Listed real estate investment trusts (REITs) are starting to get their mojo back. Nowhere is this more apparent than in the office sector. In the immediate years following the pandemic, office values across the UK struggled as investors tried to grapple with the future of work and the implications for office buildings. However, over the past 24 months, the return to offices has accelerated and supply is struggling to keep pace with demand.

Total returns – ie, including rents and valuation – for the UK office sector were 2.7% in 2024, according to real-estate firm CBRE. That lags the overall return for UK commercial property at 7.7%, but there are growing signs of momentum. Take-up of office space across the UK reached 20.3 million square feet in the second quarter of 2025, the highest rolling 12-month level since the third quarter of 2022.

Market dynamics suggest some level of hoarding. Between 2019 and 2024, the number of people employed in office jobs is estimated to have increased by 2.4%, while occupied office space has decreased by 1.3%. Space per person has fallen by around 20%. To restore office space to 2019 levels, companies in London would have to acquire 39 million sq ft more space, reckons CBRE.

To put that into perspective, 1 Undershaft – currently the largest office tower under construction in the City of London – will provide just 1.7 million sq ft of office space across 73 floors.

The lack of space, coupled with a growing desire for remote working, means there’s a rising demand for flexible workspaces. Demand for this space has surpassed pre-Covid levels by more than 200%, according to Savills. This market was dominated by the likes of Regus (part of IWG) until WeWork disrupted the market. WeWork’s model failed, but it’s left a lasting legacy. A fifth of London’s offices are expected to be co-working sites by as early as 2030, according to CBRE.

Workspace's new strategy is working

This brings us to Workspace (LSE: WKP), whose portfolio comprises approximately 4.2 million sq ft of flexible work space in more than 60 properties in London and the South East, renting to over 4,000 customers. The group was founded in 1987, grew through acquisitions, and nearly collapsed due to excessive debt during the 2008 financial crisis. However, the near-death experience taught the company a valuable lesson: do not underestimate the value of having unleveraged freehold property (something WeWork overlooked). Workspaces’s loan-to-value (LTV) ratio is around 35% and is projected to fall to 30% by the end of the decade, according to Berenberg.

The share price took a hit last week when it said that uncertainty around the Budget has led businesses to delay leasing decisions – a theme echoed by other REITs – as well as reporting a first-half loss on the basis of falling valuations. Occupancy at the end of September was close to 80%, which is the crunch point for the group. Historically, rents have started to come under pressure at this level.

However, Workspace is now implementing a “fix, accelerate and scale” strategy under Lawrence Hutchings, the new CEO who joined from Capital & Regional in November 2024. The overarching goal of the new strategy is to sell underperforming assets, upgrade existing assets, keep leverage low and return cash to investors. Last quarter, the group completed £52.4 million of disposals against a £200 million target, at an aggregate discount of 1.6% to recorded value. Berenberg forecasts Workspace will have net tangible asset value (NTAV) of 754p per share for the 2026 fiscal year, suggesting the REIT is trading at a near-50% discount to the value of its property given the current share price of 362p.

This appears unwarranted. The fundamentals of the office market, particularly in and around London, remain robust, and Workspace has laid out a clear strategy to unlock value.

Workspace Group debt

Still, one cloud hanging over the group is the cost of debt. REITs are required to distribute 90% of their net property rental income to shareholders to maintain their Reit tax benefits. That can put pressure on cash flow if other costs, such as capital expenditure (capex) and interest charges, rise. More than one Reit has fallen foul of these restrictions in the past and has either been forced to borrow more or sell assets to fill the gap.

Workspace has 82% of its debt on fixed or hedged rates, with the average interest rate on this being 3.3%. However, 75% of Workspace’s fixed-rate debt is set to mature in the next three years. There’s only one other REIT (New River REIT) that has a higher volume of debt maturities over the same period. As debt is likely to be refinanced at higher rates, the cost of financing is expected to increase by nearly 30% by the end of the decade.

Still, rental income growth is expected to offset most of this growth, with interest coverage falling to a low of 2.6 times in 2028 before rising to 2.8 times in 2029. Disposals will cover most of the cost of refurbishing old assets and additional capex, meaning debt shouldn’t increase materially from current levels. So the changes shouldn’t force a material change to the strategy.

That would be good news for Workspace’s dividend. The stock currently yields just shy of 8%, which is one of the most attractive yields in the UK Reit sector. So Workspace has all the hallmarks of a traditional value play. It’s trading at a near 50% discount to the value of its underlying assets, offers a market-beating dividend yield and is suffering from cyclical, not structural headwinds.

There’s little to no financing risk. In the worst-case scenario, the balance sheet is full of freehold property. As the REIT works through its near-term issues, there’s scope for decent upside from current levels. Investors will be paid to wait.

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The strategy employed by Temple Bar is known as value investing. This is the process of buying a company’s stock for less than its true worth, or intrinsic value. By buying at a discount, this strategy builds in a “margin of safety”: while in the short term an undervalued company’s share price might fall further, in the long run the built-in value should ultimately be recognised by other investors, prompting the share price to rise to reflect the stock’s intrinsic value. There is much empirical evidence to show that value strategies have outperformed stock markets over the longer term.

Of course, some companies are cheap for a good reason, but we believe investments in good-quality yet undervalued companies with strong cash flows and robust balance sheets offer the best potential for attractive long-term investment returns.

Three British stocks worth adding to your portfolio

Although Aberdeen Group (LSE: ABDN) has been known as an asset manager for many years, the company has in fact managed to diversify and now operates three different businesses: Investments asset management; Adviser, a business-to-business (B2B) division; and interactive investor (ii), a trading platform for consumers. Aberdeen’s B2B business is the UK’s second-largest platform offering advice, measured by assets under management; and ii is the UK’s second-largest direct-to-consumer investment platform.

The group appointed a new CEO in 2024 to help make the firm more profitable. We estimate that a restructured Investments business within Aberdeen could be worth an additional £1.5 billion, and therefore see a potential restructuring as a free call option embedded in today’s valuation. There are also financial assets worth £2.1 billion on the balance sheet. Combining our estimated intrinsic value of the three businesses with these financial assets, we deem the shares significantly undervalued.

Smith & Nephew (LSE: SN) is a medical-devices business. It has struggled for some time, losing market share in its key orthopaedics business and suffering from poor levels of productivity. There is now a 12-point plan in place to drive financial improvement. If successful, it could lead to higher sales growth, productivity improvements, expanding margins, and higher cash flow and shareholder returns. In the last 18 months, there have been clear signs that the turnaround is working, as the company has delivered annual sales growth of more than 5% and an expansion in margins. We believe that Smith & Nephew is a high-quality business with strong market positions in relatively stable but growing markets, and we expect meaningful growth in profits in the medium term.

Johnson Matthey (LSE: JMAT) is a speciality chemicals business. JMAT has historically delivered a stable level of sales and underlying operating profit. In recent years this consistency has been impeded by investments in hydrogen. Concerns around hydrogen, a decline in prices of platinum-group metals and the transition to electric vehicles have led to a derating in the stock. Management have since recognised the risk of pursuing growth in unproven technologies and have shifted their focus toward maximising cash flows and shareholders’ returns.

At the time of its results in May, JMAT announced the sale of its Catalyst Technologies division for £1.6 billion and an intention to return 90% of the proceeds to shareholders. This division accounts for just 25% of the company’s profits and yet the sale’s proceeds made up two-thirds of its market value at the time of the announcement. The shares responded favourably on this news. We believe that the shares remain significantly undervalued.

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The British banking sector is in rude health. Perhaps the most symbolic moment this year, in the late spring, was the return of NatWest to full private-sector ownership. The government, which at one stage owned 84% of the troubled lender, sold a final tranche of shares. However, while NatWest’s shares have continued to do well, it isn’t the most interesting UK bank on the stock market at present. I think you should consider a punt on its rival, Barclays (LSE: BARC), instead.

Despite being one of the few UK banks that wasn’t directly bailed out by the government in 2008, Barclays has faced criticism for the poor performance of its investment-banking division. In recent years there has even been pressure from activist investors to sell, spin out, or otherwise separate the investment-banking side from the retail-banking business. Nevertheless, CEO C.S. Venkatakrishnan (Venkat) has stuck with a hybrid strategy of keeping the investment bank while trying to build up the retail-banking and wealth-management arms.

Soaring profits for Barclays

So far, this strategy appears to be working well, with Barclays’ revenues and profits continuing to increase. Its stated profits are now 125% higher than they were in 2019, and even after adjustments they are still up by two-thirds. Dividends have more than doubled. True, there are some clouds on the horizon, in terms of ongoing litigation over the departure of disgraced boss Jes Staley, exposure to private-credit loan portfolios and possible banking taxes in the upcoming Budget. However, experts believe that the first is a relatively minor problem, while Barclays is well-placed compared with its rivals.

One big reason to be bullish on Barclays is its valuation. The stock trades at less than eight times estimated 2026 earnings; at a discount of more than a quarter to the value of its net assets; and at a smaller discount to its tangible book value. This makes it cheap, both in absolute terms and relative to its rivals, with NatWest trading at a 2026 price/earnings (p/e) ratio of 8.5, while Lloyds and HSBC both sell for 2026 p/es of 9.5. All three of these banks are priced at significant premia to net assets. The major US investment banks are valued even more highly.

Barclays’ improving fortunes have certainly caught the imagination of investors: the share price has been on a roll. It has risen by nearly a third over the last six months, making it one of the best performers in the FTSE 100 during this period. It has continued to beat the blue-chip index over the past month and three months, and is also trading above both its 50 and 200-day moving averages. As a result, I would suggest going long at the current price of 405p at £9 per 1p per share. In that case, I would put the stop-loss at 300p, which gives you a total downside of £945.

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My investment philosophy is grounded in diligence, discipline, and patience. At Fidelity, I benefit from a robust, on-the-ground analyst network across Asia that produces in-depth fundamental research. These insights enable me to identify good businesses led by competent and honest management teams, and to invest at valuations that offer a comfortable margin of safety. I deliberately steer clear of untested business models, highly leveraged firms, cyclical companies at peak profitability, and stocks trading at excessive earnings or cash flow multiples.

My focus is on managing absolute risk and minimising capital loss during market downturns – an approach which should help compound returns at higher rates over the long term. Consequently, the Trust maintains a contrarian, value-oriented bias, focusing on mispriced small and mid-sized businesses that have the potential to become the “winners of tomorrow” well before their strengths are widely recognised.

As bottom-up investors, we continue to uncover idiosyncratic investment opportunities across the Asian region. Here are three examples.

Three overlooked Asian stocks to consider for your portfolio

In Taiwan, we have invested in Pacific Hospital Supply Company (Taipei: 4126), a manufacturer of medical consumables. Despite being a small player, its new management is driving market share growth at a pace faster than the c.US$80 billion industry, which typically grows at a mid-single-digit rate. The business is focusing on higher-margin, more complex products and targeting quality healthcare markets of Japan, the US and Europe to drive sustainable growth. Its well-diversified customer base provides additional resilience to the business. The stock trades at 16 times its projected 2026 earnings and offers a 5% dividend yield.

In Thailand, we hold a position in Mega Lifesciences (Bangkok: MEGA), a manufacturer of generic medicines. Most of its revenue stems from ‘nutraceuticals’ or wellness drugs, with the remainder from prescription drugs and over-the-counter medicines. The company’s strong distribution network across ASEAN, together with its product pipeline and in-house manufacturing, confers competitive advantages, resulting in higher margins compared with peers. Its management is more agile and flexible than multinational competitors, enhancing its effectiveness in sales and promotions. The stock trades at 12 times its projected 2026 earnings, with a 5.5% dividend yield.

In addition, we have exposure to Hong Kong-listed Tuhu Car (Hong Kong: 9690), a Chinese vehicle-parts retailer that uses its app to direct car owners to its network of franchisee car-repair shops. It is a difficult business, but it is also light on capital and scalable, so companies that find the winning formula have high returns on capital and healthy long-term growth prospects. Tuhu is the market leader in China, where organised vehicle-parts retailing is still in its infancy. The management team is solid, and the firm should be able to grow significantly in the next 10 years. It is an early-stage company with a net-cash balance sheet, and its stock is on 15 times its earnings projected for 2026.

