After several years of lagging, the “value” investment style is now more attractively valued relative to “growth” than it has ever been, says Charles Brandes, founder and chairman of San Diego-based Brandes Investment Partners LP. And for Brandes, a confirmed value investor and disciple of value guru Ben Graham, that undervaluation presents an exciting buying opportunity.
“We have seen the value style turn around just in the past few months, but previously there was a period of more than 70 months when value stocks underperformed growth, based on standard indices in the U.S.,” Brandes says in an interview with Investment Executive in Toronto. “The more it underperforms and the longer it underperforms, the better the bargains become. With the prices of value stocks so compressed, and the differential relative to growth so wide, value has the potential for several years of outperformance ahead, based on past history.”
The Brandes Global Equity Fund, sponsored by Brandes affiliate Bridgehouse Asset Managers of Toronto, showed a five-year average annual return of 12.2% as of Aug. 31, underperforming the 16.1% return of its benchmark, the MSCI World Index. However, for the month of August, the fund gained 2.8%, beating the benchmark’s gain of 70 basis points.
Investors have not been as patient as Brandes in sticking to the value style through tough times, and many have abandoned value stocks and mutual funds in recent years in favour of popular growth-oriented funds, high-dividend stocks or exchange-traded funds (ETFs), which take a passive approach to market exposure. Large investors, such as pension funds and sovereign wealth funds are once again beginning to add to their value allocations, but the retail investor is now underexposed at a time when value’s tide is turning, Brandes says.
“Historically, value has outperformed growth over the long term, and I look forward to a continuation of the trend this year,” he says. “When you really think about investing, it’s value that ultimately matters.”
He says investors were disappointed by value stocks following the global financial crisis of 2007-08, when these equities failed to perform better than the steeply dropping stock market, and then failed to recover as quickly in subsequent years. This trend led to a perception that value was risky, he says.
“Investors have been equating volatility with risk,” he says. “For a patient investor, volatility has little to do with risk. In fact, [volatility] can be your friend if you take advantage of buying opportunities.”
Brandes says the passive approach to investing adopted by ETFs, particularly those that track capitalization-weighted indices, has led to “indiscriminate allocation of capital,” in which ETFs invest in all companies in an index, including the most expensive companies.
“Eventually, value stocks become so underpriced that people realize they can buy the assets cheaply, and the valuations also start to attract takeover artists,” Brandes says.
Brandes has had no qualms in sticking to the approach that has been the bedrock of the firm since he launched it in 1974.
“Our purpose is bent to value,” he says. “We are steeped in value, the effectiveness of value and the common sense of value.”
The firm, however, is finding better value outside the U.S. these days. Only 34% of the assets of Brandes Global Equity Fund are invested in U.S. stocks, a significant underweighting compared with roughly 60% U.S. exposure for the benchmark. Instead, the fund is discovering more enticing opportunities in European stocks, which make up 40% of the fund, Asian stocks (17%) and Latin American stocks (4%).
“Our weighting in the U.S. is as low as it’s ever been,” Brandes says. “There is much better value outside North America. We’re finding outstanding value in other areas, including emerging markets like South Korea, Brazil and China. “
Emerging markets lagged developed markets for the past four years, he says, creating a situation at the beginning of 2016 in which stock prices had fallen to levels seen during crisis periods — but there was no crisis. This year, emerging markets have rebounded, with the best performer, Brazil, up 54% for the eight months ended Aug. 31.
The drop in U.K. stocks in the wake of the “Brexit” vote also has presented attractive opportunities, says Brandes, who believes the political situation will have little effect on certain companies’ ability to do business.
“We are still finding overwhelming values globally,” Brandes says. “We are digging in and finding great companies to invest in at attractive prices, and we’re very excited.”
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