Value opportunities favour fearless investors

Those able to take a long-term view can tap into a pool of compelling value opportunities, says Steve Hunter.

Seneca the Younger – ‘We should not, like sheep, follow the herd in front of us, making our way where others go, not where we ought to go.’

After a long period of relatively stable markets, the past few months serve as a stark reminder of how volatile markets can be. During a bear market, the more markets fall, the more fearful we become. We see big portfolio losses as a threat to a comfortable retirement, so we cut our losses and run. Our emotions are too strong to allow us to rationalise the situation.

The falls should create opportunities for investors who can take a long-term view. In simple terms, many companies will likely be significantly cheaper to buy now than they were four months ago. We believe this value-oriented strategy of adding selectively to assets assessed to be undervalued will give us an advantage when markets recover. As value investors, we cannot control how participants in financial markets choose to price the assets we own on a day-to-day or quarter-to-quarter basis. What we can do is attempt to determine the value of the assets we invest in on your behalf, and decide if today’s price is attractive relative to that value.

Our assessment of that value may be overly optimistic, so we look to pay significantly less than this amount to give ourselves a margin of safety. In today’s markets, what we can offer is a sober analysis of value, and the courage to act on our views.

Inviting propositions

The relative outperformance of ‘growth’ as an investment style versus that of ‘value’ has been well documented in recent years. At the end of March the 10-year total return of the value style lagged the growth style by its largest margin in 35 years, surpassing that of the underperformance during the dotcom bubble at the end of the 20th century. On a price-to-book basis, value stocks now stand at their deepest discount to growth stocks for the data we have available. While this may seem bleak on the face of it, there are now real value opportunities for investors across a range of markets and sectors. Rather than worrying about market events outside our control, our sole focus as value investors should be on assembling a collection of assets we believe to be significantly undervalued.

Conviction will pay in future

Investor confidence has fallen significantly and we have seen indiscriminate selling across most markets. Over this period, we have been working hard to position portfolios in such a way that our investors can benefit significantly when we enter the next bull market. To do that requires remaining rational when those around us are at their most irrational. Our belief is that bottom-up value managers are well-suited to taking advantage of the current market environment.

This is particularly true in regard to investment trusts, some of which are able to pay dividends to their shareholders despite the current headwinds and are less vulnerable than open-ended funds, in the event of investors rushing to liquidate their holdings. Syncona and AEW UK Reit are two attractive examples.

Despite the volatility, we have continued to add to both equities and specialist assets, which trade at very attractive prices relative to our assessment of their fundamental value. As well as adding to existing UK equity holdings, we have found new opportunities trading on extreme valuations, which will also provide some revenue diversification.

Within our overseas allocation, we have seen the reopening of two funds for new investment – Morant Wright Fuji Yield and Absalon Emerging Market Corporate Debt. To ensure long-term performance isn’t compromised by having too much money to manage, the managers are very careful to control the size of their funds. The opening of these funds for investment tells us that today’s opportunity is an attractive one, as does our own internal analysis of their holdings, and we are adding to the funds.

Value investing is undoubtedly at its most challenging during difficult periods of performance. As investors in the funds alongside our clients, we endure these periods with them. The investment process and conviction in the value investing philosophy is what instils confidence that this investment strategy will in the end come safely to port, despite recent storms.

Steve Hunter is head of business development at Seneca Investment Managers.