4 OCT, 2022
By Ingrid Trawinski
Inflation, the monetary tightening measures being taken around the world to control it and uncertainty over energy supply in Europe have dominated the debates. Their interest lies largely in trying to predict when inflation will peak, when the recession will begin and how deep it will be. Moreover, these three questions have one thing in common: a short-term focus.
On the one hand, the return of inflation that we have been witnessing for several months is not a transitory phenomenon. Indeed, there is a strong case to be made that the level of inflation is likely to be higher over the next decade than in previous decades. However, in our view it is more important to assess the impact that this regime change may have on the level of a company's regulatory margin than to determine the inflation peak, as it is the essential determinant of a company's business.
Similarly, the possibility of a negative event occurring in the coming months is not in itself a reason to reduce risk and change our portfolios. In fact, this might be justified if the potential downturn is adequately discounted in the valuation of companies or if the materialisation of such a potential event would lead to an extremely difficult financial situation.
Therefore, assessing the risk of facing a new recession, whether caused by aggressive monetary policies or by the emergence of a major energy crisis, seems almost secondary. Economic cycles are, by nature, a succession of periods of growth and recession. This is where value investing comes in, because as value managers, we have to ensure that the companies in our portfolios can weather the toughest of times and adapt to long-term changes. We are investors, not traders. Therefore, we do not base our investment decisions on macroeconomic forecasts, short-term events or momentum.
Here are five reasons why adopting a value approach to portfolios will be very positive in times of market volatility:
1. All companies suffer losses at some point. Any company can experience difficulties, be they financial, strategic, competitive or managerial. This usually leads to a lack of investor interest and therefore undervaluation. Any company, whatever its sector of activity, its level of growth and its level of margin, can find itself in losses.
2. Value management goes beyond momentum. In the short term, markets tend to overreact, but value management allows precise analysis methods to avoid tracking these movements and focus on the real value of the company. Value management is thus a long-term investment approach that focuses on the valuation of a company in relation to its economic performance.
3. New market paradigm. Growth management has particularly benefited since 2014 from the various accommodative monetary policies, as well as the sharp fall in interest rates. However, the recent return of investor interest in value management is mainly due to the sudden turnaround in inflation expectations and interest rate movements.
4. Broad range of investment. Investors often limit value management to certain flagship sectors, such as banking or energy. In reality, this management approach can and should be applied to any type of company and should not be limited to certain sectors to take advantage of discount opportunities.
5. Catalyst for diversification. Value management should not be pitted against growth management because it offers complementary exposure to that gained by the growth management style. Value tends to outperform in different periods of the cycle than growth management, which argues for a diversification of styles in the context of long-term management, where cycle changes are very difficult to predict. The combination of the two styles would therefore make it possible to diversify the portfolio, favouring a reduction in volatility and an optimisation of long-term performance.