The combined market capitalisation of the Magnificent Seven group of US mega-cap stocks – Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia and Tesla – is now over $22 trillion, meaning these seven stocks make up about 37% of the S&P 500 and 23% of the MSCI World index. As a result, most investors are likely to be heavily invested in this handful of tech giants, which has worked well for the past five years. However, with the market looking increasingly frothy, it could be time to take some money off the table.

Mega-cap tech has sucked up capital at the expense of other businesses, meaning there are now some exciting opportunities appearing in corners of the market. STS Global Income & Growth Trust (LSE: STS) is one way to invest in these kinds of cheaper stocks and reduce exposure to more frothy areas of the market.

STS Global Income & Growth offers quality income

STS holds a fairly concentrated portfolio of between 28 and 34 names, selected for their predictability, resilience, quality and income potential. The strategy emphasises firms that have scope for persistent earnings and dividend growth, which should result in reduced volatility, say James Harries and Tomasz Boniek of Troy Asset Management, who have run it since early 2020. The same duo also run the Troy Global Income Strategy with a similar mandate, which has delivered an annualised volatility of 9.1% since its launch in 2016, compared with 11.2% for the MSCI World index.

The top holdings today are British American Tobacco (BATS) and CME Group. BATS offers the “unusual combination” of a high-quality business trading at an attractive valuation, says Harries. CME, the operator of the world’s largest futures and options exchange, is a high-quality firm that offers a 4% yield comprised of regular and special dividends. More recently, the managers have added Nike, purchasing it at a low point when it was “out of favour” due to strategic missteps and tariff trouble. The shares had fallen 71% from peak to trough, making it a classic quality value play.

The trust has a 33% weighting to the UK, an opportunistic allocation as “global investors have shunned the UK”. However, on a look-through, only 6% of sales come from this market. “So we’re not making a call on the UK economy at all, what we are doing is saying that we’re taking advantage of attractively valued global assets listed in the UK.”

STS Global Income & Growth: avoiding technology

Technology is just 10% of the portfolio – a conscious decision, as most tech companies don’t pay a dividend. However, the result is that STS has underperformed the market in recent years, with a net asset value (NAV) return of 36.3% versus 49.3% for its benchmark, the Lipper Equity Global Income index. Yet while the rest of the market is starting to look pricy, STS’s portfolio is anything but expensive. At the end of October, the trust’s holdings were trading at an average price-to-earnings (p/e) ratio of 18 compared with an average of 21 for the MSCI World. The estimated yield was 3% compared with the market’s 2%.

What’s more, Harries and Boniek have been able to fill the portfolio with quality names at low prices. The portfolio has an overall operating margin of 28% (compared with 14% for the market) and a return on capital of 16% (compared with 9% for the market). Quality names in the portfolio trading close to or at the bottom of the ten-year p/e range include the likes of Reckitt, Novartis, Roche, Unilever, Nestlé and Accenture.

Buying at “lower valuations means less volatility”, says Harries. With so many high-quality companies currently “out of favour for whatever reason”, the team has been able to “build asymmetry into the portfolio”. This means aiming for “limited downside and long-term decent upside”.

In a market that’s starting to look overexcited and overextended, STS offers an alternative for investors seeking quality, value and income. The trust is currently trading at a small discount to NAV and offers a dividend yield of around 3.5%.

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After five years of miserable performance and with the shares trading at a 10% discount to net asset value (NAV), despite 20% of the share capital having been bought back, the directors of the Baillie Gifford Shin Nippon (LSE: BGS) trust have had enough. They have acknowledged the need for an immediate turnaround in performance and stated that if poor performance continues, they will explore “all available options”. This has been presumed to mean not just a tender for 15% of the share capital at a 2% discount in 2027, but also a possible change of manager and strategy.

In the last five years, the NAV has fallen 25% compared with a gain of 42% in the MSCI Japan Small Cap index, a 93% gain for the AVI Japan Opportunity Trust and 144% for Nippon Active Value. The question for BGS’s directors might be why they have been so slow to act. However, a study of precedents for changing managers and style is far from encouraging. The poster child for recent change was the switch in the management of Temple Bar from Investec Asset Management to Redwheel nearly five years ago. Since then, the investment return has been 148%, nearly twice the return of the All-Share index.

But the directors wisely decided that although they would change managers, the trust would continue to invest in “value” rather than “growth” stocks, even though the former had suffered terribly in the pandemic. Since then, value has far outperformed growth. It’s not obvious that the performance would have been too different had the previous manager, Alastair Mundy, been willing to continue to manage it.

Other changes, although ostensibly maintaining continuity of style, have been less happy. In 2021, the directors of Genesis Emerging Markets, tiring of Genesis’s pedestrian performance, switched to Fidelity. The new managers sought to inject some fizz into the performance with a disastrously timed foray into Russia. To its credit, Fidelity has since performed much better, so although the five-year record remains poor, three- and one-year performance is now good.

The board of Mid Wynd appointed Lazard as managers in place of Artemis in 2023, perhaps believing that its lead manager, Simon Edelsten, was about to retire. But Edelsten has since re-emerged at Harwood, alongside his former co-manager Alex Illingworth. Mid Wynd’s board probably thought that Lazard’s growth strategy, supported by a solid record, would provide the shareholders with continuity. Instead, the trust has returned just 10% since Lazard’s’ appointment against 35% for the MSCI AC World index. Lazards appears to rely on an inflexible process, while Edelsten and Illingworth made use of insight and flair. The board should hand the management contract back to them.

Have other investment trusts fared better?

Boards that switched not just manager, but also style, have fared no better. Keystone was once managed by the investment arm of S.G. Warburg, investing in UK equities. It shifted to Invesco in 2017 and thence to Baillie Gifford in late 2020, adopting a high-growth global mandate under the new name, Keystone Positive Change. Baillie Gifford’s style fell out of favour soon after, and Keystone was unable to bounce back. It was wound up earlier this year.

Schroders struggled to replace Richard Buxton as manager of Schroder UK Growth when he left for Old Mutual in 2013. Five years later, the board tired of Schroders’ failure to replace him with a quality manager and switched managers to Baillie Gifford. This has not been a success and the trust has dramatically underperformed the All-Share index in the last five years, although only moderately over one and three years. Perhaps “UK Growth” is just a contradiction in terms; in any case, time is running out.

MIGO Opportunities Trust moved with its managers from Miton to Asset Value Investors, but its lead manager, Nick Greenwood, has now retired and AVI propose a change of focus. Instead of investing in undervalued trusts, AVI now proposes a narrower, “activist” approach, seeking to compel companies it invests in to do something about the discount at which their shares trade. But this approach is expensive, time-consuming and often unsuccessful. Moreover, the time for it may have passed. Two years ago, discounts to NAV were wide, performances had flagged, but an upturn was imminent. Opportunities were plentiful, as Saba Capital realised. Now they are much scarcer and riskier. Hopefully, MIGO will continue as before.

It’s not all bad news. Edinburgh Investment Trust has found a stable home at Majedie and generated solid returns, while the shareholders of STS Global Income & Growth seem happy with Troy’s low-risk, modest returns approach. Trust mergers have generally been successful. Internal changes of manager, such as regularly performed at JPMorgan, have a good record overall, as has the ratcheting up dividends.

A change of management company and style, however, has a poor record. A new style is adopted and management company appointed when it is riding the crest of a wave. Then, the market changes gear, the new managers struggle and don’t have the embedded goodwill from past performance to carry them through difficult times. What, then, should the Board of BGS do? They need to recognise that smaller companies have performed poorly the world over in recent years. In Japan, the growth style has been heavily out of favour, which is why BGS’s two value-orientated rivals have left BGS trailing in the dust.

Yet BGS’s performance has picked up in the last six months while Baillie Gifford Japan (LSE: BGFD) has had a good year. It looks as if the growth style is returning to favour; if so, there is nothing to be gained and much to be lost from BGS changing strategy now. BGS could merge with BGFD, as JPMorgan’s Japanese Smaller Companies Trust was merged with JPMorgan Japanese, but better, surely, to give Brian Lum, BGS’s new lead manager, a chance to prove himself.

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In 2026, the FTSE 100 index is likely to pass 10,000 for the first time thanks to the onward march of corporate earnings around the globe. UK investors have been remarkably reluctant to invest despite the relentless rise of equity markets: two-thirds of all ISA savings are in cash ISAs, and two-thirds of savers believe that investing is too risky.

With investors starting to discount a change to a more business- and stock market-friendly government, savers’ risk aversion should start to decline, even if the domestic economic outlook remains dismal and fears of a fiscal crisis are widespread.

Investment trusts tend to outperform a rising market, especially when, as now, there is scope for discounts to net asset value (NAV) to fall. They currently average more than 14%. Savers, whose real returns are being squeezed between falling interest rates and persistent inflation, need to cast aside their regret about missed opportunities and take the plunge. Fear about short-term volatility should not be a deterrent to the long-term returns that equity markets offer.

Where to start with UK equities

A good place to start is with the MoneyWeek portfolio, which includes two contrasting, but complementary investment trusts: the £13 billion Scottish Mortgage Investment Trust (LSE: SMT) and the £1 billion AVI Global Trust (LSE: AGT). Both invest globally, but SMT is very much a growth trust while AGT invests in value.

The five-year investment record of SMT is miserable at 27% against a 75% return from the MSCI All Country World index. But this includes the disastrous year to June 2022 when NAV fell 39% and the share price 46%, while the index fell less than 5%. This followed five years in which the NAV more than quadrupled while the index less than doubled, arguably making the managers overconfident.

After reaching a low in May 2023, both the NAV and the share price started to recover. The share price has almost doubled since then, helped by a narrowing discount to NAV as SMT has aggressively bought back shares. In the year to 31 August, both the share price and the NAV have returned 34%, compared with just 13% for the index, but the shares still trade on an 8% discount to NAV.

AGT has charted a much steadier course, with an investment performance of 90% over five years, but only a respectable 12% over one. The share price dropped 15%-20% in a couple of months earlier this year, but its moderate overall volatility and good performance explain the 6% discount to NAV at which the shares trade.

SMT “aims to identify, own and support the world’s most exceptional growth companies”. It recognises that many of these are not quoted, because private capital is more readily available than in the past, so companies are coming to the market later in their development. It believes that great opportunities would be missed or invested in unnecessarily late if it restricted itself to public equity. Private equity is limited to 30% of the portfolio, and this limit was a problem in 2021-2022 when the share prices of its quoted company holdings fell fast, and a widening discount of its shares to NAV resulted in pressure to buy back shares. Now, private equity comprises 26%, invested in 51 companies. This includes Space Exploration Technologies, the largest holding at 7.8%, Elon Musk’s venture that includes Starlink.

Also unquoted is ByteDance, the owner of TikTok and the sixth-largest holding at 3.5% of the portfolio. The remaining 73% of the £15 billion portfolio, excluding 1% of net liquid assets, is in 47 listed holdings, the largest of which are MercadoLibre, Amazon, Taiwan Semiconductor and Meta. Borrowings of £1.6 billion, 11% of net assets, imply optimism about the outlook, but will also constrain further investment.

Contrasting investment trusts

Portfolio turnover, at 9%, is low; SMT’s philosophy is to run its winners. It has multiplied its money 100-fold in Nvidia (a top-10 holding) and 21-fold in Tesla (now sub-1%). But it owns up to seven investments in the last decade, on which it has lost everything. Its managers note that you can multiply your money on a good investment, but only lose it once on a bad one.

AGT’s expectations on each investment are much more modest on the upside and much less phlegmatic on the downside. Its approach to value is very different from just seeking cheap or recovery shares around the world. Around 40% of the portfolio is invested in holding companies, usually family-controlled, where the whole is valued at much less than the sum of the parts. Examples include the media and entertainments groups News Corp, controlled by the Murdoch family, and Vivendi, controlled by Vincent Bolloré.

There is significant underlying growth in these companies, but investors suspect the controlling shareholders of being empire builders rather than value creators, hence their undervaluation. Another 31% of the portfolio is invested in closed-end funds trading on significant discounts to NAV, such as Chrysalis, Oakley and HarbourVest (all private-equity specialists). Again, there is significant underlying growth in these investments, but investors are sceptical.

