Rotation to value? Mr Market drops first track from new value album

– David Wanis, September 2019

The most interesting and important event in September was the sharp swing in returns from value stocks relative to growth stocks.

This may not be the beginning of a clear and definitive change in market leadership, but investors should definitely pay attention to what this track suggests the full album may sound like.

Too much has already been written about value, growth and momentum in the equity market over the past few years to repeat much of it here. The big moves in September are a reminder that despite being well known, it doesn’t mean these things don’t matter. We think September has given us a taste of what a prolonged rotation to value from momentum/growth/duration may look like.

What was useful to investors about the performance of stocks during the month was the parts of the market that are perceived as independent, but which all correlated under duration stress. On days when there was almost no leadership from global equity markets but big increases in bond yields, we saw sharp falls in stocks across A-REIT, infrastructure and healthcare, and also selected technology names, consumer discretionary and gold.

A duration sensitivity has been building up across the market for most of the year (and arguably much of the past five years) and we suspect some investors are less diversified than they think to this risk. Portfolio construction is often about looking at a portfolio through many lenses. Stock, sector, factor, style, duration, currency, commodity etc. to understand whether any unintended risks have built up through time. Having a significant exposure to any one of these risks is not a problem – after all we have to take deliberate risk to generate excess return – however we want these risks to be intentional.

The rotation to value was really quite limited, and many momentum/growth/duration names recovered by month end. The important question is what this means should Mr Market release the full value album. How do portfolios perform should value deliver sustained outperformance over a two or three year period?

Our investment approach is not built on constructing a point forecast about the future of anything, let alone the performance of one style over any period of time. What we do strive for however is to remain consistent with our philosophy of building a diversified portfolio of high quality small companies, constructed in a way to deliver outperformance in most environments.

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