Marketing communication
This page contains marketing information
Marketing communication
This page contains marketing information
Value investing may sound simple, but buying what others do not want can be uncomfortable and lonely. Shane Kelly, manager of the M&G Global Strategic Value Strategy, explains why discipline, patience and a team willing to be challenged are essential for contrarian investors. He also discusses why today’s unusually concentrated markets and a broad spectrum of overlooked opportunities support the value equities team’s view that the 2020s could be the 'decade of the cheap asset'.
The value playbook is appealingly simple in theory: buy a stock when expectations are depressed, wait for the market to recognise that reality is better than feared, and sell when the valuation recovers.
In practice, it is much harder. Buying what others do not want, when sentiment is manifestly negative, can be deeply uncomfortable. In a world where attention spans are shortening and patience is in limited supply, owning ‘cheap stocks’ without an obvious catalyst to re-rate can feel like a lonely place to be.
The importance of discipline
I take comfort from the fact that financial-market participants can be myopic. Investors can become carried away by a particular theme, leaving other parts of the market behind. What keeps us rational is the evidence, repeated through market history, that extreme misalignments eventually normalise. The timing is never certain, which is precisely why maintaining a consistent value discipline matters so much.
A disciplined process is also essential both to finding undervalued stocks and to building portfolios with attractive risk-return characteristics. Our starting point is deliberately sceptical: rather than looking for reasons to own a stock, we try to find reasons not to invest. Turning the question around helps us avoid companies that are cheap for good reason, the so-called 'value traps'.
Our starting point is deliberately sceptical: rather than looking for reasons to own a stock, we try to find reasons not to invest.
We will never eliminate every mistake. Some unloved companies will experience further problems, which is why we build balanced, diversified portfolios. We are not relying on one or two heroic forecasts. We are assembling a collection of companies where, in aggregate, we believe the balance of risk and reward is skewed in our favour.
Value investors have a reputation for being pessimists. There is some truth in that. The job requires you to think hard about what can go wrong, particularly when a low valuation may be signalling a genuine problem. But useful pessimism needs to be paired with open-mindedness. You have to recognise when the market has become too gloomy and be prepared to act.
That is where being part of a team makes a real difference. Working closely with Richard Halle and Daniel White, who manage our European and North American strategies respectively, gives me two highly experienced colleagues who understand that discipline. Just as importantly, our conversations extend across M&G’s wider equity team. We also talk to our fixed income colleagues to get a different perspective on relevant companies and investment themes.
Colleagues with different investment styles, sector expertise and perspectives challenge our views and help us avoid living in a 'value bubble'. Contrarian investing should never mean becoming closed to contrary evidence.
Sticking to value through long periods of underperformance requires conviction, but it should not require dogmatism. The best team environment combines the confidence to take different views with enough humility to keep asking whether we might be wrong.
Decade of the cheap asset
While cheap stocks will always come with challenges, we believe several of the headwinds faced by value investors a decade ago have eased. We went so far as to suggest that the 2020s could be the decade of the 'cheap asset'. That reflected our belief that the market regime was changing. Inflation had returned, interest rates were no longer anchored at zero, globalisation was going into reverse, and the world was becoming less stable and more volatile.
These changes have forced investors to reassess many of the assumptions that prevailed in the 2010s. Those include the sustainability of businesses built around a zero cost of capital, the pathway to net zero, the organisation of global supply chains, and the prospects for capital-intensive industries in an environment of higher defence and infrastructure spending. In many cases, that reassessment began at a point of maximum tension, when valuation differences were already extreme.
The opportunity for value investors comes from a simple observation: when the world changes, the companies that prosper can change too. Different stocks start to do well and different stocks start to struggle. When valuation differentials have been stretched like a rubber band, a shift in expectations can produce a powerful snapback.
Six years into the decade, we have seen evidence of that reassessment, particularly in Europe. Yet we believe there is further to go as investors consider which companies may benefit from the rebuilding of supply chains and renewed investment in industries and markets that were previously neglected.