The final 29% of the portfolio is invested in Japan (21%), Korea (6%) and property/other (2%). AGT saw a significant opportunity in Japan around 10 years ago with a large number of companies trading at very low valuations relative to assets, and their managements both complacent and uninterested in outside investors.

Prime minister Shinzo Abe (2012-2020) introduced reforms to shake up the corporate sector and these slowly bore fruit. In 2018, AVI launched a separate trust, AJOT, to specialise in value investing in Japan, but Japan has continued to be an important and successful focus for AGT. This year, Korea introduced similar corporate reforms, which encouraged AGT to invest there. It has identified 600 companies trading at a median price-to-book ratio of 0.7 and a median of 71% of their valuation in cash and listed securities, so the opportunity is significant.

Why pick both investment trusts?

AGT is not a traditional activist investor. Rather than a hostile approach in a blaze of publicity, it seeks to persuade company managements to realise value for shareholders. It is prepared to write open letters to management, to engage with other shareholders and to be patient, although a 36% gain after four months of holding Jardine Matheson shows that this is not always necessary.

AGT’s debt-to-net-asset ratio of 9% is similar to SMT’s, but only 16% of the portfolio is invested in North America, compared with 55% for SMT. Its portfolio is much less technology-orientated than SMT’s, but much more growth-orientated than a traditional “value” portfolio. AGT and SMT can be compared to the tortoise and the hare, but unlike in Aesop’s fable it’s not clear who the long-term winner will be. Markets and momentum now favour SMT, while AGT progresses steadily – but fortunes can change. That is why MoneyWeek’s investment-trust portfolio contains both.

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Law Debenture (LSE: LWDB) has been one of the best-performing UK equity trusts over both the short and long term. The trust has generated a share price total return of 48% over the past three years, compared with 35.5% for the FTSE All-Share. Over the past decade, the return has been 187.5%, against 92.7% for the index.

The structure of the trust is unique, since it has both an investment portfolio and a professional services business, which account for 82% and 18% of net asset value (NAV) respectively at the end of June. Professional services – which includes pension administration and company secretarial services – generate a steady stream of income, which has contributed roughly a third of the trust’s dividend distributions historically.

Law Debenture's diverse portfolio

This set-up gives the managers of Law Debenture’s portfolio – James Henderson and Laura Foll of Janus Henderson – considerable flexibility around what they buy and when they buy it. The portfolio contains about 150 stocks, and they always maintain a “long list” of potential equities to add to the portfolio. The pair take a value approach: they look for companies that are “a bit out of favour, but have really good medium- to long-term potential”, such as AB Foods. This approach requires a diverse portfolio, says Foll, as buying these kinds of equities has a higher level of risk.

Marks & Spencer (M&S) and Rolls-Royce have been two of the biggest winners over the past five years. Both were acquired despite their lack of dividends at the time, based on their recovery potential.

“When we invested in M&S after Archie Norman’s appointment as chair, the market perceived it as a business in structural decline,” says Foll. “We believed this was an overestimation, recognising its well-run food business and a clothing business with surprisingly high market share that wasn’t generating the earnings it should have been.

“This is the type of company we seek: one where we can buy at a low valuation, offering potential for both valuation and earnings upside, which is crucial for achieving excellent total returns.”

Taking profits

A key part of the strategy is managing the portfolio to take profits and control position sizes. Henderson and Foll take profits when shares have “moved a long way” and are no longer as “cheap” as before – as with Rolls-Royce, which they have been reducing their stake after after its 1,000%-plus run over the past couple of years.

Recently, the managers have been taking advantage of weakness in the investment-trust sector. They look for trusts that are trading at big discounts, but where underlying assets are “perfectly all right”. This is a “technical position” opportunity, driven in part by some wealth managers selling trusts to buy gilts, which looks like a misjudgment, says Henderson.

The UK economy is “flatlining with bits growing and bits declining”, but the managers still see the UK as the market “that seems the cheapest to us” and offers clear value. MoneyWeek feels the same, and so Law Debenture remains the core UK investment in our investment-trust portfolio.

Law Debenture will be hosting an evening seminar in association with CityAM on Wednesday 17 September as part of its Widening Investor Networks (WIN*) financial education initiative. The event – which will be in-person in London and online – will include panels on UK investing opportunities and on minimising taxes and costs, which will be moderated by Rupert. WIN* aims to support new and inexperienced investors. Go to lawdebenture. com/events/winstar-wideninginvestor-networks for more details and to register.

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I wasn’t at MoneyWeek when our portfolio of investment trusts was set up in 2012, but the editor tells a funny anecdote. We are famously contrarian, so all six of the trusts originally chosen were “value” plays. Just before the model portfolio was published, someone got a little twitchy. “Shouldn’t we hedge our bets with a bit of growth?” After some huffing and puffing, growth-orientated Scottish Mortgage was added. In the years that followed, this last-minute addition drove almost all of the portfolio’s performance.

The past 17 years have been a tough time to be a value investor. But value actually has a better long-term record than growth. US value stocks have beaten their growth counterparts by an average of 2.5% a year since 1926, according to figures cited in Breakingviews.

Value fell out of vogue in 2008 when the global financial crisis prompted central banks to cut interest rates to ultra-low levels, where they stayed for more than a decade. When interest rates are low, money is cheap to borrow, and companies can invest in future growth more easily. This benefits rapidly expanding firms. Growth stocks raced ahead, and some started to question whether value was dead.

Following a pandemic, war in Europe and a period of high inflation, the post-2008 era is well and truly over. “It’s difficult to predict exactly where interest rates or inflation are going to be over the next few years, but it does feel sensible to say that on average they will be more of a feature,” says Beth Shard, deputy fund manager at Invesco. “Surely in a world where money isn’t free, the price you pay for something must matter.”

Finding value: what is value investing?

Value investors buy stocks that are trading at a discount to fair value in the hope that the share price will catch up. The idea is to buy a pound of assets at, say, 60 pence. Analysts value companies by looking at data such as earnings, book value and cash flows. Warren Buffett, the world’s most famous value investor, once said: “Price is what you pay; value is what you get.”

There could be many reasons why a stock is trading at a discount. Perhaps the firm is in a sector that has become unfashionable, or investors have overreacted to some bad news. The trick is to identify companies that are unfairly undervalued rather than those that are cheap for a reason, otherwise known as value traps.

Finding the catalyst for a rerating is also important. Perhaps the company’s management team has changed, or a new business strategy is being implemented.

“There’s no point just buying something cheaply and then hoping for the best,” says Joe Bauernfreund, manager of the AVI Global Trust. “Very often, it’s shareholder activism that really is the driver there.”

Going for growth: what is growth investing?

Growth investors buy shares in companies that are rapidly expanding. They are often more expensive than value stocks, as investors are paying for future potential rather than current earnings. Growth companies don’t tend to pay large dividends, as profits are generally reinvested in future projects.

Some of the most famous growth companies are in the technology sector: the likes of Nvidia, Meta and Tesla. All three are investing huge sums today in the hope of emerging as the winner of the AI race tomorrow.

Low interest rates favour growth stocks because of the way companies are valued. Analysts discount future cash flows to account for the time value of money: money today is worth more than the same amount tomorrow. When interest rates are low, so is the discount rate, increasing the value of future cash flows.

Is the pendulum swinging back?

Value investors have been talking about a style rotation for years. Given that interest rates started rising in late 2021, shouldn’t it have happened already? We did see some initial signs in 2022, when the tech boom went into reverse. The Magnificent Seven shed 40% of their collective value that year as central banks hiked rates. Share prices quickly bounced back, though.

Things could be starting to shift again now. Data from investment research company Morningstar, focused on over 800 global large-cap funds, shows that value has outperformed growth so far this year for the first time since 2022. Value funds are up 14%, while growth funds are up around 10% (July 2025).

“The value resurgence has been driven by a couple of key factors,” says Mark Preskett, senior portfolio manager at Morningstar Wealth. “Firstly, global value funds tend to hold a bias towards emerging-market and European companies, which have both handily outperformed the US this year.

“Secondly, value funds tend to overweight stocks in the financial services sector while running an underweight to the technology sector. In 2025, the two sectors have shown a sharp divergence in fortunes, with financial stocks among the best performers year to date.”

Things look different when you examine the US market in isolation. US growth funds are still outperforming value, as US tech stocks have rebounded strongly in recent months. Meanwhile, healthcare – a sector often favoured by value investors – has struggled. Despite this, there is a sense that sentiment is now shifting.

“You’ve got this... tension,” Bauernfreund says. “There is this ‘buy the dip’ mentality, but on the other hand, you’ve got more sophisticated investors worried about valuation. Coupled with what’s going on in the US politically, they have started to look elsewhere.”

One key beneficiary has been Europe, which looks cheaper than the US. Investors pulled £622 million from North American funds in May following the Liberation Day turmoil, according to the Investment Association. Meanwhile, European funds saw inflows accelerate to £435 million.

The latest data shows North American funds returned to modest inflows in June (£52 million), but Europe still outpaced the US with inflows of £198 million. Time will tell whether this develops into a sustained trend, but mounting interest from investors could create a tailwind for value-oriented markets.

The UK offers good value in a global context. The FTSE All-Share is trading at 13 times forecast earnings, compared with 23 times in the US, according to recent data shared by Fidelity International. “Should the US market trade at a premium to the UK?” asks Alex Wright, manager of Fidelity Special Values. “I think it should, because of the much larger technology weight. But I think that gap is too large.”

The UK also looks cheap compared with its own history. Fidelity data shows the FTSE 100 is trading at a 10% discount to the average forward price/earnings ratio since 1998. That discount gets larger as you move down the market-cap spectrum.

It is perhaps unsurprising. The UK has been unloved since Brexit. Even before 2016, there was a problem with institutional investors pulling money from the domestic market. Pension funds and insurers have gone from owning around half of the UK market in the 1990s to just 4% today.

Back to Blighty: do UK equities offer good value?

The outlook now seems to be improving. “I think they’ve pretty much sold all they needed to sell,” says Simon Gergel, manager of the Merchants Trust. Policymakers are also encouraging pension funds and private investors to put more of their money into the UK, which could help over the long run. Gergel says the government and regulator are singing from the same hymn sheet for the first time in his 35-year career.

There are also some big buyers in town. International private-equity firms have been taking the opportunity to shop around in bargain Britain, snapping companies up at a discount. Shard thinks more of this activity could help “shine a light on the value on offer here”. Management teams clearly recognise the value in their own stock too. There has been a record amount of buyback activity in recent years.

Stock market turnarounds are famously difficult to call until they have already happened, but so far this year, UK performance has been strong. The FTSE All-Share is up more than 13%. Wright doesn’t think the UK market as a whole will grow its earnings in 2025, partly because dollar-earners will be hurt by currency effects when converting holdings back to sterling.

However, there are still opportunities to be found. For the companies in his UK equity portfolios, he is forecasting 6% operating profit growth in 2025, 11% in 2026, and 9% in 2027. With this sort of earnings growth and dividends on top, “we don’t actually need there to be a rerating to produce very good returns”.

Where to invest

From a regional perspective, the UK is worth a look. Fidelity Special Values (LSE: FSV) invests in undervalued companies across the market-cap spectrum, with an emphasis on UK small and mid caps. The trust has delivered 26%, 15% and 18% on a one-, three- and five-year basis (annualised share price returns as of 30 June).

The Invesco UK Opportunities Fund (UK) has more of a large-cap bias, and has delivered annualised returns of 13%, 12% and 16% over the same periods. Meanwhile, the Merchants Trust (LSE: MRCH) is a good option for value investors seeking income. It has a yield of 5% and has raised its dividend every year for the past 43 years.

The AVI Global Trust (LSE: AGT) also looks interesting. Many of the companies it contains are conglomerates and holding companies. This gives investors exposure to a diversified pool of firms, often at a discount. One example is the Italian holding company Exor – a significant owner of Ferrari. “Ferrari makes up over half the value of Exor, and Exor itself is trading at a discount of more than 50% compared with the value of its underlying companies,” says Bauernfreund.

