With the rotation from Growth to Value stocks a key talking point for investors over recent years, discussions have focused on how style performance may look going forward. We talked to our EM equity investment expert, Laurence Bensafi, to find out her thoughts on the rotation and what this means for opportunities in the Value segment of emerging markets equity.
The lack of high growth levels in recent years, compounded by major global events, proved conducive to Value stocks outperforming. How has that led us to where we are now?
Expensive Growth names that were in vogue with investors but had stretched valuations unbacked by fundamentals suffered, with many delivering disappointing earnings figures. These names could derate further; valuations remain excessive and index concentration levels in the largest names still sit well above 2017 levels.
The rotation from Growth to Value since November 2020 has also been driven by shifting expectations around inflation. If inflation remains high for a protracted period, without entering a deep recession, we could see a continuation of this rotation, with increased yields historically supporting Value names.
While the gap between Value and Growth has narrowed of late, data from the last decade suggests that the reversion has some way to go. Our view is that the rotation is not over, and that Value and Quality continue to look attractive.
What does this mean for sectors?
Financials and cyclicals, Value stalwarts and sectors that have been out of favour, could benefit from inflationary trends, with financials in particular rebounding from the impact of a low interest rate environment.
As an example, if we look at MSCI China Index data from October 2020 (when the weighting of internet stocks peaked), since then we have seen a large rotation out of tech and healthcare stocks and towards financials and cyclicals. It’s a similar story for the MSCI EM Index.
The cyclical industrials, energy and materials sectors are poised to experience tailwinds from the global move to decarbonise, a movement that is fast reaching the top of global priorities.
On that note, are there any themes which play well to Value investing?
Emerging markets is a leader in green infrastructure, and within our team, it is one of five long-term themes that drive our top-down views.
We see electric vehicles, renewables and transition materials as the best ways to gain exposure to this theme. These areas are all segments of the market that have a high composition of Value names.
In our view, green infrastructure is a multi-decade growth story and capital expenditure in areas that support the world’s journey to decarbonisation, such as renewable energy, energy storage and power networks, is likely to surge.
Can you tell us more about why you find these areas of the market so compelling?
Green infrastructure is driven by rising incidence and awareness of extreme weather events and health implications as a result of climate change. We believe the theme is particularly relevant in EMs due to a combination of geography, higher greenhouse gas emissions and challenges in dealing with unexpected natural events.
We play the green infrastructure theme through three key sectors for the following reasons:
- Electric vehicles: transport accounts for 25% of global CO2 emissions, mainly because of its reliance on oil. However, EVs are set to make the transport sector cleaner. China has led the way, announcing a net zero carbon target by 2060 and investing heavily in EVs and renewable sources of energy. Other countries have followed up with their own net zero pledges.
- Renewable energy: this is set to be the fastest-growing energy source over the next two decades, driven primarily by solar and wind power. Capacity concerns and policies being vulnerable to change means that we believe the best way to invest is through pure-play, high-quality manufacturers differentiating themselves through technology.
- Transition materials: raw materials allow us to make the transition into a cleaner energy world by moving away from hydrocarbon. Many alternative raw materials will be required to make the transition; we have a preference for aluminium and copper as these are generally seen as high quality assets within this space and these companies have a strong focus on ESG factors.
Other sectors such as energy storage, food and agriculture, and hydrogen are also interesting ways to access the theme.
And finally, how do you see the environment for Value going forward?
Style performance will likely remain volatile in the coming years as the world faces multiple challenges. However, the sectors discussed above are segments of the market that have a high composition of Value names, and with the imperative to spend as a tailwind, Value as a style could continue to rise.
Conversely, as to whether Growth stocks may make a comeback, it is unlikely that such strong outperformance will happen again in the short term. In order to see another period of Growth outperformance, we would need to see the emergence of a new large disruptive trend, but these are rare.
At a strategy level, we focus on investing in companies and sectors that exhibit structural growth and avoid those in decline. As always, in-depth research is key to discovering opportunities and in particular, we focus on smaller and undiscovered companies and segments which, if thoroughly researched, can offer significant upside.
Our ‘The Return of Value’ piece gives a detailed perspective on the journey from Growth to Value, discusses global developments and provides an in-depth outlook on how long such a rotation might last, given current tailwinds.