Defining value in post-crisis markets

In severe market downturns rational thinking is usually one of the first victims. As investors seek a way out of the volatile equity markets, and into the relative safety of other asset classes, the frenzied selling that accompanies the onslaught of a deep bear market can punish good companies along with the real underperformers. Now as markets the world over appear to slowly enter recovery and investors look to cautiously rejoin the equity markets, a key challenge will be telling the difference between stocks that are undervalued and those that are oversold. In the post-crisis world, value investing takes on renewed importance, but with the S&P 500 dropping 38.49 per cent in 2008 and other world markets suffering similar outsized declines the real question may be “has the crisis changed the definition of value?” As part of the multi-boutique Natixis Global Asset Management Group, Natixis Global Associates can draw perspective from a deep selection of value-oriented affiliated investment managers, each with their own views on value and the market at large. In this, we ask three value specialists from the Natixis Global Asset Management Group – Vaughan Nelson Investment Management; Loomis, Sayles & Company; and Harris Associates – whether their views have changed. Vaughan Nelson Investment Management’s senior portfolio manager for equity investments, Chris Wallis, believes value investing has always been incorrectly defined. “Our view is that value is always driven by the underlying price of a security relative to its profitability and rate of reinvestment, which then determines its growth rate,” he said. “So you can never truly differentiate between growth and value.” Mr Wallis says true growth investors have so much confidence in a business that they are willing to let the current valuation get ahead of the current underlying intrinsic value based on today’s cash flows. “We have a lot of companies in our portfolios whose underlying free cash flows, rate of reinvestment and rate of growth would represent a growth company but they have value multiples,” said Mr Wallis, co-manager of the Vaughan Nelson US Small Cap Value Fund*. “If I can buy a company that offers high return on equity and at the same time can grow in a global economy, where many companies are going to be shrinking or permanently impaired, and get it at 8,10,or 12 times earnings, that is value to me.” Today’s value opportunities – at least at the individual security level – are better than we have seen in the last eight or nine years, says Mr Wallis. “Unencumbered companies – essentially those that don’t need access to credit and their customers don’t need access to credit to buy their products or services – are trading at deep, deep discounts to the extent that their markets are still maintaining their value to grow,” he said. According to Mr Wallis, many of these opportunities are now available because there is no longer a concern about the credit bubble. “We were always being asked when the credit cycle is going to end and what will happen next,” he said. “I believe we are now beyond that point and that we will have a sustainable period of access to money. We are going to be printing money, and those dollars either have to go into pricing or liquid assets. I believe they’re going to go into liquid assets.” Blurring the lines Loomis, Sayles & Company portfolio manager Warren Koontz says broadly declining stock prices have resulted in a contraction of P/E ratios and the hard line that once delineated growth names from value names is now blurred. “While recent changes in valuations have not altered our definition of value investing, some unconventional stocks and sectors have temporarily entered the value arena, and our hunting ground has certainly expanded,” he said. In addition to traditional value haunts like energy, Mr Koontz says he is seeing attractive opportunities in sectors like technology and biotechnology that are accessible for virtually the first time. “We continue to focus our attention on true large-caps, and most names of interest have market caps above $15bn (E11.1bn),” he said. “We continue to seek opportunities to invest in fundamentally sound companies that we believe are selling at a significant discount to intrinsic value and can produce exceptional long-term results,” added Mr Koontz. Redefining value Harris Associates portfolio manager Ed Loeb is equally bullish about value opportunities. “We think the opportunity today is as great as we have ever seen it in our firm’s history, and that goes back 30 years,” he said. In Mr Loeb’s opinion, value began to be redefined a few years ago after the technology bubble burst, resulting in high-quality businesses dropping into value investors’ laps. “Names that we admired for a long time and never thought we would be able to buy suddenly became available at cheaper prices,” he said. “We are seeing it today not only in technology, but in healthcare, pharmaceuticals, and large retailers. There are so many businesses now available across the entire market that at one time carried such premium multiples because of the great nature of their businesses that are now at value prices,” explained Mr Loeb. Current market aside, Mr Loeb says long-term he still defines value opportunities by measuring the current price of a portfolio compared to its intrinsic value. “What do we think the business would be worth if a rational buyer was willing to purchase the entire enterprise,” he said. “Today that discount is sometimes greater than 50 per cent. In other words, some stocks are selling at less than 50 cents on the dollar, which implies that these stocks may double over the long-term to reflect that fair value. This is much wider than we have seen in recent years and even wider than we saw in the late 1990s.” Mr Loeb does believe that the distinction between growth and value, and to some extent between large-and small-cap, has become less relevant in recent years. The reason for this is the markets have corrected substantially. “We think the market generally looks cheap, so it may not matter as much whether you are in value or growth,” he said. Recovery may present significant investment opportunities. But following a period of tumultuous market activity it makes sense to find an expert who can help you sift through the aftermath and uncover the real values presented to investors by today’s markets. Natixis Global Associates believes it is important to consider a diverse range of opinions before you act. *The fund is a sub-fund of Natixis International Funds (Lux) I which is organized as an investment company with variable capital under the laws of the Grand-Duchy of Luxembourg and is authorized by the financial regulator (the CSSF) as a Ucits. The funds have also been authorised for sale to the public in certain other European jurisdictions including the UK

Chris Wallis: “You can never truly differentiate between growth and value”