For much of the time between 2015 and 2019 many investors when considering their Emerging Markets exposure seemed intent on looking for Value oriented strategies. We know this because they told us as much. And given the bull run of Growth (over Value) since 2010 perhaps a belief in some sort of reversion was natural enough. But just like Vladimir and Estragon and their vigil for Godot, these investors are still waiting for Value investment to put in an appearance.
As you know we take the view that Emerging Markets by their very nature are more suited to a growth approach: it is a growing part of the world with many growth companies which provide great opportunities for the right process. Despite our conviction however, the ‘comfort’ of a value oriented approach was seen by these investors as more appropriate “at this stage in the cycle”.
Judging where we are in a cycle is always a difficult task, particularly when a global contagion is added on top of a decade or more of ultra-low rates. But 10 years of underperformance seems to suggest that the old assumptions underpinning Value investing may need reappraising. Even on the occasions when stress in the markets would prompt Value to mean revert in a meaningful way its resurgence has been shallow and short lived.
Many of you will have picked up on the research which has sought to explain Value’s decade long abeyance. The behemoth of ETF investing is said to have increased the effect of momentum. Others suggest low rates have forced investors into higher risk assets. We wrote a piece in March ‘Growth & Value’ which suggested that the ascendancy of Growth investing was the result of a number of factors. Without reiterating the arguments, it could be summed up by “the world has changed” from the days when Graham and Dodd first described their secret sauce.
One study¹ that particularly caught our eye at the end of last year is certainly worth considering. It proposes that the growth of intangibles may have been one of the key difficulties that has undermined the Value approach. Without any physical substance, brands, intellectual property, patents and nascent products arising out of existing technology are difficult to measure let alone value and so do not necessarily enter the Value calculation. Additionally, GAAP means that R&D, one of these key intangibles, is expensed rather than capitalised. Consequently not only are book values understated but earnings are reduced. The study contends that the failure to take account of unrecorded intangibles has indeed undermined Value’s ability to pick winners. It goes on to offer concrete advice: the beleaguered Value manager should be adding back to book value an amount representing a company’s knowledge capital (by capitalising all R&D expenses) and organisational capital (by adding back a part of SG&A expenses) but excluding goodwill.
Much of this seems sensible to us. By all means attempt to value knowledge and organisational capital but also be very wary of goodwill particularly when a supposed growth strategy is achieved by acquisition. We believe that the growth of these intangibles is only likely to continue in our changing world (since the 1970s the component of the book value of US listed stocks accounted for by intangibles has increased from 20% to well over 35%).
However, we remain high conviction Growth managers and it seems that these intangibles are only part of the story: even when their value is added back many of the stocks that have made major contributions to our performance would not necessarily make the cut in a Value approach. In our changing world there is an ever widening gulf between businesses which are growing and have a future, and those that do not.
Our portfolio has benefitted this year from our exposure to China as the market has been perceived it as a beneficiary of COVID FIFO. In addition, our exposure to eCommerce has helped as digitisation has been an obvious winner during the months of curfew. Our research suggests that shopping mores will not reverse even when COVID is banished. We are maintaining our weightings in both these areas with a decent exposure too in India.
And for those of you who are convinced by the Growth approach in EM but who are perhaps concerned about the ongoing trade tension with the US and China, please bear in mind that the significance of US trade to China’s GDP has long since dwindled as indeed has its trade generally. Today it is a domestically driven economy. Within that economy the consumer, who is our exclusive focus, is still in rude good health.
P.S. Those of you who remember Samuel Beckett’s “masterpiece” will recall that, despite several intimations that Godot would be making an appearance imminently, he had still not arrived by the time the final curtain came down…………
¹“An Intangible-adjusted Book-to-market Ratio Still Predicts Stock Returns” by Hyuna Park of the City University of New York, 2019
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