A range of geographic exposures to value is available through exchange-traded funds run by Invesco. There is the FTSE RAFI All World 3000 UCITS ETF (LSE: PSRW) for a global value play; the FTSE RAFI US 1000 UCITS ETF (LSE: PRUS) for US value; and its European counterpart the FTSE RAFI Europe UCITS ETF (LSE: PSRE). The British version is the FTSE RAFI UK 100 UCITS ETF (LSE: PSRU). Meanwhile, the FTSE RAFI Emerging Markets UCITS ETF (LSE: PSRM) gives exposure to opportunities in developing economies.

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Last year saw record consolidation and corporate action in the investment trust sector. If the past seven months are anything to go by, 2025 will be a year of note as well. At the beginning of the year, 20 trusts were undergoing managed wind-downs, and since January, a further six have proposed or had wind-downs approved, according to Deutsche Numis.

Wind-downs usually happen because an asset class, strategy or individual trust is out of favour. At the same time, they can present a new opportunity if they offer a timetable and a catalyst for realising value from a portfolio that is persistently trading at a deep discount to net asset value (NAV).

This is especially true in the alternative-asset segment of the market. That said, alternatives trusts normally own illiquid assets, which means it can take some time to realise value. If a buyer cannot be found for the entire portfolio, the trust must sell assets piecemeal. Take NB Distressed Debt (LSE: NBDG) as an example: it began to wind down in 2018 and is still ongoing – although the board hopes it has entered the final stages of asset sales, according to its latest update. So this kind of investing certainly is not a trade for anybody with a short-term time horizon.

Investment trusts winding down

Abrdn European Logistics Income (LSE: ASLI) entered a managed wind-down last year following a failed sales process for the entire portfolio. It sold three assets in the first quarter of the year and returned an initial £16.5 million to investors (5.3% of its NAV). Following additional sales, 16 of its 27 assets have now been liquidated and further capital returns are planned in August and September. The estimated NAV is now 57.9p, reckon analysts at Deutsche Numis, putting the shares on a discount of 17%.

JPMorgan Global Core Real Assets (LSE: JARA) failed a continuation vote in September and is now returning assets to investors. The first cash from sales, totalling £33 million or 17% of NAV, was paid in February. Further sales are in the pipeline, and the trust expects to redeem 80% of assets by the end of 2026. The end-June NAV of 89.1p implies the shares are trading at a discount of 11%.

Following a strategic review, Riverstone Energy (LSE: RSE) has proposed a managed wind-down, with investors set to vote on this on 22 August. Management has laid out a plan to distribute two-thirds of the capital by 31 March 2026, with the remaining illiquid assets sold by the end of 2027. The trust’s reported discount has recently narrowed to 22%, based on the latest NAV of 1,136p.

Investors need to be aware that the manager is getting a termination fee of 7.5% of realisation proceeds, but even allowing for that, the discount is still in double-digits.

Investment trusts to watch

Syncona (LSE: SYNC), the once high-flying backer of early-stage biotech companies, announced in June that it will wind down its portfolio. The trust has said it will aim to continue supporting key companies in its portfolio and open a private vehicle for those investors interested in rolling their investment over. This puts a question mark over the liquidation timetable, but with a discount of about 40% there could be a lot of value there for patient investors.

Life Science Reit (LSE: LABS), which announced a strategic review in March, recently said it has received significant interest from buyers for parts of the portfolio. Management is also continuing to explore a managed wind-down. The portfolio includes assets at Oxford Technology Park and Cambourne Park Science & Tech Campus – both located in two high-growth, tech-focused areas of the country – and King’s Cross in London. The Reit has struggled since listing (recent leasing has been slower than expected, with occupancy now at 85%) and has suspended its dividend. But at a 32% discount to NAV, it is worth watching closely.

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Investors in 2025 are either anxious or happy. The anxious believe investing is all about costs. Buy some cheap trackers, and in the long run, you’ll do fine with minimal effort. The happy are active investors who have avoided the largest stocks. It is an anomaly for the largest stocks to lead the market (1929, 1972, 1999 excepted), and following the crowd into richly valued areas doesn’t end well.

As an active manager, I have found 2025 rewarding mainly because my portfolios pursued value outside the US. A weak dollar has meant US equities have lagged the world. US equities have delivered zero returns in sterling this year, and the MSCI World index, with 70.3% exposure to the US, is up just 2.4% including dividends. Contrast that with the FTSE 100, up 12%, or the pan-European EuroSTOXX, up 20% this year. US exceptionalism has once again been exaggerated.

Passive investing makes sense for people who do not want to take an interest in their finances, which presumably counts out MoneyWeek readers. It delivers a market return, before fees, and prevents a worse outcome from incompetent active managers or bad actors. Being cheap and simple, it deserves to be the default option for the majority, and rightly so. After all, beating the markets is a minority sport.

Therein lies the opportunity. Passive management is now so vast that, according to US investment platform Market Structure Edge, trading in index products accounts for 56% of market volume; in 1995, it was in its infancy. If passive management today is so vast, it means active management should provide fertile grounds for rich pickings.

This is reaffirmed by a recent market trend that shows active fund-management companies on the up this year, while the passive managers are waning. For example, shares in institutional active manager Schroders are up 25%, while BlackRock, owner of iShares, is down for the year. Is this a one-off? I don’t think so, because the valuation gap is enormous. Schroders trades on twice sales, with a free cash-flow yield of 16%. Contrast that with BlackRock on a hefty eight times sales with a free cash-flow yield below 3%.

Youthful investors forget, or have never witnessed, that active managers were among the most highly rated stocks in the 1990s. Today, they are dirt cheap. My recent picks include Man Group, Jupiter, and the Dutch company Allfunds, which provides trading infrastructure for the funds sector.

The investors' Money Map

Other investment themes that stand out include gold, precious metals and copper – all beneficiaries of a weak dollar, money printing, and burgeoning deficits. There’s bitcoin and crypto, which are increasingly looking like core allocations. There are also the banks, which benefit from high interest rates, and China, which has impressive technology companies trading on attractive valuations.

On the other hand, 2025 has been another year to avoid gilts. The long bond yield has settled at 5.5%, a level not seen since 1998. It is supposed to mimic annual nominal GDP growth, which comprises economic growth (1.3%) and inflation (4.4%), so the yield is about right. For it to come down, we would need to see a recession to break inflation, tough love in dealing with the budget deficit, or “growth” policies that don’t involve raising taxes. A recession will come about sooner or later, as they always do, but a balanced budget? Unlikely.

The economy may be in better or worse shape next year, but does it matter? In 30 years since I took an interest in financial markets, I am certain that value is more important than the economy. Therein lies the importance of my Money Map (pictured), which I last wrote about for MoneyWeek in 2017: What to take with you in the investment jungle. It outlines the investment strategy most suited to different macroeconomic environments. When times are good, stay on the right, and when bad, stay on the left. When inflation rises, stay high, when it is low and stable, duck.

I have long built portfolios around this idea, filled with undervalued stocks, bonds, commodities, or funds. The Money Map helps to identify the key areas on which to focus, and more importantly, the areas to avoid. Above all, this is how to diversify a portfolio: by having exposure to each quadrant, whatever the weather, because macroeconomic environments can change quickly.

That said, I have more exposure to the favoured quadrant, and to the adjacent quadrants, with less in the least-favoured one. In recent times, this has meant having more value, and less quality and bonds in the portfolios, while staying broadly neutral in growth and gold. At some stage, this will change, probably when there are clear signs that inflation is under control and interest rates fall.

I am looking forward to that because you will have noticed that quality stocks such as Unilever, Diageo, and Reckitt Benckiser have struggled in recent years and now offer good value. In the US, quality stocks such as Nike, Procter & Gamble, McDonald’s and PepsiCo are also waning, and maybe they’ll be cheap by 2026, or 2027. In any event, the world’s best companies have had their bubble pricked and are headed lower, which is something to look forward to.

Charlie Morris is the CEO and founder of ByteTree. It offers investment research for private clients through the Multi-Asset Investor, in addition to other research services. ByteTree also has a Bitcoin and Gold ETF (BOLD) managed by 21Shares in Zurich.

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In recent months, investors have discovered what happens when the euphoria surrounding growth investing fades.

Share prices fall sharply when highly-rated companies announce disappointing results and companies without a clear pathway to profits and sustainable cash flow are severely punished.

But when the initial enthusiasm for value investing dissipates, the currently-favoured companies and sectors will also face challenges.

That stage may not yet have been reached, but value investing has become more of a consensus than a contrarian trade. The onset of some scepticism can’t be far away.

Successful value investing is about a lot more than just ratios

The question for value investors will not be whether the stocks they favour are still cheap (they always are) – but are they cheap for a reason? It’s an easy task to divide the share price by last or current year’s earnings to get a price/earnings ratio or to compare the share price with its “book” value (net assets per share). If the result is comfortably below the market average, the stock is regarded as “value.”

This is made easier by the screening programmes used by most professional investors, but it is rarely enough by itself. A successful investment requires the identification of factors which most investors don’t see or disregard: an undervalued asset, an attractive business opportunity or recovery potential.

A change of management and corporate shake-out may change the company’s fortunes or a change in the outlook for its business may mean that business is about to boom. For example, the share prices of travel companies crashed in the pandemic but recovered when it became apparent that travel restrictions were not permanent.

Recovery stocks may represent “value”, but they are also regarded as high risk by most investors because of the possibility that they might not survive. Recovery investing can be hugely lucrative but some companies take a very long time to turn around (Marks & Spencer) or don’t recover at all (Debenhams). Most value investors prefer to wait till the risks have diminished, thereby missing much of the opportunity.

The recovery phase for pandemic-hit stocks started in the autumn of 2020 when the arrival of vaccines became apparent but suffered setbacks in subsequent phases of the pandemic. Now, ironically, the recovery opportunity may lie in the heavily out-of-favour vaccine innovators, BioNtech and Moderna, and other tech casualties.

Value stocks and sectors may be lowly-rated with good short-term visibility but the investment case is rarely straightforward.

Banks and oil stocks are popular, but for how long?

Resource stocks (hydrocarbon producers and miners) are now popular because demand is rising and supply is constrained, pushing up prices. Yet increasing resource efficiency means the consumption of resources per unit of global growth has been declining for decades.

Rising prices do not flow directly to higher profits as costs, notably of people and equipment, also rise. Ore grades and recovery rates decline until, eventually, the mine is closed and the oil well runs dry. Substitution may undermine demand growth; for example, fibre-optic has replaced copper cables and renewable energy is replacing hydrocarbons.

Governments raise royalties and taxes, depriving producers of windfall profits. Partly to avert this, producers increase investment, usually at the peak of the cycle. As with other cyclical sectors, valuations are at their lowest at the cyclical peak, so the best time to invest is when producers are struggling.

The profitability of banks is based on the margin between loan and deposit rates. A margin of at least 2% and probably 3% is required to cover costs, provide for bad debts and give an adequate return on capital, but is hard to achieve. Technology has driven down costs but also reduced barriers to new competition.

The volume of lending can be a multiple of net assets but, since the financial crisis, banks have been required to maintain larger capital bases, which reduces the return on capital. The extra revenue once earned from currency dealing, insurance and asset management has mostly disappeared while much of commercial lending now takes place through securities markets. The core business of UK banks is now the servicing of government-backed loans, such as mortgages, which makes banks vulnerable to higher taxes and bank levies.

Other financial sectors such as insurance and fund management are fiercely competitive with fees under constant pressure and customers highly mobile. Tobacco companies have done well to grow profits through consolidation and cutting costs (such as marketing and advertising) but the reality that smoking kills people means that regulation is increasing and cigarette consumption worldwide is declining.

Investing is simple, but not easy

The consumer sectors contain both growth and value businesses due to changing consumer habits, fashions and preferences. With innovation, companies can prosper but those that fall behind find it very hard to catch up. Nowhere is this clearer than in the ever-changing shape of retailing, where competition and pricing pressure have been increased by internet shopping.

Travel companies may be recovering from the pandemic but there’s always a headache round the corner – a terrorism scare, a volcanic eruption in the wrong place or an accident. Airlines have been notorious for losing money ever since the first commercial flight, but new ones are always springing up while old ones are kept afloat by governments.

