Important information: The value of investments and the income from them, can go down as well as up, so you may get back less than you invest.
2020 was a year of winners and losers in the stock market. The former consisted of lockdown beneficiaries, whose value continued to rise as conditions got worse. The latter comprised ‘old economy’ industrials, financials, retailers, airlines and so on, who saw their operations and profits grind to a halt as demand vanished overnight.
Broadly speaking, these winners and losers belonged to two pre-established investment styles - “growth” and “value”, respectively.
As we head into 2021 and (hopefully) a more optimistic future, you’re likely to hear a lot of talk about the two styles, as investors anxiously try to predict whether yesterday’s losers will become tomorrow’s winners. For the value-heavy UK market, that could have a significant bearing on our fortunes over the coming year.
Understanding the difference
Though not necessarily mutually exclusive, you’ll often see funds or managers subscribe to one of the two styles. It’s a divisive subject across the industry, and some of those disagreements are coming to the fore now.
Growth companies are more expensive than value, but the prospect that they’ll continue to deliver rising earnings (regardless of what’s going on with the wider market) is thought to justify the price. They’re inherently more speculative than value - you’re essentially hoping their future growth will be worth the initial outlay. Investors look for hints to suggest they’ll achieve that, often some USP that keeps the competition at arm’s length.
Value companies promise none of these things. They’re unlikely to change the world. Their appeal lies in valuations which look cheap compared with their fundamental value. Value investors are more interested in what a company is worth today than what it could be worth tomorrow, and whether the wider market has overlooked that worth.
“Cyclical” is another helpful piece of jargon. Cyclical companies tend to do better when the economy is healthy (hence their poor performance last year) and typically fall into the value category. They’ve weighed on the style’s performance, meaning 2020 capped a miserable decade for the value investor, whose returns since 2010 would pale in comparison to the growth investor’s.
But financial markets are fickle beasts, and a shift in the balance of power could be on the horizon. Value investors who kept the faith will be encouraged by historical trends which suggest a rotation is overdue and, more importantly, shifting market conditions which could favour their style of investing.
Growth stocks have benefitted from a low rate, low inflation environment that makes their future cash-flows look attractive. But life after COVID should be good news for value stocks, both because demand will return and also because the prospect of inflation would hurt growth stocks.
So, what does all this have to do with the UK?
Generally speaking, the UK is more exposed to value stocks than it is growth. That meant it performed poorly over 2020, trailing the US and Chinese markets which boast the world’s biggest growth names like Apple and Alibaba. But it also means a return to normal could be especially good news for the UK.
Of course, no one knows for certain if or when that recovery will come, nor whether it will entail a value rotation. As such, there are a number of valid ways to invest in our home market this year.
Putting theory into practice
Our Select 50 choice of favourite investments features at least one UK fund for each style.
For growth-seekers, the Liontrust UK Growth Fund could be a good option. Managers Julian Fosh and Anthony Cross look for companies with one of three “intangible assets” - intellectual property; a strong distribution network; and high levels of recurring revenue. In the manager’s eyes, each of these provides a company with ‘pricing power’ - i.e. the freedom to charge a little bit more, which in turn brings about and sustains high profits.
Another UK growth fund is the Fidelity UK Select Fund. Managed by Aruna Karunathilake, the fund aims to identify quality businesses and hold them for the long term. Karunathilake is looking for “companies with a strong brand, that dominate their industry, and that can demonstrate good cash generation, a strong balance sheet and a simple business model.” That leads him to certain industries, such as consumer goods and media companies, over others like financials and life insurers.
For value-seekers, Alex Wright’s Fidelity Special Situations Fund is one to consider. The rationale behind Wright’s process is that highly-valued companies have little potential to rise much further, whereas undervalued shares can rise sharply if things turn out to be better, or no worse, than the consensus expects.
He sees now as the prime time for UK value investors: “The UK stock market and particularly UK domestic-facing stocks look very attractively priced, with many also having strong fundamentals. Two clear catalysts that we were hoping for have now occurred: the approval of multiple vaccines for COVID and a Brexit deal. I believe both will quickly increase the interest in UK equities both from domestic and foreign investors and corporates”
It’s hard to be certain how best to play the value vs growth question - no investor has a crystal ball. That’s why Tom Stevenson recommends both Fidelity UK Select and Fidelity Special Situations for his ISA fund picks for 2021. Doing so means he’s well-diversified enough to capture the upside, as well as protect against the downside, of either outcome.
You can find all of Tom’s picks here.
Important information: Investors should note that the views expressed may no longer be current and may have already been acted upon. Select 50 is not a personal recommendation to buy or sell a fund. Reference to specific securities should not be construed as a recommendation to buy or sell these securities and is included for the purposes of illustration only. The Fidelity UK Select Fund invests in a relatively small number of companies and so may carry more risk than funds that are more diversified. The Fidelity Special Situations Fund and Fidelity UK Select Fund can invest in overseas markets, so the value of investments can be affected by changes in currency exchange rates. Both funds and the Liontrust UK Growth Fund use financial derivative instruments for investment purposes, which may expose the funds to a higher degree of risk and can cause investments to experience larger than average price fluctuations. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to an authorised financial adviser.
Are corporate earnings strong enough to sustain markets?
Companies have significantly bettered expectations so far
Is now the time to buy for dividends? | A new commodities supercycle
This week, after a tough year for income hunters are UK dividends at last in …