Value Funds Aren’t Bullet Proof
Price discipline doesn’t guarantee bear-market resilience.
Plus many price-conscious managers that we admire, such as Anthony Bolton, who was then running Fidelity Special Situations, Chris Burvill and then Alastair Mundy at Investec UK Special Situations (known as Investec UK Value at the time), and Colin Morton of Rensburg UK Equity Income, fared even better during 2000-2002 selloff.
In hindsight, the resilience of value-oriented managers made common sense. Their price-conscious approach kept them from investing in expensive tech stocks that ultimately failed to live up to the hype. In addition, most value managers only invest in companies they view as fundamentally sound. That insistence on quality helped them avoid the fly-by-night tech firms with little to no earnings that imploded during the ensuing sell off.
But if you assumed those traits would serve value managers well in every bear market, you’ve been sorely disappointed this year. Value-oriented funds have been in the center of the maelstrom this time around. The financial sector has long been a favorite hunting ground for value managers, and many of these holdings turned toxic amid the current credit crisis. What’s more, other favorite areas like industrials and energy have also stumbled this year. As a result, the typical value fund hasn’t proved any more resilient than the competition during the current downturn. Over the past 12 months, the typical UK large value fund has dropped about 41%, which is about the same as the UK large growth and large blend category averages (click here to see a rankable list of all Morningstar peer group returns).
So what’s the takeaway here? First of all, it’s dangerous to make pat assumptions about which investing styles will fare better during bear markets. Market downturns stem from different causes, and bear markets do not produce uniform results. The one we are experiencing now has been agnostic about investing style or asset class. Unfortunately, there have been few places for investors to hide.
Furthermore, valuation multiples are virtually useless when there’s serious doubt about the denominator of the equation. It’s now become apparent that the earnings and book values of many financial firms were built on foundations of sand that crumbled when the credit markets faltered. Only a tiny minority of the fund managers we speak to around the globe--even ones who were experienced bank analysts--were fully aware of those risks.
Finally, this downturn shows that a price-conscious strategy won’t protect a fund from every risk. After all, cheap stocks can get even cheaper, sometime for irrational reasons. Some stocks have been justifiably punished during this downturn, but investor panic and forced selling by hedge funds and institutional investors have caused many otherwise solid stocks to fall well below reasonable valuation levels according to many of the managers that we talk to. As a result, these managers are seeing more attractive opportunities than they’ve seen in years. That’s likely to be the silver lining in the clouds overhead, but the same managers caution that it may take some time for those clouds to clear.