Strong brands protect food and drinks companies but investors pay a corresponding premium for that protection, without which high margins in a slowly growing market are hard to sustain. Elsewhere, value usually represents corporate failure or a commodity sector without product differentiation.

Glaxo has a disappointing record of developing new drugs, perhaps because, as a large company, it has struggled to recruit innovative scientists. Telecommunication companies such as BT and Vodafone struggle to differentiate their services from each other or from competitors.

At the right price, value stocks are undoubtedly attractive, offering dramatic recovery, slow but steady growth or the switchback ride of a cyclical sector. With little prospect of more than modest growth, cash-flow can be directed to paying generous dividends, giving investors “jam today” rather than the “jam tomorrow” of growth stocks. Occasionally, value stocks will get a new lease of life and turn into growth stocks, giving investors the best of all worlds.

Value cycles, however, tend to be short. Share prices are re-rated, some stocks escape the value category and others are taken over. Value managers insist that the current upturn has several years to run; so it may have, for the investor with the right portfolio but it won’t all be plain sailing.

As Warren Buffett said, investment is simple but not easy.

“Value versus growth” is one of the easiest frames through which we can look at investing styles. Yes, it is a simplistic divide (see below): no investor can ignore valuations nor how earnings are likely to evolve. But it still says something about the psychology of an investor: do you favour a solid chance of profits today or the riskier possibility of a bigger gain in the future?

Splitting markets into growth and value also shines a useful light on trends. The MSCI World Growth index has beaten its value counterpart by six percentage points per year over the past decade, which is remarkable, but by more than sixteen points per year over the past three years, which is barely believable. With the growth index now on a forecast price/earnings of almost 30, compared with 13 for value, it’s hard to see how that can be repeated.

Investors want excitement

Value against growth is not the only long-standing anomaly to struggle lately. History also suggests that stocks with lower share-price volatility tend to outperform more volatile ones on average, yet the S&P 500 Low Volatility index (which holds the 100 least volatile stocks in the main US benchmark) has lagged the S&P 500 by 3.5 percentage points per year over ten years and almost ten percentage points per year over the past three years. No matter how you break it down, you can see the preference for glamorous, volatile growth stocks over anything duller.

Yet neither value nor low volatility have performed badly in absolute terms. The World Value index has returned an acceptable 9%-10% per year over three, five and ten years. The S&P 500 Low Volatility has returned 15% per year over three years and 12%-13% over five to ten years. This makes it hard to be confident that we can expect value stocks or low-volatility stocks to do well in absolute terms when the environment changes, because in many cases they have not done worse than expected up to now – they’ve simply been outstripped by a boom in growth.

In particular, much of the return from value stocks usually comes from improving valuations as investors become less negative about their prospects, not through growth or increased profitability (see the chart above from Verdad Capital, which shows that about two-thirds of the total return in US value over the last 25 years came from changes in valuations). Today, value is not especially cheap in absolute terms, even if it is relatively cheap compared with growth. That will make it harder to benefit from the tailwind of improving valuations. Thus while value – and low volatility – will probably do better relative to growth, only a few genuinely unloved sectors (perhaps oil) seem likely to deliver impressive absolute returns.

The difference between growth stocks and value stocks

Investors in stocks can follow a number of distinctively different approaches – often referred to as styles – when deciding which companies to buy. The two styles that are most frequently used to classify investors are growth and value.

Growth investors look for companies that are expected to grow their earnings faster than their sector or the wider market. They will often be willing to buy shares on valuations that appear quite high compared to other companies if they believe that these may be justified by future profits. This approach places more emphasis on the firm’s potential, as opposed to its current financial situation.

Value investing is the opposite. Value investors focus on companies that appear to be cheap today (or sometimes stocks that should be cheap in the very near future if the business recovers after a recession or crisis). While growth investors are typically mostly concerned with earnings, value investors will often look for stocks that trade at a discount to book value (assets minus liabilities) or offer high dividend yields.

Some investors view the distinction between growth and value as artificial. A successful growth investor still needs to be confident that a company is not so overvalued that its earnings can’t justify the price they are paying. A value investor needs to consider whether a stock is cheap because the underlying fundamentals of the business are faltering and will lead to reduced profits, financial distress or bankruptcy in future.

That said, growth versus value provides an easy way to divide the market into stocks that are popular and high-priced and those that are out of favour and trade on lower valuations. Historically, the value segment of most markets have tended to beat the growth segment over the long run (which may be attributed to exuberant investors overvaluing potential growth). However, in the past decade, growth has handily beaten value.

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Merryn Somerset Webb: Hello and welcome to the MoneyWeek magazine podcast. I am Merryn Somerset Webb, editor-in-chief of the magazine, and with me today I have Andrew Hunt. Andrew is a personal investor, very much a value investor, and author of a book called Better Value Investing, which if you haven't read, I suggest you do. Andrew, welcome. Thank you for joining us today.

Andrew Hunt: Thank you. Hi, good morning.

Merryn: The first thing I'd like to talk to you about is what exactly is value investing right now? We talk to a lot of fund managers. All of them, while they might not call themselves a value investor, they believe, of course they're buying value. Who would buy something that they didn't think was slightly undervalued and therefore going to make them money over time? The real question to you is what is value investing? What do you mean by it?

Andrew: That’s a great question. It is a difficult concept and different people have different interpretations. Even people like Terry Smith and Baillie Gifford would say in a way they're value investors. They're buying things that they think are almost priceless, so of course they're undervalued. When I talk about value investing, I'm talking about what some people call deep value investing. This is operating at the market extremes in often quite obscure, quite small, very troubled companies.

Things that even on very conservative assumptions, where you're not assuming much growth, can probably go up 300%, 400% minimum. We're talking companies that will typically trade with a tenth or even a twentieth of the typical valuation multiples that many of the fund managers you interview will be investing in. It's investing at the extremes, in the forgotten, the neglected, the hated things in the market, the underbelly, if you like, that’s what I mean when I talk about deep value investing.

Merryn: It's interesting because you look at that and think it's such a huge market, thousands of fund managers all looking for similar opportunities. How does that fringe of companies that are that cheap and able to survive, even on conservative assumptions, why do they even exist?

Andrew: That is one of the fascinating things. A lot of the people talk about the behavioural quirks and the difficulties of psychologically being able to invest in them.

But a more fundamental reason to understand why they're there, and particularly why they're there just now, because let's face it most things are really expensive, so why can you buy these crazy cheap things? You're right, it's odd. No one’s picking them up. To really understand that you have to look at the structure of today’s markets. If you went back to the 1970s, 20% of the market would be institutional investors. Today it's over 80%. In a way, sadly, a lot of the big institutional investors have lost their way a bit.

There's a lot of pressures and agendas. They have these risk models and they have all these PR and ESG stuff they're expected to do. They worry about headline risks. They might have certain client groups that don’t want to own an oil company or a gambling company. They have to worry about liquidity and they have to worry about regulators. They don’t always have time to go and look at these tiny little stocks. If they do buy them, then their funds aren't scalable, and that’s a problem.

You’ve got all these reasons that have come together, and in a way institutional managers have dug themselves into a hole. They can't do this sort of stuff. A helpful analogy for any personal investor is if you can imagine being a free runner. You put your trainers on and you can run up the hill. You can run down the road. You can around around your house. You can run to Australia. You can run wherever you like if you're a free runner. That’s the position a personal value investor is in.

But if you're a big institutional manager you have to run straight down the road with your shoelaces tied together. It's having that flexibility to be opportunistic and pragmatic and not to worry about things like liquidity and headline risks and all these other things all the time and to be able to seize these opportunities. Not many people out there can do that. It’s a big inefficiency.

Merryn: The rise of the institutional investor, the rise of all the compliance and regulatory stuff around the institutional investor, and in particular perhaps the rise of the ESG agenda, and the fear of an attack social media, or the fear of getting in trouble with your big client who may have ESG parameters inside which you have to invest, have meant that the big institutional investors have effectively voluntarily limited the universe in which they can invest, and left possibly more outlying value opportunities than there have been in the past?

Andrew: That’s exactly right. That’s precisely it, yes.

Merryn: So right now, almost ridiculously, given how expensive we see markets are in the face of it, right now is actually a really good time to be a value investor. Is that fair?

Andrew: It’s a fabulous time. It's wonderful. There's some really great stuff out there.

Merryn: Let us talk about some of that great stuff. You have written in the magazine about buying into energy services. This came from a conversation you and I were having on LinkedIn about fossil fuels.

I wrote about how we've got to stop ignoring fossil fuels, or ignoring investment in fossil fuels, because we know we’re going to need fossil fuels for many decades to come. If you like to or not, we need them. Not investing in them is turning out to be, I don't think we can see around it at the moment, some of you have mistaken, and you’ve agreed with that, right?

Andrew: Absolutely, yes. We've done an awful lot. We’ve made a huge amount of progress with renewables, but it's only scratching the surface as the world continues to grow and develop. I could not agree more with that.

Merryn: One of the things that comes out at me, I was reading a book, There Is No Planet B, which I'm sure lots of people have read. It was very much designed to encourage people to be more enthusiastic about renewables. But when I read it and I looked at the energy uses and looked at how our fossil fuel demand continues to rise a couple of percent a year, my takeaway from this book was not, oh my God, I must invest more in wind, it was, oh my God, we must find a way to get people to be more enthusiastic about fossil fuels.

Andrew: I couldn't agree more. I have a scrapbook about this because every day you have these headlines. The past week you've got, gas boiler ban risks increasing carbon emissions. US coal and oil demand is on the rise again. Experts say alternative energy sources are overhyped and attack blue hydrogen. What we get wrong about green. Smart meter rollout has failed. It really is two steps forward, one step back.

I looked this up the other day. Pre-pandemic, it was 2019, the major economies of the world could use 10 000 terawatt hours of electricity in 2019. Of those, 60% were fossil fuels, only 10% were wind and solar. Now you think over the past decade, we've busted our coconuts on this. Our utility bills have gone through the roof. Governments have taken on loads of debt. We've had ESG investors just throwing vast sums of capital at this.

We've got to 10% of global electricity generation, and that’s before we start thinking about gas usage and motor cars and everything else. That shows how long and difficult this transition is going to be. If you're realistic about it you realise were going to need a lot of these fossil fuels for a long time. It's very important, because a lot of people try and take the moral high ground on this, that there's an awful lot of very poor people in the world. They are getting richer and they want the lifestyles that we have.

Why shouldn't they have a holiday each year and a fridge and a microwave and some air conditioning and a car? We have them. We take them for granted. They're not things we are willing to give up. This is the thing when you go and talk to these people in these emerging countries, they're, like, we’ll care about the environment, thanks, when we've got our two cars in the forecourt and our three holidays a year and our free at the point of use healthcare, thanks.

When we've got all that then we’ll join you, but until then why don’t you go and get on with it. I must say I have a lot of sympathy with that.

Merryn: But then there's not much point in us getting on with it by ourselves. If you look at the UKs carbon emissions are 1% of global emissions. China’s are 30%+. All the things that we do while they might make us feel good and it may allow people in the UK to grandstand around the place on, as you say, the moral high ground, not actually making any difference.

Andrew: That’s the sad thing. We’re less than 1% of carbon emissions. The other slightly icky thing is we've been really good. The UK gets a lot of criticism for its emissions, but it's been better at cutting them than most other countries. But then if you dig into that, a lot of the cuts have happened because we torched our manufacturing sector and outsourced it to China. In a way you're even worse off because we're now importing everything from China that’s dirty and polluting. We just get China to make it and ship it over.

It makes you sound like a bit of a pessimist, but it is a difficult problem to solve. It will take time. The optimistic thing is we will solve it. Over decades we will get there. In the meantime the solution is, yes, you're right, to carry on innovating. Actually, the solution might be to buy our way out of this, to get richer. One idea I'm particularly interested in is the Bangladesh hypothesis.

You and many of your readers may remember in the 1980s you’d switch on the news and you'd see these harrowing pictures of often children waist-deep in dirty water because of the Bangladesh floods. You say, well, what happened? The answer is that Bangladesh followed the IMF playbook and get a lot richer. It bought its way out of the flooding problem. It got everyone working and then it spent the money on building the infrastructure. Then you look at places like Dubai, which is basically a desert, and they’ve done well.

