After ‘value investing’ made a comeback in 2016, Prudential’s asset manager, M&G, explains what it is and how to benefit from it.
An M&G guide to ‘value investing’
At M&G, we pride ourselves in taking a long-term approach to investing.
While the market value of an investment may rise or fall from day-to-day, its fundamental value should prevail over many years. Where assets with robust long-term prospects are undervalued by today’s market, it follows that there might be buying opportunities.
This strategy of buying desirable assets when they are out of favour, and therefore cheap, is commonly known as ‘value investing’.
The price of an investment should reflect both prospective returns and the risk that these will not be achieved, or that it will lose value over time.
The key to value investing is identifying assets – be they bonds, property or equities (company shares) – that are trading at a price below what’s considered to be their 'fair' value, taking into account all the risks and rewards. Doing so accurately requires market expertise and skilled analysis.
Value investors believe that markets are moved away from 'fair' long-term valuations by short-term factors. It is common for investors to react disproportionately to news events or policy changes, losing sight of the fundamental value of assets.
As a result, opportunities arise where assets become undervalued. Investors focused on achieving long-term value aim to buy assets when they judge the market price to be cheap, and profit when the assets move back towards their 'fair' value once short-term factors recede.
If successful, a strategy of buying low and selling high will deliver a capital gain for the astute value investor. This is not all, however. Where an asset generates income, such as the coupon on a bond or rent from a property, the value investor will also receive higher total returns (the combination of income and growth of capital) as a percentage of their investment. Of course, if the price of an asset falls over time then the investor will make a capital loss and might have overpaid for any income that it delivered.
Does it work?
Over the long run, value investing has tended to slightly outperform the market, although it is worth remembering this is no guarantee that it will continue to do so.
From 1975 to the end of 2016, total returns from the MSCI World Index – a benchmark for stockmarket performance in developed economies – have averaged 10.7% a year. The MSCI World Value Index, which includes companies from the same markets that satisfy ‘value’ characteristics, has delivered total returns of 11.8% a year.