In an interview with Morningstar last November, International Value Advisors CIO and portfolio manager Charles de Vaulx outlines what he sees as headwinds for value investing.
De Vaulx cites the following major headwinds for value investing:
- Interest rates: One of the most powerful headwinds, says de Vaulx, has been what he described as “ultra-low” interest rates that have been distorted by central banks and have “resulted in misallocation of capital in some value-friendly industries.” When rates have been this low in the past, he argued, it was due to high economic growth, which is not the case in today’s environment.
- Aggressive share buybacks in the U.S. present another concern for value, says de Vaulx. While buybacks may have bolstered the intrinsic value per share of many value stocks, he argues that it has made it difficult for them to become cheap enough to offer investors a margin of safety.
- Lack of business cycle: De Vaulx notes that, compared to the 19th century, the periods of economic expansion have become protracted. Specifically, he cites data reflecting that in the 19th century, the economy was in recession 50% of the time compared to 26% in the 20th century and 18% so far in the 21st century. Conversely, the average length of economic expansions were 25 months (19th century), 44 months (20th century) and 101 months (21st century). De Vaulx argues that we need more volatility in both the stock market and the economy in order for value investors to practice their strategies. Further, he doesn’t believe the lack of business cycles in the U.S. is sustainable, particularly given the backdrop of growing corporate and government debt.
- Reversion to the mean: De Vaulx asserts that there has been an absence of “reversion to the mean” for over a decade for many quality and growth stocks, adding that the “fade rate” has waned—that is, growth stocks are able to keep their status for longer periods of time. Further, increased corporate profitability has been driven by a wave of consolidation in growth industries. But the converse also holds true for many sectors associated with value investing such as retail, oil & gas, financials and consumer staples.
De Vaulx contends that active managers are still able to add value in less efficient markets such as international (especially small- and mid-cap), high-yield, and distressed debt. While he believes that the advent of passive investing has been important in that it exposed closet indexers who were charging high fees, he notes that indexing offers investors no downside risk, something they should be aware of.