You look at Holland, half of which would be under water, but they've gone and built those incredible land reclamation projects. The cool thing is if you want to be an optimist, if we give ourselves time and money, we can buy and innovate our way out of this. It doesn't have to end in everyone getting flooded and drowned. There is human ingenuity there.

Merryn: It's an interesting one. We talk so much about reducing carbon emissions, about the work we have to do very globally. One of the things that we've just discussed is that it's incredibly hard, but getting rich enough to mitigate the effects is something we don’t talk about nearly as much, and possibly we should at this point.

Andrew: Yes, exactly. It's been the story of the world. It's a lovely story because when people get richer they do all sorts of good things. They care about the environment. They can make better decisions, better lifestyle choices. Also, particularly when women get richer and become empowered they have fewer children, and that takes a huge amount of pressure off the environment ultimately.

In some of these projects we're funding empowering women in the developing world and giving them great educations. In the long run that’s really going to help our environment and it's going to make people a whole lot better off. I don't want to throw shade on Greta Thunberg, but I don't like this sackcloth approach to the problem. You can be optimistic about human ingenuity and good things solving this, and constructive things, so making ourselves wealthier and better off and better people, rather than somehow having to go back to the Middle Ages.

Merryn: You can also be optimistic about fossil fuels, can't you? One of the slightly frustrating dynamics in the last few years has been this idea that it’s somehow evil, immoral, wrong, to put any money at all into the fossil fuel sector. In investment you see this trend towards divesting rather than remaining investing and attempting to improve. Whereas, in fact, a better way to look at it may be to say we do need fossil fuels. We're going to have them for a long time.

Let's all invest to make them better, to make them more efficiently extracted, to make them more efficiently used. One of the things you wrote about in the magazine was about the energy services companies and the extent to which they’re a deep value opportunity and they can be used to make this a more efficient and better sector all round.

Andrew: I couldn’t agree more. We've had huge amounts of technological progress over the past decade and energy is no different. One other thing you’ve got to remember is that, for example, gas is much cleaner than coal. Gas is part of the way out of this, certainly in the shorter term. Often you get a lot of gas is a product of creating oil. Internal combustion engines are getting cleaner all the time and more efficient, so we are again making real technological progress, and the energy services industry is making real technological progress.

As I wrote, those are going to be really exciting tech stocks, because you can't buy any other tech stocks on bombed-out multiples, apart from energy fossil fuels tech stocks. They're going to have a cyclical boom like the rest of the tech industry. They just haven't had it yet. They've been waiting ten years for their cyclical boom. When they do they're going to go the way of Tesla. Some of these companies that have invested a lot of R&D in solving a lot of the problems of the fossil fuel industry, we're really going to need them.

We're going to need to embrace them pretty quickly because these shortages are starting to bite. The thing is it takes a long time to bring new oil and gas on. A deep-water well will take you about five or six years starting from scratch, so this isn't a problem we can solve overnight, and we’re going to have to throw a lot of resource at it.

Merryn: One of the things you say in your article is that these kind of businesses are risky and they're cyclical. Don't own one or two, own quite a few, and once you've got them don’t sell them too soon. What are your favourites in this sector?

Andrew: The easiest one, particularly for UK investors, is Petrofac. I like it because it got very bombed-out. They do oil and gas engineering. No one’s been doing any big engineering projects for the best part of a decade, so they were cyclically very bombed-out. Then to make matters worse there was a big SFO investigation into historic corruption, which they've now settled for a much lower fine than anyone thought they’d get, so they're out of the woods.

Because they've settled that they can now go and win new work. The good thing about Petrofac is they are really good what they do. In spite of the dodgy contracts and the past, they have very strong capability. The other great thing is that many of their competitors have simply gone bust in the downturn. You’ve probably seen a few of the headlines. A lot of these oil and gas services companies have just disappeared. They've hit Chapter 11.

There's this huge pent up demand coming and very few players who can fulfil these contracts who have the engineering capability. I look at Petrofac and you think if it goes right for them, the shares are probably 1.70 today, and you can get 9 or ten quid without trying that hard. Petrofac is a great place to start and its UK listed. It's fairly liquid. It's easy for your readers to buy. Petrofac is one my favourites. It's also personally one of my bigger positions for the record.

Merryn: Good to know. Thank you. Wood Group?

Andrew: Wood Group is similar. Less troubled than Petrofac, but similar. Serial disappointments, no one doing any energy services work for the best part of a decade, but good capability. Wood Group has more debt. It's about three times levered. These things are so operator geared, so once profitability and demand starts picking up, the debt evaporates so quickly because these guys throw off so much cash once the industry gets going.

Merryn: Those are interesting UK companies. Anything abroad that you just can't live without in your portfolio?

Andrew: As I say if you can get an account with someone like Interactive Investor, you can invest in quite a broad range of markets, including developed Asia. Some of the most interesting opportunities are in developed Asia. I mention in my article Sinopec Engineering, which is again the oil and gas engineering division of Sinopec. This company is literally trading at the same value as the cash and investments on the balance sheet, so you're getting the entire company for free.

This is basically a Chinese state-backed company and it's got loads of work and that work is going to grow. Even at the bottom you're paying trough P of 6 and a 9% yield for a company with a perfect balance sheet. Again, what's interesting about it is they've adopted these profitability measures, EVA, ROE measures, which for a Chinese state company is incredibly rare, incredibly unusual. That suggests that someone high up wants Sinopec Engineering to start making a lot of money.

If you’ve got that reformed management plus a cyclical boom, that company should just absolutely fly. You're getting paid 9% in the meantime. That seems pretty good.

Merryn: That’s a stunning bet that you can get a 9% yield on anything at the moment. It's fairly extraordinary, particularly on something that you're suggesting is reasonably low risk.

Andrew: Exactly. Yes, precisely. The other one which I also mention in the article is CSE Global. We've talked about the benefits of technology and bringing technology to the energy service industry and that’s what this company does. They do all the internet of things. They do automation. They do IT processing. They do all the trendy tech stuff that if you buy in the NASDAQ you'll pay umpteen times sales for.

This company is on a trough P of 11 and a 6% yield, for a tech company which is probably likely to face a massive cyclical and secular boom and a clean balance sheet. That seems almost too good to be true. It's really worth looking around for this stuff. It is there.

Merryn: That’s incredibly interesting and I know our readers are going to be very taken by that story. Are there any other areas of market where you can see deep value being ignored by the wider market?

Andrew: There's some things around Hong Kong and China. It's very difficult for institutional investors to buy companies with links to the Chinese government, for example, and that’s created some really odd anomalies. To give a couple of examples, which, again, silly multiples here. Goldpac, which is a leading payment technology company in China, again, trades on an enterprise value of roughly zero, so the market cap is about the same as the net cash. PE of 7, 7% dividend yield, for a payments technology company.

You can buy a satellite company on 0.3 times book, so that’s like a third of just the book value. Again, net cash is roughly the market cap. There are these crazy little anomalies of things often listed in Hong Kong that have these connections to the Chinese government. It's quite an esoteric little quirk. What's also odd is there's so many of these things exist, just that they're these odd, forgotten little companies.

One that you'll like, because you did that interesting article about India the other day, for example. I could talk about these all day. I own about 100 of them. Just bringing them to life, these things are crazy. OPG Power, which is listed on AIM, they have state of the art coal-fired power stations in India. India is now recovering really strongly as you say and power demand is going through the roof. That sounds quite a nice way to get Indian exposure.

Do you know what the multiples on that company are? It's basically paid out. It's almost debt free, which is very rare for a utility. You can go out today, you can buy it on a p/e of four and a 45% free cash flow yield.

That’s a tenth of what other investors are paying for Indian exposure. Wow. These little things keep cropping up, so I'm a pretty happy hunter.

Merryn: It sounds like it. Andrew, let me ask you, do you own any cryptocurrency exposure?

Andrew: I don’t own cryptocurrency exposure at all. It's something I've looked it. I've not been able to understand it or get my head round actually and so I’ve just left it. I always think of the Buffet admonishment to stay within your sphere of competence and stick with what you understand. It's timeless. It's always good advice. I haven't bought any crypto.

Merryn: What about the goldmining sector? Anything of interest there for you?

Andrew: I've always struggled with gold. I love a lot of the commodity stuff, but you look at it and you're like… I get the whole central bank debasement argument on the one hand, but then you look at the cost of digging out a pound of gold, and it's about $800, $900, allegedly, and gold is 2000-odd. I've never been able to square that circle between the reproduction cost argument on the one hand, which is very bearish, and the mining cost. And then on the other conspiracy theory, central banks are going to print money and destroy their currencies.

Again, I've never been able to answer that and get comfortable with those two arguments both ways.

Merryn: What I'm really thinking about is how our readers are hedged against inflation. It would seem to me that perhaps the deep value style of investing is a natural hedge against inflation.

Andrew: I think it absolutely is. If you go back to the real proponents of this deep value stuff, and this is what people like Warren Buffett and Rick Guerin were doing in the 60s and 70s when inflation took off, and this is when they were making hay. Buffett’s best period was in the 60s and 70s. It wasn't when he became famous. He was compounding at a much higher rate before he became well known in the 1980s.

When inflation booms it's great because you’ve bought some real hard assets at a massive discount to their reproduction cost. Almost no matter whether it's shopping malls or satellites or whatever it is. They just get dragged up. The value of them gets dragged up along with inflation because you’ve got these hard assets backing things up. If you're worried about inflation then deep value is a great place to be.

But if stuff is so cheap and if you're getting your 9%, 10% yields and you're paying p/es of one or two then that’s going to bail you out anyway. It's a happy place to be.

Merryn: Andrew, that is all absolutely fascinating. We have to leave it there, but thank you so much for joining us today. I'm rather hoping, and at this point our readers are probably hoping as well, that you will join us again one day and tell us more about your deep value picks.

Andrew: I'd be absolutely delighted to. Thank you, Merryn.

Merryn: Thank you. Listeners, if you'd like to hear more from MoneyWeek you know where we are, moneyweek.com. On Twitter we're @Moneyweek. You can hear more from me on Twitter @MerrynSW and John @John_Stepek. Andrew, are you on Twitter or anywhere else people can hear from you?

Andrew: No, I keep myself to myself actually. But now and again I write things for things like ValueWalk and stuff like that.

Merryn: And for us, of course, so watch out for that.

Andrew: I’ll tell you if I find something really good.

Merryn: Thank you. If you haven't read Andrew’s book yet go out and get it. Thanks very much. Talk to you next week.

Last week, the Dow Jones Industrial index hit 30,000. You can say the Dow is an outdated index, you can say that this isn’t a record high in real terms, but record round numbers still mean something to market watchers – and the much broader S&P 500 has risen around 8% since US election day.

Cue a flurry of comments to the effect that the milestone reflects the fact that the stockmarket prefers, as one Twitter user put it, “sensible” Joe Biden to “lunatic” Donald Trump. (Never mind Trump’s pre-election claim that a Biden victory would lead to a stockmarket crash and a “crippling depression the likes of which you have never seen”.) But does the latest bull run really tell us that? It’s a tough case to make. After all, between Trump’s 2016 election and the middle of February, when Covid-19 began to bite, the Dow and S&P both rose more than 60%.

Valuations have also risen to historically extreme levels: Trump is handing Biden a US market where the S&P 500 has an average price to reported earnings ratio above 30 times against a historical average of more like 15 times. If investors have been nervous of investing in the US under Trump, they have had a funny way of showing it.

The stockmarket doesn’t care too much about politics

It is tempting to see events through the lens of political preferences, but is the stockmarket as interested in politics as we are? Perhaps 30,000 has no moral element to it at all. Biden’s win coincided nicely with the release of excellent news about three coronavirus vaccines – and stockmarkets are very good at looking through noise. Surely the market strength reflects the fact that, barring rollout disasters, we should have our normal lives back within months – that means travel companies can make schedules and cinemas can advertise blockbusters.

Now add in the widely held assumption that the expected new Treasury secretary, Janet Yellen, will deliver the additional stimulus she has called for, and the newish Federal Reserve rhetoric that holds interest rates need to stay low to give inflation time to catch up so that it can rise above the historic 2% target. Suddenly it makes perfect sense to think that pent up demand and possible productivity gains created by the crisis could help set off what Goldman Sachs calls the “Roaring 20s Redux”. Perhaps, barring extreme political promises of long-term dividend bans, super-high corporate taxation and capital controls, developed markets don’t much care about the personalities of presidents at all.

