All posts by cdadmin

Value is a Big Tent

Increased manager dispersion within the Value space highlights the division in the subsets of Value

It is undeniable that over the past decade Value equity has taken a back seat to Growth equity in the mind of investors (annualized returns of the Russell 1000 Growth versus the Russell 1000 Value for the ten years ended 9/30/20 were 18.84% vs 11.33%1).  This divergence in returns, which really began in earnest in 2017, has only exacerbated over the past four years.  This has clearly led us to thinking about the future relationship between Value and Growth, but more recently we have considered, within Value, what constitutes the landscape for managers of that discipline.  While it is certainly typical to see dispersion amongst manager returns in the universe given the multitude of sub-strategies that make up the “Value” manager universe (i.e., Traditional Value, Relative Value, Deep Value, and Growth at a Reasonable Price (“GARP”) among others), what we have discovered is that the divergence of manager returns within the Value universe (as measured with the PSN Informa system) is over two standard deviations greater so far in 2020 (through 9/30) than the average dispersion over the past decade. 

We dug a little deeper and discovered that the last time we saw universe divergence this great was 1999-2001, right through the Tech Bubble.  Market extremes usually correlate with increased dispersion both at the stock and portfolio level.  We believe that we’re experiencing similar conditions now in terms of market concentration (the top 5 names in the S&P 500 at 9/30 made up just under 23% of the total market cap of the entire benchmark, top 5 concentration didn’t even make it to 18% during the Tech Bubble2), preference for growth at any price, and divergence in individual sector returns as we did in markets twenty years ago.  Sector and factor exposures have had outsized effect this year.  If a portfolio was overexposed to Health Care (+20%YTD) and Materials (+12%YTD) or underexposed to Energy (-45%YTD) or Financials (-12%YTD) those would have greatly positively influenced performance on the year3.  With the variations in strategies followed by managers within the Value universe, it is clear that “Value” is a big tent.  Looking at this year when we have seen this great divergence, we found that GARP-style managers, as measured by the S&P GARP Index TR, returned -5.76% while the Russell 1000 Value was down -15.12% and Deep value, as measured by the Acquirers Deep Value Index was down -34.33%4.  Subsets of Value will have varying risk and return profiles that could be useful to investors at different stages of the coming recovery.  Market extremes and increased dispersions tend to drive even wider chasms between investment styles and this year, with everything that has changed for us all, has been no different.

We want to wish everyone a Happy, Safe and Healthy Thanksgiving!

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Thoughts on the Rapid and Persistent Beta Reversal

There are many measures of risk that investors rely on but few are as ubiquitous as beta.  Beta, a simple measure of volatility calculated by regressing the past returns of an individual security relative to the broad market, is widely used by experts and non-experts alike as a gauge of the “riskiness” of a stock.  In actuality, risk takes many forms and beta, by its very definition, is backward looking.  In stable market environments it is theoretically possible to surmise that the best indicator of performance (or volatility) tomorrow is performance yesterday, but one thing I think all market participants can agree on right now is that this is not a stable market.  At the outset of COVID-19, markets saw a swift (and thus far persistent) change in the beta of many stocks with those of Technology companies taking a marked step down and those of other companies taking a similar step up (see the chart below for a sample) broadcasting to investors that these stocks are now “low risk”.  Now, a case can be made for the fact that many of these Technology companies are benefitting most from the current “Work-from-Home” conditions but that would bely other financial risks inherent in these positions.  These names have grown in market cap to dominate the indices of which they make up a greater share today than similar shares did even during the 1999-2000 Tech Bubble, increasing index concentration to peak levels.  As valuation multiples continue to expand for these names, market participants need to be concerned about the lofty heights in the event of a reversal.  The risk exacerbates if we take account of what could come from regulation as these companies continue to grow market share.  While no investor can deign to know the direction of future markets with certainty we would caution investors to be aware of their risks and to be aware of the biases inherent in their measurement and analysis.


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What has been the biggest takeaway from your calls with management teams this earnings season?

Earnings have always been about managing expectations and the most recent period has been no different.  After drastically reducing and, in many instances, suspending guidance due to the uncertainty and the onset of the COVID-19 pandemic in the early part of the year, the read from most companies is that things are recovering.  2020 is being looked at as a throw away year and 2021 for most sectors and industries appears on track to resume sales and earnings growth progression especially versus the more normal 2019.  It seems that consensus estimates for the second quarter were far too pessimistic.  Companies beat, often very strongly in the case of those that we view as being of high quality and low leverage, and price performance didn’t align with what those beats would have earned them in the past.  Sentiment towards the current earnings period by investors and analysts has been muted and somewhat skeptical regarding the sustainability of progress for most, with the exception of a select group of cohorts that appear to be benefiting from the stay-at-home economy for whom markets are discounting very optimistic assumptions and are attracting rich multiples.

There is reason, however, to be skeptical of overly lofty valuations at this point.  There has been much stimulus offered to companies recently with the intention of seeing them through rough times, but it as yet remains unclear how long this protracted period of stress will continue and if stimulus measures wane at a point many of the lower quality, higher valuation businesses may see significant drawdowns.  The most forward-looking management teams we have spoken with are using their time during the downturn to strengthen their businesses, either by increasing the efficiency of their operations or by taking market share from lower quality, less insulated competitors – oftentimes both.

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