Geopolitical uncertainty also creates more frequent dislocations. We do not know where the next crisis will come from, but volatility can offer us the chance to buy what we believe to be fundamentally sound businesses at prices that reflect excessive fear. For a patient value investor, both the structural changes under way and the turbulence around them can be fertile ground.
Volatility can offer us the chance to buy fundamentally sound businesses at prices that reflect excessive fear.
Opportunities in overshadowed areas
One of the biggest conundrums for investors today is the dominance of technology. The sector represents a very large share of major global equity indices, while equity-market performance has become concentrated in a narrow group of companies associated with artificial intelligence (AI).
We have almost always been underweight in technology, but today that underweight is material and the largest it has ever been. That creates an obvious headwind when the biggest technology names lead the market. Yet sector exposure and stock selection are not the same thing. Despite the underweight, technology has been a significant source of alpha for us.
That outcome came from decisions that were difficult at the time. When excitement was elsewhere and parts of the technology supply chain were deeply out of favour, we held companies such as Samsung Electronics and Seagate. Both were exposed to cyclical areas where expectations had become depressed. There was no guarantee that sentiment would turn quickly, and holding them through the discomfort required patience.
We do not buy a stock because we think we can identify the precise catalyst for its success. We are more interested in good businesses where the valuation implies a bleak future and where reality is susceptible to positive surprise. In these cases, the acceleration in AI-related demand helped produce exactly that kind of surprise, supporting strong recoveries and meaningful stock-specific returns.
We are…interested in good businesses where the valuation implies a bleak future and where reality is susceptible to positive surprise.
For me, the lesson is not that we should chase the dominant theme. It is that a dominant theme can cast useful shadows. Capital and attention crowd into the obvious winners, while other businesses, including some connected to the same underlying trend, can be overlooked or mispriced.
The AI trade can appear all-encompassing, but we invest globally and see many other developments creating opportunity. The challenge is to keep searching where others are not, rather than allowing the index, or the prevailing narrative, to dictate where we look.
Widespread value
Six years into the decade of the cheap asset, the world is certainly different. We cannot claim credit for forecasting the events we have lived through, from trade tensions to energy shocks. But some of the valuation extremes we highlighted have begun to unwind, and markets previously ignored by global investors, including Japan and South Korea, have reawakened.
Even after those moves, we believe the value opportunity remains significant and widespread. Europe is still priced against a backdrop of limited optimism. In Asia Pacific, there are businesses that have not participated in the AI-driven rally, while the governance and shareholder-return reforms under way in Japan and South Korea are, in our opinion, still in their early stages.
The US is perhaps the most striking example of the tension building beneath the surface. Market leadership has become exceptionally concentrated, while the valuation gap between the cheapest and most expensive stocks remains very wide. The longer that concentration persists, the more normal it can feel. But it also stretches the rubber band further. If expectations or market leadership change, the resulting effect could be enormous.
History reminds us that the companies defining one cycle do not necessarily define the next. Our opportunity set is therefore always moving. Some of the high-quality businesses that dominated the last decade have already begun to derate and move towards 'value land', while previously overlooked companies are improving and returning capital to shareholders.
History reminds us that the companies defining one cycle do not necessarily define the next.
Value investing begins with scepticism, but it does not end there. We spend much of our time asking what can go wrong because that is how we protect against permanent loss. Yet buying a cheap stock is ultimately an optimistic act. It is a belief that a company can endure, that reality can be better than feared, and that the market will eventually recognise the difference.
With the breadth of attractively priced stocks available today, continued global instability and the extraordinary concentration in parts of the market, I believe the opportunity for value remains substantial for the rest of this decade. Who says value investors are all pessimists?
The views expressed on this webpage should not be taken as a recommendation, advice or forecast, nor a recommendation to purchase or sell any specific security.
The value of investments will fluctuate, which will cause prices to fall as well as rise and you may not get back the original amount you invested. Past performance is not a guide to future performance.
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