Dogmatically following a pure growth or pure value investment style is dangerous and misguided. Instead, equity investors need to be pragmatic and adaptable as to where to find the best investment ideas.
Europe has been dogged by political setbacks and muted growth for quite a while, and especially since the start of 2010, when the global credit crunch that began in the US sub-prime housing market evolved into a full-blown European sovereign debt crisis. During this time, however, European companies have ultimately delivered decent performance for investors. A total return of 27.6% (Source: Bloomberg, MSCI Europe Index, 1 January 2010 to 30 April 2013, in euros), cumulative performance of over 8% per annum, seems very reasonable given the level of investor uncertainty, record-low interest rates and the lacklustre macroeconomic environment.
So while progress has been intermittent, we have seen a stockmarket recovery of sorts. What is different about this upturn, compared with the historic norm, is leadership. For the majority of the past three years growth stocks have been favoured over value stocks – re-igniting the debate between growth and value managers. Over my career I have always chosen those companies that I believe can grow sustainably – allowing us to participate in their development. This generally puts me on one side of a rich industry discourse, with more value-orientated managers on the other side.
Recent evidence favours European growth stocks, which have produced a total return of 41.1% since the start of 2010 (Source: Bloomberg, MSCI Europe Index, 1 January 2010 to 30 April 2013), whilst European value stocks have returned 15.9% – a difference of over 25%.
Source: Bloomberg, MSCI Europe Index, in euros, as at 30 April 2013. Past performance is not a guide to future performance.
So what has caused this divergence in performance? Value indices are heavily skewed to financial, utility, energy and telecommunications stocks, which tend to generate a high proportion of their revenues domestically in Europe, where government spending is retrenching and economic growth is scarce. Each of these sectors are characterised by their own industry-specific issues: the capital base for a number of European banks remains questionable; utility firms are struggling to find growth as taxation pressure grows from revenue-hungry governments; energy companies are having to increase capital expenditure in search of greater productivity; and telecommunications firms are faced with intense pricing pressures and falling sales, forcing some to cut dividends sharply due to high debt levels.
In contrast, growth indices are largely biased towards those globally exposed companies where growth has, on the whole, been more robust, such as industrials, consumer, information technology and healthcare stocks. Aside from geographical diversity, many of these companies are also benefiting from other structural advantages, such as high barriers to entry, pricing power or favourable regulation.
Source: FactSet, MSCI, at 22 April 2013
Given these advantages, it is not surprising that growth companies have outperformed. And while economic growth globally and in Europe remains below the long-term trend it seems likely to me that growth stocks will continue to do well. The debate however, is not clear cut; the lines between growth and value are often blurred at any one time (and these lines move over time as well) and it is becoming harder to classify stocks as ‘pure value’ or ‘pure growth’. For example Deutsche Post is my largest holding. I like the stock because of its impressive growth in parcel deliveries as more and more consumers order their goods online. Performance is particularly strong in Asia where Deutsche Post’s DHL division is the market leader. Other managers hold the stock because of its valuation case and dividend yield.
The same is true at the sector level where the materials sector is heavily represented in the growth index – something I find surprising. A number of stocks in the sector have exhibited good growth in the last ten years as the China-fuelled resources super-cycle has been in full swing, but with China seeking to reduce its dependence on infrastructure spending, the potential for future growth seems highly questionable. To complicate this further, what is thought of as growth can also become value – and vice versa. The technology sector is one example, which has transitioned from growth to value and back again since the start of the new millennium.
Easier distinctions to make, in my opinion, are the ones between high quality and low quality– with high quality characterised as industry leaders with strong balance sheets, low borrowing costs, sustainable cash flows and management teams focusing on the long term. I would also include companies that are actively and constructively seeking new avenues of expansion. This group of stocks is naturally biased towards growth names but there are also opportunities in so-called ‘value’ businesses. Deutsche Post is one example, but others include industrial conglomerate AP Moeller Maersk, Allianz (insurance), Deutsche Telekom and BT Group (telecommunications), and Novartis and Sanofi in the pharmaceuticals industry (once thought of as the growth sector but which is now primarily value).
When constructing my portfolios I try to avoid becoming too fixated on growth or value nametags. The results have tended to lead to a judicial mix of core quality growth stocks and those that are more cyclically sensitive. I tend to favour a more holistic approach, favouring companies with diversified sources of revenues, operating in established markets, with robust business models, proven management teams and solid finances – attributes which should help them to outperform in both rising and falling markets. These are the companies that I expect to be around and do well in the years to come.
Past performance is not a guide to future performance. The value of the fund and the income from it is not guaranteed and may fall as well as rise. You may get back less than you originally invested.
Tim Stevenson, manager of the Henderson Horizon Pan European Equity Fund
