Value investing: back in favour?

04/06/2019

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​Alec Perkins, Portfolio Manager for Perkins' Value Strategies, discusses the global themes he expects to impact markets, performance year to date, and why he believes a value-based approach to investing in US equities provides compelling long-term opportunities.

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Given the political uncertainties in the US, what are your thoughts on the presidential elections in 2020?
This early in the US election cycle it is too early to call favourites. That said, we try to construct portfolios that are defensively positioned no matter who takes office. From a stock-specific perspective, we pay close attention to how various industries might be affected by political shifts and policy changes and factor those risks into the risk/reward analysis we do on every stock. Healthcare is one area that could be significantly impacted by the elections so we are watching particularly closely there. There is considerable chatter about drug pricing legislation that could hurt the big pharmaceutical stocks. As a result, we believe companies like Merck & Co and Pfizer are attractively priced and should hold up better in a more volatile or negative market environment.

What are your expectations for US interest rates?
Determining the future of rates in the US is a difficult game to play, and not many investors get it right. We try to construct a balanced portfolio that will perform well in a variety of rate environments. For example, we think the Janus Henderson US Strategic Value Fund’s exposure to US regional banks mitigates some of the risks from rising rates, while the holdings in real estate investment trusts (REITs) should benefit in a stable or low interest rate world. Clearly, the current low rate environment is good for the US stock market generally in the near term, however, there will come a time when rates will have to rise again, and we want to position ourselves defensively for that eventuality.

What is your view of the recent US tax reform?
We are generally happy with any reforms that enhance our investee companies' bottom line, so from that perspective we were pleased with the Federal tax cuts and the timing of them. Tax reform has been a significant tailwind for many of our holdings, in particular for small and mid cap stocks. One of the reasons we love running an all-cap portfolio is that we can invest in small and mid cap stocks that benefit from tax reform and merger and acquisition activity; moreso than most of the larger capitalised companies in the US. Over the past 20 years, small and mid cap stocks have outperformed large caps, so we believe that maintaining exposure to smaller and mid-sized companies should be return enhancing over time.

Are macroeconomic and political uncertainties likely to influence your investment approach?
We have a defensively oriented value investing strategy that has worked well for us over multiple full market cycles dating back more than 40 years, and so we will not deviate from our core defensive value philosophy. We always seek to refine our process, however, and have made some enhancements along the way. The past decade has been characterised by an extreme bull market coming out of the global financial crisis that has seen growth and momentum investing significantly outperform the value style. We strongly believe that conditions are now ripe for value to outperform going forward. In particular, we believe that a defensive-oriented strategy at this point in the economic cycle is crucial for any investors concerned about stockmarket corrections or an economic downturn in the future.

The Janus Henderson US Strategic Value Fund is currently weighted towards financials; are you planning any re-allocations in terms of sectors?
Yes. The financial sector broadly has been our best performing sector from an attribution perspective year to date, and delivered strong total returns for the fund as well. We have reduced the weighting in financials since the beginning of the year on this strength, but we continue to find good defensive value stocks in both the smaller regional banks and the large cap majors within the US. We own several bank stocks that we believe are attractively priced and should be well positioned if interest rates rise in the future. We also have a sizeable position in two insurance stocks, which we believe should behave defensively in a market pull back.  

As a stock picker can you provide an example of where you have added value this year? 
Laboratory Corp of America (LH) has been the fund’s best performer so far in 2019. The stock is up nearly 30% year to date* and it is our largest position in the fund. The company is one of two large national lab service providers in the US with a patient database that reaches 50% of the US population. LH’s merger with Covance in 2015 has created a company with a significant competitive advantage in the lab testing and drug development spaces, and both business segments have solid secular tailwinds due to an ageing population. Despite the solid run-up in the stock price this year, the company still trades below a market multiple, has a strong balance sheet, and most importantly to us, we believe that the LH revenue streams will be steady even if the economy weakens from here. The need for blood tests does not ebb and flow with the economy and LH is one of the lowest cost providers. As such, we think the stock should hold up well in an economic downturn. 

*Source: Thomson Reuters Datastream, in USD, as at 30 April 2019.
 
What has been the main detractor from performance year to date?  
Occidental Petroleum (OXY), the oil and gas exploration and production company, has been a significant detractor from performance. Interestingly, as a sign of both our defensiveness and the overall strength of the market recently, our worst performing stock is down 13% year to date*. Again, this highlights our defensive approach to investing and our effort to mitigate downside in every stock that we buy.
 
While we have not realised much of a price decline in OXY, it is our worst performer because the company recently announced a bid to buy rival Anadarko Petroleum, which will meaningfully increase their leverage in the near term. As a defensive value manager we dislike deals that compromise a company’s balance sheet, and so we are in the process of re-evaluating the fund’s position in OXY. The portfolio is already underweight energy because we have a negative bias toward commodity-oriented stocks generally and energy companies specifically, which, as a rule, do not show much capital discipline. That said, if we find a company in the energy space that is a low cost producer, has a clean balance sheet, strong management and capital allocation discipline, with limited downside, we are likely to be buyers.
 
*Source: Thomson Reuters Datastream, in USD, as at 30 April 2019.
 
What is your outlook and where do you see challenges and opportunities for investors?
The US economy continues to look strong with record low levels of unemployment, solid GDP growth and interest rates that remain very favourable and pro-growth. That said, we are now in the tenth year of an economic recovery, multiples on US stocks in aggregate appear fully valued, and there are several macroeconomic risks that could prove destabilising to US stocks going forward. As long only equity investors Perkins was founded on the belief that staying invested in equities is the best way to invest and compound wealth over a long time horizon, but it does strike us that now is perhaps the best time to take a defensive position in equities.
 
The best opportunities we see right now are in high quality companies with real competitive advantages in their market places, and with clean balance sheets that can weather an economic pull back when the time comes (which it most certainly will). As mentioned earlier, after a decade of growth investing outperforming value, we believe that the value style of investing is well positioned to outperform over the next several years. Therefore, we think the best opportunities in US equities today can be uncovered by a defensive oriented value approach.
 

 

These are the views of the author at the time of publication and may differ from the views of other individuals/teams at Janus Henderson Investors. Any securities, funds, sectors and indices mentioned within this article do not constitute or form part of any offer or solicitation to buy or sell them.

Past performance is not a guide to future performance. The value of an investment and the income from it can fall as well as rise and you may not get back the amount originally invested.

The information in this article does not qualify as an investment recommendation.

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