Many so-called “value” shares on the UK stock market are “cheap for a reason”, according to top investors at Janus Henderson and Schroders.
Growth strategies have comprehensively beaten their value-focused counterparts in recent years as depressed bond yields have forced investors to look to equities for income. Investors instead fixated on sectors like consumer staples and utilities, which possess bond-like characteristics.
Despite this, many income fund managers, most notably Neil Woodford, are now focusing on value-type stocks that have seen their share prices slump, such as UK retailers and financials.
Last month, Woodford claimed there’s “an opportunity to capture assets at incredibly depressed valuations, the likes of which I have only seen two or three times during my 30-year career”.
But John Pattullo, manager of the £2 billion Morningstar Silver Rated Janus Henderson Strategic Bond Fund, says many of these types of firms are “going bust pretty quickly”.
“Neil Woodford, of course, would tell you… that value is very cheap and you should buy it,” Pattullo told advisers at an event in London last week. “But I would suggest some of these businesses are cheap for a reason.”
He names the likes of retailers Debenhams (DEB) and New Look as two of these, claiming that sectors such as retail in the UK and car hire firms in the US “are going to disappear full stop”.
Pattullo expects bond yields, and inflation, to stay low. As a result, he suggests he would rather be invested in a Terry Smith-style equity portfolio, focused on arguably expensive growth stocks, than a Neil Woodford-style one for the long term. He does, however, acknowledge that value strategies have a part to play at times.
“We don’t think bond yields are going to do an awful lot and we find growth strategies pervasive – very Terry Smith, if you like,” he says. “For what it’s worth, we think you want to live in growth, but, hey, occasionally have a holiday in value. But holidays don’t last that long.
“We’re kid of in a holiday period at the minute but we remain very persuaded that growth-type strategies with large-cap, sensible, reliable businesses is really the way to go.
“It’s a very challenging world that we live in, very few industries have much pricing power and it’s hard to find the good ones.”
Avoiding Value Traps
Kevin Murphy, a value investor and manager of the £2.1 billion Morningstar Bronze Rated Schroder Income Fund, agrees that there are plenty of “value traps” around in the UK market right now.
However, he says there is 100 years worth of data that proves that the cheapest companies outperform over the long term. Murphy's team uses a valuation filter to reduce their investable universe to the cheapest 20% of their particular marketplace.
“If you do that today, the kind of stocks that come out of that filter are companies such as banks, mining companies and retailers,” he says. “They are sectors that very few people are willing to invest in, but these are the most attractive companies today.”
However he stresses the importance of analysing the stocks you’ve identified as being the cheapest before taking the plunge. “If you’re fishing in that pool, what you’re trying to do is separate out those companies that are cheap temporarily from those companies that are cheap permanently,” he explains.
Murphy has a seven-point checklist, which includes investigating a company’s balance sheet, the quality of the business and if there are any structural changes within its industry.
Once you’ve analysed these companies, the key is deciding what not to invest in, he claims. The Schroder Value team analysed around 300 stocks over the course of 2017 but only bought 1-2% of them.
Carillion (CLLN), the UK outsourcer that recently filed for compulsory liquidation, is a case in point. It's been screening as one of the cheapest companies in the UK for the past 18 months, Murphy explains.
However, he adds: “We didn’t own it in any of our portfolios because it failed to turn profits into cash, it failed the financial stress test and it failed the business quality.”
