One of the big debates in investment today is whether the time has come for growth-focused investors to hand on the baton to their counterparts in the value camp. After years in which the growth or quality approach has ruled the roost, a synchronised global upturn has arguably created the conditions for more cyclical investments to play catch up. Will value finally have its moment in the sun?
Value investors look for good companies at a great price. The key is less the growth potential of a stock than its perception in the market. As Fidelity's Alex Wright, a champion of the value investment philosophy who manages the Fidelity Special Situations Fund, says, it's about finding 'stocks that have been unfairly tarred and are trading below their medium-term value'. For him, investing is about being a contrarian, going against the consensus.
The reason to focus on out-of-favour stocks, Wright says, is that when things are going well the market is quick to recognise it. There is, therefore, very little upside potential for the shares - the good news is already in the price. By contrast, an unpopular stock can rally strongly if things turn out better than expected. The trick for the value investor is to identify the catalyst for improvement ahead of everyone else.
This is not easy and requires plenty of in depth research, but the rewards can be significant. Indeed, over the long run there is plenty of evidence that the value approach outperforms growth investing. The risks are material too, however. High among these is the danger of being caught in a so-called 'value trap'. This is when a share looks cheap but ends up becoming cheaper still because its prospects have been permanently damaged.
When another colleague, Jeremy Podger (who manages Fidelity's Global Special Situations Fund), was asked recently about where he thought the worst value traps lay he said 'any business dependent on the internal combustion engine - and most of the High Street.' His second point is that the value of bricks and mortar retail has been permanently compromised by the technological disruption of online shopping. Some of the seemingly cheap retailers that value investors may be tempted by today will simply never recover their former glory.
The growth or quality side of this argument is made very forcefully by Nick Train, manager of the Lindsell Train UK Equity Fund and a champion of investing in 'businesses, brands and franchises where we have high confidence in their durability and sustainability.' Train believes that, within reason, there are some shares - 'extraordinary, rare companies' he calls them - where no price is too high. This is anathema to Alex Wright, who says he 'will not pay up for anything'.
The argument that value shares will outperform in a recovering economy, with rising interest rates and bond yields, is the flip side of the case for growth shares in recent years. For a long time, investors have chased certainty in an uncertain world. They have gone for stocks that, in Nick Train's words, 'sell products that customers either love or, preferably, cannot do without.' It is no coincidence that alcoholic beverages feature so prominently in a Train portfolio.
But he has little time for the argument that in a healthier economy, with rising inflation, investors will abandon the comfort blanket of consumer staples for companies more dependent on an improving backdrop. 'Most of the time that Warren Buffett was championing stocks like Coca-Cola was a period of rising inflation and that is why he favoured quality. History shows that inflation will erode the value of cyclical businesses like engineers, construction companies, insurers and banks.' He contrasts these value-investor favourites with companies like Diageo, which he says can put up its prices in inflationary times and so maintain the value of the company. His message to value investors is that they should be careful what they wish for.
Most investors are less willing than Wright or Train to place themselves in either the deep value or the extreme quality camps. Value and growth investing sits on a spectrum and most good investors combine elements of both styles. They look for value but are prepared to pay a premium for reliable growth when they have to. Even the most contrarian investor, sometimes just has to go with the flow.
One such investor is James Thomson, the highly-rated manager of the Rathbone Global Opportunities Fund. Interestingly, he has responded to the increased volatility experienced by investors in 2018 by tilting his portfolio towards more defensive, higher-quality companies. Where he combines the two styles is by looking for what he calls 'under the radar' growth - in other words, high-quality companies that for whatever reason the rest of the investing community has not recognised as such.
The good news for most investors is that they do not need to take a position on the growth versus value debate. Building a well-diversified portfolio out of both value and growth investors like Alex Wright and Nick Train, as well as more middle-of-the-road investors like Jeremy Podger and James Thomson, will ensure that they enjoy a smoother ride whichever approach wins the argument.
Investment style is perhaps less important than stock selection and all four of these managers are bottom-up stock-pickers wherever they sit on the growth/value spectrum. In 2018's more volatile, but quite possibly sideways-moving markets, it is the ability to pick winners and avoid losers that will matter most. Growth or value, it is being active that will distinguish 2018's outperformers.
Tom Stevenson is Investment Director for the Personal Investing business at Fidelity International. Tom joined Fidelity in March 2008. He acts as a spokesman and commentator on investments and is responsible for defining and articulating the Personal Investing business' views. Prior to joining Fidelity, Tom was a financial journalist writing for various publications including Investors Chronicle, The Independent and The Telegraph.