With that in mind, take a look at the other market that is also heavily influenced by politics – the UK. British stocks are ridiculously cheap. The FTSE All-Share hit the same record relative low this year against the S&P 500 as it did in 1974. Back then the UK had both capital and long-term dividend controls in place.

Global stocks as a whole are trading on a multiple of twice their sales for the next 12 months, says Schroders. This is 45% higher than the average for the past 15 years. But, in the UK, large companies are trading on about one times sales and small-caps on only 0.5 times forecast sales – both are below the 15-year average. Analysts will tell you that this is because of the uncertainty around Brexit (I’ve done it myself). This doesn’t chime with the idea that stockmarkets can look through short-term trouble. It is tempting to assume that the market reflects the political prejudices of its watchers.

UK stockmarkets tend to be value-based

But the real reason for UK cheapness might actually be the nature of the stocks that are listed here. The US is easily categorised as a growth market – the main value of its listed companies is in future earnings. In the UK, the exciting growth potential is found in private companies. The listed UK sector is a classic value market: investors expect relatively little from the future earnings of its old energy companies, miners and financials. And value investing has been enduring its worst run in two centuries. The relative valuation gap between growth and value is near record levels.

Near, rather than at, because over the past few weeks a reversal has begun – a shift from Covid-19 winners to Covid-19 losers and from growth to value. Energy and commodities have been strong, for example. In the US, 9 November saw value stocks outperform growth by the largest one-day difference on record. And so far this month, the FTSE 100, which I think is the ultimate value index, has returned nearly 14%, compared with 10% for the FTSE All-World index.

A global rotation into value is really another strand of vaccine-related trade because it reflects the performance of companies strongly linked to economic fundamentals. If the reopening of the world economy continues, that trend will too. Brexit will be resolved around the same time. If there is a deal of any sort, analysts are sure to announce that the market prefers a sensible deal over a lunatic no-deal exit.

But do not forget that something else is affecting the UK market – and it is at least as strong as Brexit relief: a vaccine-triggered rotation that was going to happen anyway.

• This article was first published in the Financial Times

That was quick. In last week’s issue, Jim Mellon told Merryn that investors should buy Lloyds Bank (watch the interview at moneyweek.com/videos). Between that issue coming out on Friday, and Wednesday lunchtime, the share price had risen by 20%. Much as we’d like to claim the credit, the main driver was of course the surging hopes for a vaccine (see page 6). Lloyds was just one of many “value” stocks (companies that look cheap on their “fundamentals”, as measured by various financial ratios) to have rallied sharply on the news that we might soon be able to put the misery of intermittent lockdowns behind us.

Value stocks have lagged growth stocks since at least March 2009 (when they had a short-lived blip of outperformance) and we’ve heard many a call that “this must be the turn”. So is this just another false alarm? Or did poor Ted Aronson, who closed his $10bn value-focused hedge fund AJO Partners only last month, actually call the bottom of this cycle when he threw in the towel?

The case for value

Why has growth trounced value so badly? One factor is that in a low interest-rate, low inflation, weak-growth world, fast-growing companies which promise lots of future profits – even if they make very little today – are at a premium. If inflation is low, then investors are happy to wait for their money. Given the choice between a reliable but barely-growing income stream today, or the promise of a pot of gold at the end of a rainbow sometime in the future, investors are happy to wait for the pot of gold. So growth stocks (which could be described as “long duration” assets – see below) do well. But if inflation picks up, it becomes riskier to wait, and cash-generative value looks more appealing.

So if we’re seeing a turnaround now, it’s because the vaccine news means markets expect economies to open up faster, which means better economic growth, and potentially higher interest rates and inflation to go along with it. Does that seem a reasonable bet? We’d argue that it does. If anything can generate inflation, then huge pent-up demand combined with free-spending governments is surely it. So what should you invest in? The UK is a good option for value. Despite the recent surge in airlines, banks and oil stocks, there’s plenty of room for more. We looked closely at the value-focused Law Debenture (LSE: LWDB) investment trust in last week’s issue and we’re very glad we kept it in our portfolio. If you prefer pure passive, a plain old FTSE 100 tracker will give plenty of exposure to value. And if we’re wrong? Hang on to your holding of Scottish Mortgage (LSE: SMT), just in case – but think about rebalancing.

I wish I knew what duration was, but I’m too embarrassed to ask

“Duration” is a measure of risk that usually relates to bonds. It describes how sensitive a given bond is to movements in interest rates. Think of the relationship between bond prices and interest rates as being like a seesaw: when one side (interest rates) goes up, the other (in this case, bond prices) goes down.

Duration (you can find the measure in the fact sheet of most bond funds) tells you the expected percentage change in a bond’s price in response to a one percentage point (100 basis points) change in interest rates. The higher the duration, the higher the bond’s “interest-rate risk” – that is, the larger the change in price for any given change in rates. This is also known as “modified” duration.

Duration can also refer to the weighted average length of time (in years) it will take to recoup the price paid for a bond in the form of income from its coupons (interest payments) and the return of the original capital. So if a bond has a duration of ten years, that means you have to hold it for ten years to recoup the original purchase price (this is also known as “Macaulay duration”). In practice, both measures of duration return very similar values. So in the above example, the duration value of ten also indicates that a single percentage point rise in interest rates would cause the bond price to fall by 10%.

As a rough guide, the duration of a bond increases along with its maturity – so the longer a bond has to go until it repays its face value, the longer its duration. Also, the lower the yield on the bond, the higher its duration – the longer it takes for you to get paid back. All else being equal, a high-duration bond is riskier (more volatile) than a low-duration bond.

When applied to other assets such as equities (as above), a “long duration” asset refers to the fact that the payback period is lengthy (it takes a while to earn your original investment back) and thus the asset is sensitive to movements in interest rates.

It’s the end of what’s been a long week. The US election is over bar the shouting (I suspect there will be a lot of that). We’ve got a very promising Covid vaccine coming round the corner. After a burst of euphoria on Monday, we now have all the doubts creeping back in. So now it’s Friday – what have we learned?

Let’s deal with the least important event first – the US election

Monday saw a rare eruption of unbridled optimism in markets and in the world more generally. Monday was a truly explosive day, by the way. If we’d seen those sorts of moves to the downside rather than the upside, we’d be talking about fragile markets and hedge funds blowing up and things like that (as it is, it’s perfectly possible that some funds could have blown up given the sharpness of the moves).

Anyway, a lot of long-term, grinding trends were properly disrupted: value outperformed growth; ordinary boring industries outperformed tech; interest rates went up (a bit). Non-US stocks outperformed US stocks – oil and bank stocks went up, for crying out loud. You get the picture. The question now is: is this a one-off blip, or has the trend really turned? Obviously, the short answer is, “I don’t know”. But it’s useful to think about these things so we can make sure our portfolios are prepared for all eventualities.

Let’s deal with the least important even first. The US election ended in stalemate, as far as markets are concerned. Before the election, lots of analysts said this would be a terrible thing. After the election, they fell over themselves to explain why “gridlock” was in fact the golden scenario. Analysts talk a lot of backside-covering nonsense, as you may have gathered by now. Best ignore them.

If Joe Biden had won and also had a Democrat senate, you’d have got a great big spending splurge (good for markets), a big tax hike (bad for markets) and probably a less active Federal Reserve, because fiscal spending would have taken the pressure off the monetary side (moderately bad for markets). If Donald Trump had got back into power and had a Republican senate, you’d have got a smaller spending splurge (OK for markets), no tax hikes (OK for markets) and probably a less active Fed for the same reasons (not ideal for markets). Instead, you’ve got political paralysis. So you get a little spending splurge (not great for markets), no tax hikes (OK for markets), and the Fed is left holding the bag, which means more money printing, yield curve control, and maybe even negative interest rates at some point (great news for markets, at least for now).

Looking at these summaries, one thing stands out: they all mean more money getting pumped into the system, the only difference is the timescale and who’s doing the money pumping. That’s why I’m saying that the US election just wasn’t that important from a markets’ point of view. The real game changer (to quote Merryn’s editor’s letter in this week’s issue) was of course the vaccine news.

The rally has further to run

We’ve had time to think about the vaccine and of course we’ve had time for all the spoilsports to come along and raise a dozen other problems with it. Logistically, it’ll be a challenge to vaccinate lots of people. Also some people might be reluctant to take it. And in any case, Covid is still about and appears to be getting worse in the US.As Cedric Gemehl and Nick Andrews of Gavekal point out, European stocks have been among the bigger beneficiaries of the vaccine “rotation”. “Over the month to date, the euro Stoxx index is up 15.8% in dollar terms, easily outstripping the 8.2% gain in the US S&P 500.” So if this rotation isn’t going to last, European stocks (and you could certainly include UK stocks by extension, though they’re not in the euro Stoxx index) will wilt again relative to their US counterparts.

The good news is that it probably will last. Yes there will be hurdles to the vaccine being rolled out. Yes, the latest session of lockdown will cause economic damage. Yes, we might even see further lockdowns early next year if we can’t get Covid down far enough and we’re still rolling out the vaccine. But the point is – and always has been – that there is now a degree of certainty. It’s not deranged to imagine that we might be back to something very close to normal in a year’s time. You couldn’t have said that with conviction less than a week ago.

That’s why the big re-rating – while violent – was perfectly logical. We’ve gone from a very real prospect of a stop-start economy for potentially years, to a return to a healthy economy within a year. That entirely justifies the sort of whiplash moves we saw earlier this week, and more. In short, as Gavekal put it, “while a near-term consolidation is probably, the rerating of Covid-stricken and cyclically sensitive companies still has further to go."

How can you benefit? I mean, if you’ve been reading MoneyWeek for a while, then your portfolio is already likely to be tilted towards the sorts of value stocks and value markets that benefited greatly this week. I’d stick with them. And if you don’t read MoneyWeek – well, why not pick up your first six issues free today?

Below is an excerpt from John Stepek's book on contrarian investing, The Sceptical Investor.

Value investing is probably the purest form of contrarian investing out there.

The value investor makes money by understanding the true value of an asset, then buying or selling when the market’s mood swings offer the opportunity to do so at an advantageous price.

As one of the best known and most successful value investors, Seth Klarman, puts it: “Value investing is at its core the marriage of a contrarian streak and a calculator.”

The question is: what is it, and how do you go about it?

The value investing equation

Value investing involves two core concepts: intrinsic value, and margin of safety. Intrinsic value is what you – the value investor – believe an asset is truly worth. Margin of safety is the gap between its intrinsic value and the price you would feel comfortable buying it at (in order to give you sufficient upside, and to limit the downside if you are wrong).

So, boiling it down to a very simple equation, a value stock can be considered to be one where:

Current market price < (intrinsic value - percentage margin of safety required)

So if you think that the intrinsic value of a stock is £1, and you require a margin of safety of 30%, then you wouldn’t buy until the market offered it to you at 70p or below.

This simple definition immediately flags up a couple of points about value investing. Firstly, both of these measures are highly subjective. The calculation of intrinsic value can be done in lots of different ways. And the margin of safety required will vary from situation to situation and person to person.

Secondly, value stocks are traditionally thought of as “bargain basement” stocks. But this definition makes clear that a stock doesn’t necessarily have to be “cheap” based on simple ratio analysis, or even relative to the rest of the market, in order to be a bargain.

A stock could look quite expensive on some measures, but still represent good value, assuming that it is trading sufficiently below its estimated intrinsic value. Equally, a stock can be cheap without being a value stock – it might be cheap for a reason, which is also known as a “value trap”.

The evolution of value investing

Purists may not like this characterisation of value investing. But it reflects the evolution of value investing over the years.

Benjamin Graham, Warren Buffett’s mentor, is generally accepted as the father of value investing (his books, Security Analysis – written with David Dodd – and The Intelligent Investor, form the bedrock of the value canon).

Graham is often associated with buying distressed stocks trading at rock-bottom levels. This was largely the result of Graham investing during the Depression era, when these sorts of opportunities abounded.

