Last week, Morningstar ran our annual investment conference, on subjects ranging from Brexit and risk management to the cost of funds and the future of advice. Read on for our coverage of the Morningstar Investment Conference UK in our special report: What the Experts Say.
Emma Wall: Hello and welcome to Morningstar. I am Emma Wall and joining me today to talk about value investing is Charles Pohl, Chief Investment Officer for Dodge & Cox Worldwide.
Hello, Charles.
Charles Pohl: Hi.
Wall: So we've just heard from you at the Morningstar Investment Conference about why it is good time to go for value. And there has been a change in value stock's fortunes recently, hasn't there? For years, about four-five years in the U.K. Growth outperformed value, but now value is taking center stage once again. Why should we believe that this is the strategy that's here to stay?
Pohl: Well, really, if you take a long-term point of view, the relative valuation of value stocks compared to growth stocks is at multi-decade lows and so whereas there has been a little bit of a rally in the value stocks since the middle of February, it doesn't come anywhere close to erasing that overall valuation gap. So this is something that we think could persist actually for quite a few years into the future.
Wall: There are couple of markets, however, where the idea of finding good value stocks may seem a little tricky. In the U.S., for example, which we've been told for a number of years is at its all-time highs, and now is the time to crystallize your gains. And indeed the U.K. has come on leaps and bounds on Europe over the last five years. So where are you finding good value?
Pohl: Well, in the developed markets, particularly in some of the more economically-sensitive areas – the financials, energy, some of the material stocks, those are the areas where there are a lot of values today in the developed markets. In the emerging markets, we're seeing it really across the board and in almost all of the industries, and the markets themselves, the emerging markets themselves are trading at quite sizable discounts and valuation on a P/E basis to the developed markets.
Wall: I mean some people would say those things are good value because of the risk associated with them. You mentioned materials, obviously, the oil price dropping has had significant impact on mining and commodity stocks. And indeed emerging markets, a lot of people are very nervous about that. So how do you work out what's a quality stock that's at a good value right now and what was just too risky to touch?
Pohl: Well, I think there are two aspects to that question I'd like to address. One is, is that the lower the valuation that you get in at, we think the lower the risk that you'll lose money. Because if you buy it cheap enough, you buy it at the right point in the cycle. That removes some of your risk just because you're buying at such a low valuation.
So in some ways growth stocks to us appear quite risky today, many of them, because they're starting at very high valuation, and the valuation potentially could come down and result in losses for investors. And, conversely, some of these value stocks, yes, there is volatility in the economic outlook and volatility around the outlook for some of the specific companies, but they are starting from relatively low valuations.
The other thing that I'd like to highlight is that we think that it's a point for active value management, in that I think there are value stocks, which are value traps. They are crummy businesses. They have very volatile earnings and cash flow streams, and they don't grow. And that's why they have low valuations. And the key to being a successful value investor, an active value investor, is differentiating between those companies that are cheap for a very good reason and those companies that are temporarily cheap, but actually have good long-term prospects.
Wall: Because, of course, you cannot [differentiate] for a strategic beta or smart beta ETF right now, with a value bias. But what you are saying is if you do that, if you take the passive approach, you are leaving yourself open, at risk, to these value traps?
Pohl: Yes. I think you wind up with those strategies. You get all of the value stocks, and we think that you can gain. Particularly, I think, it's true in some of the emerging markets, where some issues like corporate governance, the rule of law, alignment of the management with the shareholders, there are so many issues like this that are present in the emerging markets. A broad-based approach, such as some of these smart beta approaches or these passive approaches, you are going to wind up with some companies that have issues in governance and other kinds of alignment issues that may perform poorly over time.
Wall: Charles, thank you very much.
Pohl: You are welcome.
Wall: This is Emma Wall for Morningstar. Thank you for watching.
