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The faceoff over value

By Paul Mackintosh   
  • Asia
  • Global
An enduring investment strategy draws some brickbats but many push back

Value investing is one of the most enduring and common-sensically persuasive of all investment strategies. Nonetheless, it runs into periodic bouts of bad press. An article in The Economist magazine in November 2020 declared that value investing was “struggling to remain relevant”, faced with issues related to the rise of hard-to-track intangible assets.

It cited the value investing principles pioneered by Benjamin Graham and promoted today by Warren Buffett. These were to look for hidden value in the form of a low price-to-book ratio, where recent profits or the book value of assets were not reflected in a commensurately high stock price.

However, many value investors maintain that the story is by no means as simple as that outline appears. Anne-Christine Farstad, an equity portfolio manager for the Contrarian Value strategies at MFS Investment Management, sees the valuation of a stock as the reciprocal of probability. “The lower the price, the less certain you have to be about what happens in the future,” she says. For her, value investing is a matter of investing not in certainty, but in probabilities.

Others feel that the critique in The Economist has been overblown, in a way that confirms Farstad’s views. Writing in the Financial Times, also in November 2020, Michael Mauboussin, a researcher at Morgan Stanley Investment Management, pointed out that the mechanical application of the value factor, measured as a multiple of price-to-book factor per share, no longer delivered the reliable results it once did, but that the real measure of value in the value investing sense remained the gap between price and value. The value in this case could easily include the kind of intangible assets, such as research and development spending, which weigh on the current balance sheet while holding great promise of future value.

Tough year

Value investing endured a bad year for most of 2020 amid the coronavirus pandemic. The value investment-focused hedge fund AJO Partners which was founded in 1984 ceases to manage money this quarter, according to its website. This comes after what Ted Aronson, the co-chief executive officer, described in a resignation letter to investors as “the drought in value – the longest on record”.

Recovery came late in the year amid hopes that the rollout of effective vaccines for Covid-19, the disease caused by the coronavirus, would return the world to a more normal economic environment sooner than expected.

Farstad says there was “a rotation in market leadership” during the fourth quarter which pushed up the prices of stocks broadly defined as value that had suffered most during the earlier stages of the pandemic.

She says the disruption caused by the pandemic has opened up opportunities to invest in “high-quality cyclical businesses in unloved industries”. However, she warns that the value investing maxims demand a focus on “players with scale at the bottom of the cost curve that have strong balance sheets and operational flexibility”, as there will always be winners and losers at every level.

A paper entitled “Value Investing: Requiem, Rebirth or Reincarnation?” published in February on Elsevier’s SSRN website argues that the current problems with value investing are largely not to do with the thesis, but the practice.

The authors, Bradford Cornell of the UCLA’s Anderson Graduate School of Management and Aswath Damodaran of New York University’s Stern School of Business, say that the current value investing behaviour is “rigid and ritualistic”, embodying “practices and rules of thumb that have outlived their usefulness”. They believe that a leap of imagination is needed to bring it up to date.

Farstad maintains that “individual companies’ market position, management strategy and execution, and valuation discipline will guide good investments”. The secret of value remains the careful selection.