Are value funds and investment trusts topping the performance charts?

Rising interest rates present a favourable backdrop for cheap shares. Kyle Caldwell crunches the numbers to find out if value fund managers have outperformed in this environment. 

There’s been a number of false dawns over the years, but the rising interest rate environment presents a more favourable market backdrop for value strategies.

For more than a decade, growth funds enjoyed having the style tailwind of low interest rates. As a result, growth stocks were bid up due to the expected future earnings of such companies, which looked attractive when measured against the low cost of borrowing.

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Now, with UK interest rates having risen from 0.1% in November 2021 to 4.25% in April 2023, growth stocks are facing into a macro headwind. Rising interest rates, which boost the income returns on lower-risk investments such as cash and bonds, reduce the appeal of growth stocks promising future profits.

As a result, valuations cool and the shares re-price. This has particularly hurt shareholders in Scottish Mortgage (LSE:SMT), which has seen its share price more than halve since November 2021.

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With growth stocks out in the cold, the spotlight has turned to value shares, with investors prioritising companies making money today.

The value approach explained

The value investment style involves picking stocks that appear to be trading at prices lower than their true value, including how much money they make and how much excess cash is being generated. Such out-of-favour companies tend to have a low price/earnings (PE) ratio, which compares a company's value with its profits. If the company pays dividends, it will tend to have a high dividend yield.

Such companies tend to be found in sectors that are more economically sensitive, including finance, energy and materials. Value stocks are cheaper than growth stocks, with valuations more reflective of current earnings rather than their future potential.

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Fund managers who hunt for value shares do not simply buy on valuation grounds alone. They also look for, and hope for, a catalyst to revive an under-priced company's financial fortunes. This could be in the form of a restructuring, refinancing or management change.

Have value funds capitalised on the macro tailwind?

Value sectors, such as oil, gas, miners and banks, comprise a large part of the FTSE 100’s market cap. Given that this is the case, it is not a surprise to see that in terms of funds and investment trusts, the UK has more value fund options than other markets.

Most funds with ‘value’ or ‘recovery’ in their name invest in value shares, while some ‘special situations’ funds also follow the value approach.

Around 16 months on from the Bank of England leading the way in being the first major bank to increase interest rates, have valued-focused funds and investment trusts capitalised on the more favourable macro backdrop?

Research by interactive investor, using FE Fundinfo, looked at 16 value fund strategies from 1 December 2021 (shortly before interest rates started to rise) to 21 April 2023. More than two-thirds – 11 out of the 16 – outperformed the average UK fund over this time period.

How UK value funds and trusts have fared

Data from 1 December 2021 to 21 April 2023. Source: FE Fundinfo. Past performance is not a guide to future performance.

As well as good stock picking, for the funds that have outperformed holding BP (LSE:BP.) and Shell (LSE:SHEL) among the largest holdings has been a key driver of performance. Share prices for the two big energy stocks soared as oil and gas prices rose in response to Russia’s invasion of Ukraine. Since December 2021, BP is up 56.4% and Shell has gained 43.8%.

Half these funds outperformed the FTSE All-Share index, with Jupiter UK Special Situations leading the way, with a return of 19.1%. Ben Whitmore, who manages the Super 60 fund, told interactive investor in a video interview last year that he hunts for shares that are “lowly valued” and “unpopular”. The top three holdings are BP, GSK (LSE:GSK), and Shell.

Temple Bar (LSE:TMPL) is second in the rankings, with a return of 14.5%. Its fund managers, Nick Purves and Ian Lance, invest in good quality companies they believe are unjustly out of favour. The duo focus on financial strength – strong cash flows and robust balance sheets – to avoid ‘value traps’, companies that are cheap for a good reason due to structural decline.

The pair say the approach “gives us the confidence that a company can survive through a prolonged period of lower profitability caused by company-specific issues or an unexpected downturn in the economy”.

BP and Shell are the top two holdings. The third-biggest position is Marks & Spencer (LSE:MKS), while two banks, NatWest (LSE:NWG) and Standard Chartered (LSE:STAN), feature in the top 10.

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In third place is Man GLG Income, up 14.4% over the period. The fund, which appears on interactive investor’s Super 60 list of investment ideas, has a value-driven approach, which involves seeking to find positive dividend surprises. It pays out income monthly.

Man GLG Income also holds Shell and BP, ranked first and fourth in the portfolio. In-between those two stocks are HSBC (LSE:HSBA) and Imperial Brands (LSE:IMB).

However, not all value strategies have benefited from the more favourable market backdrop. As the table below shows, five funds and trusts have posted losses since 1 December 2021.

Hurting performance was less exposure to the two oil majors compared with other value strategies appearing higher up the table. In addition, three of the funds, Fidelity Special Values (LSE:FSV), Polar Capital UK Value Opportunities, and Premier Miton UK Value Opportunities, have most of their exposure allocated to mid-cap and small-cap stocks.

Smaller company shares, which are more domestically focused than the mega-caps in the FTSE 100, have notably underperformed over the past 18 months, due to their higher-risk nature. Stagnant economic growth, high inflation and interest rate rises have led investors to be more cautious, which has caused share prices and valuations to slump.

However, as we have explained separately, various professional investors argue that too much bad news is now priced in, meaning that now could be a good opportunity to consider the funds and investment trusts specialising in UK smaller companies. 

How global value funds have fared

As mentioned above, there’s less choice for fund investors looking for a global strategy. However, five active funds adopting a global approach have all outperformed the MSCI World index since 1 December, with four comfortably outpacing it, namely Murray International (LSE:MYI), Jupiter Global Value Equity, Ninety One Global Special Situations, and Schroder Global Recovery.

All four of those active funds also outperformed three value ETFs, which delivered similar returns ranging from 8.9% to 9.2%.

Topping the charts is Murray International, which is also a Super 60 rated fund. It is managed by Bruce Stout, who in the current environment is favouring stocks that own “real assets” and have pricing power.

How global value funds and investment trusts have fared 

Data from 1 December 2021 to 21 April 2023. Source: FE Fundinfo. Past performance is not a guide to future performance.

Mix and match between the two styles

Realistically, any potential prolonged market rotation towards value is unlikely to go in a straight line. The first quarter of 2023 has been a good example of this as the five FAANG stocks have made very strong starts to the year. 

As ever, balance is key. Therefore, it is prudent to mix and match between growth and value strategies. Doing so, will help investors achieve greater levels of diversification.

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