How to play the market rotation: fund, trust and ETF ideas

Here’s how investors can take advantage of the return to form of value shares. 

When stock market pundits say ‘this time is different’, it is always worth being sceptical, but if they are correct we may be seeing a significant change in the stock market winners and losers of the past 12 years.  

Over this time period, there’s been a number of false dawns for the predicted resurgence of value shares at the expense of growth shares.

The most recent was in November 2020, when the Covid vaccine breakthroughs were announced. Initially, this proved a boost for value shares. However, by June 2021 the rally had fizzled out, with investors moving back into growth shares.

Value versus growth explained

The value investment style involves picking stocks that appear to be trading at prices lower than their true value. Such companies tend to be in sectors that are more economically sensitive.

Growth shares, which are perceived to be safer and higher-quality stocks, have comfortably outpaced value shares since the global financial crisis. This has largely been attributed to low interest rates, which have made richly valued growth stocks more alluring, as the expected future earnings of such companies when measured against the low cost of borrowing look more attractive.

• Fund Finder: value versus growth investing 
• Market rotation harms our three growth-focused model portfolios 
• Why this popular fund has sold tech shares and bought banks

However, experts argue that the tide has now turned as central bankers tighten monetary policy.

Tom Becket, chief investment officer at Punter Southall Wealth, described growth shares enjoying the upper hand over value shares in the second half of 2021 as “the last hurrah of the pandemic trade”, which he notes “appears to be over now”.

As Becket says, various growth shares, particularly technology firms, have been hit hard since the start of the year. At the other side of the trade, value shares, which tend to benefit from high inflation and increases in interest rates, have been back in favour with investors.

Value sectors, including banks, energy, materials and some retailers, have strong pricing power. This enables many companies in these sectors to pass inflation-related costs on to customers.

However, tech companies and other growth stocks see the value of their future earnings devalued by higher inflation.

Vincent Ropers, a multi-asset fund manager at Wise Investments, says that the driver behind the sea change in investor sentiment is central banks – chiefly the US’ Federal Reserve – which is expected to raise interest rates a couple of times in 2022.

• Looking to diversify your portfolio? ii’s Super 60 recommended funds is full of great ideas
• Check out our award-winning stocks and shares ISA

Ropers notes that a tightening in monetary policy “significantly darkens the outlook for growth stocks”. He explains that the higher the interest rate, “the higher the discount rate used in valuation models, and the lower the value of future growth when brought back to today”.   

He adds: “Conversely, with less emphasis and worth assigned to future growth, value companies look increasingly attractive, particularly when their business models are sound, and their valuations remain at historically low levels both in absolute and relative terms.

“Investors having joined the fast-paced technology train late and suffered heavy losses, might be prompted to jump ship to protect their eroding capital, while earlier passengers might naturally want to recycle their gains into the next big thing. This could be the beginning of a great rotation indeed.”

So if the value rally does have legs this time, how can investors take advantage?

Mix and match approach

Realistically, any potential ‘great rotation’ towards value is unlikely to go in a straight line. 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.

Investors could potentially pair the pro-growth Scottish Mortgage (LSE:SMT) with the value-focused Murray International (LSE:MYI), which has a yield of close to 5%. Both invest in global shares, and are members of interactive investor’s Super 60 list.

For UK shares, a blend of Temple Bar (LSE:TMPL) and Finsbury Growth & Income (LSE:FGT) would give investors exposure to both value and growth shares.

Darius McDermott, managing director at fund ratings provider FundCalibre, says: “Those looking to invest money at the moment have two quite binary choices, depending on their personal outlook.

• Baillie Gifford retains crown as active investors’ favourite fund firm
• UK funds are making a comeback, but remain unloved by investors

“They could either choose to invest in value-oriented funds such as Schroder Recovery or Ninety One UK Special Situations, or top up on quality growth stocks that have fallen to much more attractive valuation levels. In this case, they could pick funds such as Baillie Gifford Global Discovery or Rathbone Global Opportunities.”

Funds and trusts that invest in value shares

The return to form of value shares over the past few months has benefited the UK market, as it is more economically sensitive than other exchanges. Value sectors – oil, gas, miners and banks – comprise a large part of the FTSE 100’s market cap. 

In terms of funds and investment trusts, the UK has more value fund options than other markets.

Examples of UK value funds include Man GLG Undervalued Assets, Polar Capital UK Value Opportunities, Premier Miton UK Value Opportunities, Dimensional UK Value, JPM UK Equity Value, Schroder Recovery, ES R&M UK Recovery, Slater Recovery and M&G Recovery.

Some ‘special situations’ funds also hunt for bargains. Examples include Super 60 members Jupiter UK Special Situations and ES R&M UK Recovery. Other options include Fidelity Special Situations and Ninety One UK Special Situations.

Four UK investment trusts that invest in value shares are Temple Bar (LSE:TMPL), Merchants (LSE:MRCH), Fidelity Special Values (LSE:FSV) and Aberforth Smaller Companies (LSE:ASL).

Global value funds include Jupiter Global Value Equity, Schroder Global Recovery, Ninety One Global Special Situations and Overstone Global Equity Income. For investment trusts Murray International (LSE:MYI) is another option.  

ETF options to play a value rally

In terms of exchange-traded funds (ETFs), the iShares Edge MSCI World Value Factor ETF (LSE:IWVL) and the Xtrackers MSCI World Value ETF (LSE:XDEV) are viewed as ‘aggressive’ value options. These ETFs track the MSCI World Enhanced Value Index, which is more concentrated than the MSCI Value Index, tracking 399 stocks versus 991.

As a result, when value stocks do well, stocks in this index usually do very well, making it a ‘high conviction’ bet on value. It will, of course, go the other way when value stocks perform poorly.

According to Dimitar Boyadzhiev, a senior analyst for manager research and passive strategies at Morningstar, the Invesco FTSE RAFI All World 3000 ETFs (LSE:PSRW) is a more conservative value strategy.  

He says: “FTSE RAFI indices achieve exposure to value by weighting constituents according to their dividend yield, free cash flow, total sales and book equity value. This ETF would be an option for investors with a more conservative risk profile.”