Investment

The return of value investing…and why it’s outpacing private equity

Glory be! After lagging for decades, US mutual fund managers have been beating their benchmarks this year. 

According to research by Goldman Sachs, 56% of active managers beat their indices against a more typical 33% over ten years, after a surge in value and small-cap stocks.

…small-cap stocks offer the same value as private equity – without its illiquid, fee-heavy, structures…

Small caps, particularly favoured by active managers, rose the most. The Russell Microcap index rose 120% in the year to March, against an annualised 12.2% over the decade. More speculative growth opportunities, including SPACs and bitcoin, have wilted. 

So far this year, Russell’s index of value stocks has risen by 18% against 6% from its growth equivalent and 4.6% from the NYSE Fang-plus index. The reluctance of active managers to invest in highly-priced Fang stocks, for fear of losing their clients, was a big factor behind this year’s improvement. 

The eclipse of growth stocks follows economic stimulus in the US and China which has fuelled commodity prices and expectations of higher interest rates. This, in turn, put a lid on soaraway earnings expectations for growth stocks, which led to the rotation to value, led by the banks, and small caps.

Because they were so badly overlooked during the growth surge, a strong bounce was inevitable. 

In May 2020, Verdad, a family office adviser, said small-cap stocks were suffering their worst ten year run since the Great Depression.

Ever since, small-cap stocks have surged. And many of the managers who invest in them have done even better. Paradigm Micro-Cap has just disclosed a staggering 145.6% in the year to March, against its ten-year annualised return of 14%, despite pausing for breath in the first quarter. 

Family office matriarchs may be interested to learn that Paradigm is run by a rare mother-and-daughter team, Candace King Weir and Amelia Weir who take a painstaking approach to finding neglected stocks.

O’Shaughnessy Asset Management (OSAM) say small-cap stocks offer the same value as private equity – without its illiquid, fee-heavy, structures. 

Verdad believes European small-cap value stocks offer outstanding opportunities, coming out of their lowest relative valuation in recorded history in 2020. Despite smart gains of 69% over the year to March, against 39% for large-cap growth, it expects further gains on a ten-year view.

Overlooked UK value and small-cap stocks have also enjoyed a post-Brexit bounce. Gervais Williams of Premier Miton has enjoyed an 85% rise in his UK small-cap fund in a year. Once threatened by decay, his inflows have become so strong that his fund has closed to new investors to digest them. 

Family offices have been struggling to get a handle on all this. But an interesting contribution to the debate was recently published by O’Shaughnessy after a study of previous cycles.

“As the new technology shifts to becoming the new norm, the deployment phase begins. It takes advantage of the infrastructure laid in the installation phase and expands to broad societal acceptance. 

“This begins with a high growth phase, where real growth occurs, and the technological revolution diffuses across the whole economy.

“This is a time of creative construction. Winners emerge to form oligopolies, and this growth eventually slows to the maturity phase, where market growth stagnates.”

This means disruptive technology is increasingly being used by value stocks to improve their bottom line, making them more like growth. Growth stocks are continuing to shovel in profits, making them more like value as their shares mark time. 

As everything flattens out, stock pickers could be in a decent position to score some wins from growth and value. And family offices may be well advised to ride both horses. Which would be their natural inclination, in any event.

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