Global Special Situations  fund, has meanwhile been adding to his positions in banks, materials and energy companies.

‘In this environment of global expansion, I think over the next five years we will see stronger growth come from some of those laggards – particularly financials, materials, and energy,’ he said.

‘The fund has benefited by being relatively cautiously positioned to those underperformers [in the past] and now is somewhat more balanced.’

Rising inflation has ‘forced’ Podger to look at ‘value and growth’ in context, and he has changed the portfolio on the back of higher inflation expectations.

‘In the last few months we have seen a rise in inflation expectations but it has not been accompanied by a rebound in value [stocks] compared to growth,’ he said. ‘There is normally a tight correlation. If we see inflation being higher this year then I think the background conditions are somewhat better for value investments.’

'We are more geared towards value than we were,' he said, but added that ‘has gone as far as it should’ as growth stocks were still exciting investors despite the market correction.

‘We are not overly concerned and think it was a technical correction but it highlights that we are likely to have more periods of volatility this year…and valuations are not as low as they were five years ago, so you have to be increasingly vigilant,’ said Podger.

Message has meanwhile injected a more explicit value bias into his fund. 

‘I’m very aware that value relative to growth has endured a tough time. Value has generally struggled since the financial crisis but from
a contrarian instinct, they are the areas I’m finding interesting,' he said.

That value focus has taken him to some of the domestic-focused UK stocks hit hardest since the Brexit vote, like Dixons Carphone (DC).

‘[This] clearly had a pretty tough time recently but actually the core electricals business is performing okay. There has been weakness around [the] mobile part: the company has announced they are looking at ways to improve that business. I’m still happy to hold it at the moment. Given my broader macro view and where I want to be positioned, it fits that theme as well.’

For a global investor like Podger, UK stocks are likely to hold some value appeal, given how they have lagged global markets since the EU referendum, but he is not looking to add to his domestic exposure just yet.

‘The UK has significantly underperformed the rest of the world,’ he said. ‘We have very little exposure to the UK but there is a price for everything. Perhaps later on this year we may find some bargains but at this stage I remain cautious.’

If Podger is to be tempted by domestic-facing stocks, banks may be a target.

‘Banking is interesting and appealing not least because we are seeing an improvement in the interest rate backdrop for banks and margin for deposits will be pretty good,’ he said. ‘It’s a concentrated market so there is potential for profitability but we have seen some corporate debt problems and valuations are not compellingly low.’

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