Value In Patience
Accumulating risk assets as they are being discarded by the herd pays eventually. But it requires patience: momentum is a very powerful force in markets and richly valued asset classes such as US equities continue to thunder ahead of cheaper Emerging Markets and European assets.
"Patience, hard thing! the hard thing but to pray,
But bid for, Patience is!"
- Gerard Manley Hopkins (English poet, 1844 – 1889)
Replace the word “patience” in Hopkins’s poem with “value” and you might get a sense of the travails of the 21st Century value investor. A timeworn investment strategy, going back at least as far as Benjamin Graham in the 1950s, who in turn mentored Warren Buffett (the Anakin Skywalker to Graham’s Qui-Gon Jinn, perhaps) and thereafter the multitudes inspired by Buffett, value investing has in the past twenty years threatened to shred some stellar reputations.
In essence “value” investing is simple: acquire assets that are cheap, which almost always means those that are unloved or overlooked by the rest of the market; hold on to them long enough to see the cycle turn and for those assets to become popular again.
Of course, this is easier said than done. The pre-eminent economist John Maynard Keynes, bruised by the failure of his impeccable analysis and fearsome intellect to overcome the markets in his early investing career, observed ruefully that “the market can stay irrational longer than you can stay solvent.” (1)
Periods of time when assets meeting the definition of “value” underperform the market can last for years. In the meantime, assets that are already expensive may continue to become even dearer (the “momentum” effect). Research by Schroders (2) shows that in the past decade the gap in performance between value stocks and growth stocks is wider than it has ever been.
The strongest performers in recent years (Apple, Amazon and Alphabet, for instance) have been the best-performing stocks this year, too. Value investors need to be comfortable holding unpopular stocks while simultaneously not succumbing to the fear of missing out (3) on popular stocks that seem to keep rising forever.
What is true within one market (US equities) can also be seen at a broader level. The US stock market has led the way for many years, despite being more expensive than at any time in history except for 1999 and 1929! Emerging Markets and European equity markets, by contrast, have been relatively cheap.
Over long cycles markets tend to revert to the mean, roughly speaking, so a “value” approach would suggest buying Emerging Markets and Europe and selling US equities. To have done this at any point over the past 5 years would have been costly, however, as the markets have remained supposedly “irrational” for longer than some value investors could stand.
The good news is that, unless you run a value strategy investment fund, you don’t have to choose. In a typical long-term diversified portfolio with broad equity exposure you effectively hold both the momentum and value assets, anyway.
In our clients’ portfolios we still try to incorporate “value” principles; not by making a big bet on a particular market but by rebalancing and tilting allocations towards cheaper assets. In effect, we recycle excess gains in expensive parts of the portfolio into cheaper assets.
This should improve long-term returns while still leaving the (relatively expensive) US as the largest part of the portfolio. Just as importantly, these simple actions can help clients to achieve the patience necessary to stay invested, because while they might miss out on short-term, momentum-driven returns, their journey will likely be a smoother (4) one.
Although the evidence for attributing this quotation to Keynes is limited (https://quoteinvestigator.com/2011/08/09/remain-solvent/) the phrase elegantly expresses the point. Keynes adapted his approach and went on to have a very successful investment career. Reports of his actual returns vary; https://www.maynardkeynes.org/keynes-the-investor.html suggests long-term outperformance of c. 10% p.a. after a difficult early period.
Fear of missing out: well, we could just have written FOMO to underline our hip credentials. We’re cool.
The Economist published an excellent, concise piece on the benefits of simple rebalancing in long-term, diversified portfolios: https://www.economist.com/finance-and-economics/2018/07/26/why-simple-rules-are-best-when-spreading-your-investment-bets