In 1932 he wrote a three-part series for Forbes magazine, in which he pointed out that almost a third of companies trading on the New York Stock Exchange were trading for less than the value of the cash (or easily liquidated assets) on their balance sheets.

In other words, the pavements were scattered with $5 notes and investors were so terrified that they were ignoring them.

Graham was also an early proponent of index investing for investors who didn’t have time to dig for bargains, and suggested other techniques in line with an investor’s level of experience.

But regardless, it’s the approach that we might call “deep value” that he’s best known for. And his most famous disciple – Buffett – at first used similar techniques, or what he called “cigar butt” investing. Here’s Buffett, writing in 1989:

“If you buy a stock at a sufficiently low price, there will usually be some hiccup in the fortunes of the business that gives you a chance to unload at a decent profit, even though the long-term performance of the business may be terrible. I call this the ‘cigar butt’ approach to investing. A cigar butt found on the street that has only one puff left in it may not offer much of a smoke, but the ‘bargain purchase’ will make that puff all profit.”

But what Buffett realised was that this is a high-risk approach to value investing. For a start, bad businesses tend to have bad luck – they might look cheap today, but another problem is likely to be just around the corner. “Never is there just one cockroach in the kitchen,” as Buffett puts it.

Also, you have to be alert to “flip” them quickly when you get the opportunity to take a profit. Otherwise your money is locked up in a dud business. Again, quoting Buffett: “Time is the friend of the wonderful business, the enemy of the mediocre.”

How Buffett quit smoking cigar butts

So with the help and persuasion of his business partner Charlie Munger (and the ideas of Philip Fisher, author of another canonical investment book, Common Stocks and Uncommon Profits), Buffett moved on to a different model.

Rather than trawl through the bargain bin looking for businesses that were worth more dead than alive, Buffett began looking for excellent businesses being sold at a discount to their intrinsic value.

As he put it: “It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.” Some people describe this strategy as “growth at a reasonable price”. But really it’s just value investing given a rebrand (although it’s also often abused as a great intellectual fig leaf for fund managers to justify their decisions to buy companies that are already popular).

You can see why buying quality assets at cheap prices might be more appealing than buying poor assets at bargain prices. There are fewer decisions involved – one is a “buy-and-hold” strategy, whereas the other is a “buy-to-flip” strategy.

The trouble with cigar butts is that you always need to be finding more of them, and there aren’t many around. Whereas if you can buy a decent company cheaply and then see your return compound up over and over again, then frankly it’s less work.

There are also fewer risks involved in buying high-quality companies. The big risk with cigar butts is that the market is right. Cheap stocks sometimes just keep getting cheaper, all the way down to zero.

John Maynard Keynes went through a similar intellectual journey to Buffett, when he moved from being a speculator to a value investor. “As time goes on,” he wrote, “I get more and more convinced that the right method in investment is to put fairly large sums into enterprises which one thinks one knows something about and in the management of which one thoroughly believes.”

• For more on this topic, and many others to do with contrarian investing, you can grab a copy of John’s book here.

The coronavirus crisis has been painful for everybody, but value-focused fund managers have particular reason to feel miserable. After a decade in which growth strategies (those that look for companies with higher earnings growth) generally beat value approaches (investing in companies that look cheap on metrics such as price/earnings, price/book or dividend yield), value investors expected to be rewarded in the next bear market. Overpriced growth stocks would be crushed, cheap ones would shine and their patience would be rewarded.

To say that this has not happened is an understatement. The gulf between value and growth this year is staggering. Using indices compiled by MSCI, growth stocks beat value ones in America by 28 percentage points in the six months to the end of June. In Europe, Japan and Asia ex Japan, the gap was around 15-17 percentage points.

The vanishing value premium

Results over ten years look worse than before. Even in Asia ex Japan, where value was beating growth until 2017, value now has an annualised deficit of 4.5 percentage points per year. Perhaps even more strikingly, virtually all the cumulative outperformance of value over growth since the inception of these index series (1974 in most cases, 1996 for Asia ex Japan) has been erased.

This will spark another round of headlines on the lines of “Is value investing dead?”. But it shouldn’t be much of a surprise. The idea that value should beat growth in a bear market is based on events like the dotcom crash, which involve a bursting bubble in growth stocks. However, value stocks on average tend to be riskier (eg, more cyclical, indebted or distressed). That’s the rational reason why they should deliver higher returns in the first place – to compensate investors for the increased risks. So in crashes that involve an economic shock, you’d expect them to do worse, because their survival may be called into question.

Data from Research Affiliates (see below) supports this: out of four shock-driven US bear markets in the last 50 years, value lagged growth in three (it beat growth in both valuation-driven ones). In five out of six cases, value then beat growth over the next two years.

The Covid-19 crisis is a shock like no other, so the huge hit to value is rational. History suggests that this should now bring better returns. That said, there are structural concerns around many stocks (such as some retailers), so history should not be trusted blindly. But solid value sectors such as large-cap energy look so unloved that exchange-traded funds dedicated to these (eg, SPDR MSCI World Energy ETF (LSE: WNRG)) seem a compelling way to back a recovery.

Guru watch

Rob Arnott, founder, Research Affiliates

Markets are “skating on a knife edge”, says Rob Arnott, the smart-beta pioneer whose firm advises on around $145bn in assets. Stocks could still head higher, driven by US retail traders speculating with their stimulus cheques instead of spending them and the belief that “there is no alternative” to buying shares when interest rates are so low, he tells Bloomberg. But “we’re in a bubble – or at least certain names are in a bubble” and that bubble must eventually burst.

The US stockmarket is very expensive by historical standards, on a Cape ratio (see box) of 29, he tells Financial Advisor. Even if valuations remain higher than their long-term average, real returns from here might be as low as 0.5% per year over the next decade – and that’s with optimistic assumptions (“earnings and dividends hold and there are no long-term growth headwinds and a normal number of bankruptcies”).

That top-down valuation disguises a lot of variation, however. “Valuations are now stretched for growth relative to value stocks wider than [they were] at the peak of the tech bubble,” he tells Bloomberg. For example, Amazon is now trading at more than 120 times earnings. Even if the firm were to grow revenues at 20% per year for the next decade – at which point it would be bigger than the entire global retail sector – it would not justify such a high price. Meanwhile, beaten-down sectors such as energy, retail and financials look attractive; they face challenges, but these are reflected in their prices.

At the end of 2017 I wrote about the unusual-looking value on offer from our domestic stockmarket. Thanks to a mix of Brexit- and Corbyn-related hysteria, British equities were among the cheapest in the world.

I like cheap. So I suggested you take a look. I quoted Neil Woodford on the matter and suggested various domestic and value-orientated funds you could buy in the hope that the market began to agree. None have exactly covered me in glory since. Temple Bar, for instance, which I suggested and still hold myself, is down 30% in the past three years.

The only redeeming piece of advice I offered at the time was that I specifically told you not to buy Woodford’s flagship fund in your search for value – because of the unlisted stocks. It is now a year since that fund was suspended. The lessons from the whole debacle have been much discussed.

Time is your friend – markets do revert to their mean

But if there is one that all investors should take away, it is to make sure that you invest in a way that gives you time. It was, you see, time that Woodford ran out of in the end. Given more of it, his private equity investments may have come good. Recent news that 19 of the holdings are to be sold to Acacia Research Corporation at least suggests that someone apart from him believes they are worth something. And his value plays (which he was already finding “uncomfortable” in 2017) almost certainly would have.

Individual stocks don’t necessarily revert to the mean in any consistent way. But markets do – in the end – revert to valuation averages and to relative valuation averages. It’s a standard cycle.

Think about the relationship between growth and value stocks. People look at one group of stuff. They think they can’t possibly want to hold it because this and that is wrong with it. They can’t see how it can fix this or that – and it isn’t growing anyway. They look at something else, a bit newer and perhaps a bit shinier. There’s nothing wrong with it at all – and it’s growing. They must have it.

Then one day they look at the first thing and think, gosh that’s so cheap I don’t care about this or that any more. At the same time they look at the other thing and notice that there is something wrong with it after all – it costs too much.

At some point what you have to pay for a great and growing company matters more than the greatness itself. Now we are at the very end of one of these cycles.

Growth stocks have had a good run

The valuation gap between growth stocks and value stocks is “as stretched as it has been since 1904”, according to Edward Troughton of Oldfield Partners, a value-focused fund management firm. Growth stocks in the US have massively outperformed value since the global financial crisis and by some 20% this year alone. At the end of March, based on price to book, expensive stocks were about 12 times as expensive at cheap stocks (against a long-term median of 5.4 times). Extreme stuff.

One possible explanation for this might be that value stocks somehow represent worse companies than in the past. Not so, says Troughton. Numbers from AQR Capital Management suggest that if you look back at the cheapest 30% and the most expensive 30% of the largest 1,000 stocks over 53 years you will find that the gap in profitability between them is 14% at the moment, the same as its historical median. This is not a dynamic driven by a “previously unseen quality differential”.

You might also argue that this can go on forever. The scarcer growth is, the more you are prepared to pay for it. The lower interest rates are, the less you are bothered about the lack of immediate cash return from that growth. And perhaps our age of extreme monetary stimulus makes valuations irrelevant.

You can endlessly faff around finding academic justification for rising and ostensibly expensive equity prices at the moment. But is it worth the bother? As long as the central banks keep producing cash confetti, equities should keep going. Note that this week the European Central Bank announced a near-doubling of its corporate bond purchases to €1.35trn: EU equity prices obligingly leapt 2.2%.

Finally, you could say that in an age of lockdown many stocks deserve to be cheaper than usual. Who wants airlines, energy, cruise ships and commercial property?

In the long run, value wins out

You could be right. But before you start to feel too comfortable, two things to note. First, run the data back to 1825, as Two Centuries Investment has, and you will find that over the long run a value approach has outperformed – by around 3% a year. Second, value often outperforms as economies shift back from recession to growth – and the switch in the cycle could already have begun.

Airlines, casinos, cruise companies, energy companies – all the things the market has dismissed – are on the up. US airline stocks have risen 30% since Warren Buffett told us he was selling all his. Shares in Tui are up 63% from their May low. Shares in Shell are up 48% from their low. Shares in retail property firm Hammerson are up 180%. And my Temple Bar shares (which I am not recommending due to the manager change) are sadly still some distance from their 2017 level – nonetheless they are up 47% from their March lows. Phew.

A final stat for you. In 1904, value had been underperforming for 14 years and by 59%. This time around it is 11 years and 59%. It showed its best performance ever over the subsequent 16 years. Do you really want to bet on that not happening again? It may still not be fashionable enough. But I still like cheap – and I have plenty of time to wait for the rest of the market to like it too.

• This article was first published in the Financial Times

“Never has a venial sin been punished this quickly and violently,” says Cliff Asness of AQR, the quantitative-investing giant that manages around $185bn. Back in November, AQR began increasing its exposure to value stocks on the basis that they then looked exceptionally cheap compared to the wider market – despite the firm’s long-standing principle that trying to time the market in this way amounts to an investing “sin” (because market timing is hard to get right and likely to backfire).

Thankfully, “we only sinned a little”, by increasing exposure a small amount. That turned out to be very fortunate, because the timing of AQR’s decision could not have been worse.

“In a decade quite bad for value investing, the start of 2020 is the absolute worst six-week period”: between 1 January and 13 February, the Russell 1000 Value index underperformed the Russell 1000 Growth index by 6.4%. (The Russell 1000 tracks the 1,000 largest US stocks – it’s similar to the S&P 500 but broader.) On a 30-year view, a span that includes events such as the 1998-2000 tech bubble and the 2008-2009 global financial crisis, value has only done worse 3% of the time. And among smaller companies, this has been the worst spell for value since at least 1963.

“I have been a pooh-pooher … of some who compare this value pain to the tech bubble.” Value is not quite as cheap relative to the rest of the market as it was back then. However, the comparison is getting stronger, in terms of both the scale (“no more slow steady losses for value, now it’s very quick big ones”) and “the widespread embracing by many of all the reasons … why value is never going to work again”. Value investors need to stick to their process, even though that’s difficult when performance is as bad as this and others are finding reasons to throw in the towel. “We’ve seen this movie before a few times and we know how, but definitely not when, it ends.”