Welcome to Soundbites, weekly insights on market trends and investment strategies, brought to you by Investment Executive, and powered by Canada Life.

For today’s Soundbites, we’re talking about value investing with Chris Koltek, institutional client portfolio strategist with Portfolio Solutions Group. We talked about metrics he watches, being a contrarian when it comes to viewing companies, and how value stocks support a balanced portfolio. And we started by asking why value investing makes sense in volatile markets.

Chris Koltek (CK): In volatile markets, investors may become more risk averse, and be more attracted to companies that exhibit more of a certainty in terms of earnings and cash flows but aren’t being rewarded for it. So, instead of companies that are focusing on potential future growth of earnings, investors are looking for companies that have predictable earnings and free cash flow today, not just promised in the future. In addition to the potential for price appreciation, they can provide steady dividends, which is an additional component of income return. So, this additional return provides a bit of a margin of safety for investors in uncertain times.

Is now the right time for value investing?

CK: We believe that higher interest rates, market volatility, and a desire for a margin of safety are driving the interest right now in value investing. Today’s higher-interest-rate environment really appears to be focusing investors more on earnings and free cash flows, the things that value investors typically admire. Value investors typically focus more on existing earnings, existing cashflows, and valuations of companies. They want to pay less than intrinsic value for a company. Growth managers, they tend to focus more on the future growth and strategies of a company. That’s kind of the promise of future earnings, instead of what’s paying off or providing some earnings right now.

Why is taking a contrarian view so important in value investing?

CK: Being contrarian is really the basis of value investing. Buy low, sell high. Value investors want to buy closer to the point of pessimism in the market, because it’s closer to the point of maximum financial opportunity than it is to the point of maximum financial risk. So, one way to describe the value investor is someone who has a contrarian view and can see the value in a company that the rest of the stock market hasn’t seen yet. So, they’re buying the stock because the company is likely going through some short-term issues, but having done their research and established an intrinsic value, the value investor has confidence in the long-term value of the company and the stock. So, valuation of a company for value investors is typically where the heavy lifting comes in.

Key metrics he watches.

CK: As multi-asset managers, we’re investing in mandates with both styles, so value and growth. And really what we’re looking for is consistency between what the managers are saying that they’re going to do from a qualitative perspective — their philosophy, their style and the process — and then, the quantitative metrics of the fund that we’re looking at. So, for example, if we’ve got managers who’ve stated that they have a value style, but when we look at the average price-to-earnings ratio, and the average price-to-book ratios, and they’re higher than market average, they’ve got very low earnings relative to the industry, and no or low dividend yields, that’s going to likely lead to some questions for the managers. Next, we’re looking for long-term consistency. So, have managers always maintained their stated style, even in times when that style hasn’t been the flavour of the week? And the question becomes, you know, how strong is their conviction in the process. So the point here is that we’re looking for diversification of our mandates throughout a cycle. But we’re also looking at the metrics to reaffirm what we’re hearing from the qualitative side of business.

Value stocks and a balanced portfolio.

CK: Yeah, I’d say value and growth mandates can really both complement each other quite nicely in a balanced portfolio. Within the context of a portfolio, there are times value investing will outperform. But even in times that it’s not outperforming as a style, individual value stocks can add value, as a disciplined active manager can trade around certain opportunities, buying or reinvesting into value opportunities, while others come to fruition. So, value stocks can add value to a portfolio, whether it’s margin of safety, risk mitigation, dividend income, or the diversification that it can add to a portfolio.

And, finally, what’s the bottom line on value investing?

CK: Right now, on the value side, patience is required, because you’re, by definition, waiting for the market to realize the company’s value in the stock price. Value investing is an active-management approach, which can help with risk mitigation, especially in times of market volatility, and be advantageous to clients who lack the time, the inclination, or the expertise to manage their own portfolios.

Well, those are today’s Soundbites, brought to you by Investment Executive and powered by Canada Life. Our thanks again to Chris Koltek of Portfolio Solutions Group.

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