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It has been a difficult decade for the ‘value’ approach to investing, but this may be about to change. There are clear shifts in the inflation and interest rate environment, which should favour value, while the value approach still has a clear advantage on valuation. However, we would argue there are other reasons to look at value today – from balancing ESG (Environmental, Social and Governance) exposure to its diversity.
The first reason to reappraise the value approach is simply the valuation argument. Value always trades at a discount to growth, but that elastic has been stretched. Now the gap between the valuations of growth and value stocks is at historic highs, even after the recent bounce back for certain value sectors such as energy.
This coincides with a change in the interest rate regime. Our view is that inflation is likely to persist, given the situation in Ukraine and the supply chain bottlenecks that are a legacy of the Covid pandemic. Higher food and energy prices are likely to be around for a little while longer. The US Federal Reserve has not wavered on rate rises despite the rising cost of living, recognising the need to tackle inflation, and is still forecasting at least six rate rises for the year ahead.
In general, this is a far more favourable environment for value investors. Looking at the 80–100-year history of value versus growth, value tends to do best is in periods of higher and rising rates and higher and rising inflation. This is the regime likely to prevail for the foreseeable future.
The ESG angle
However, there are other, less obvious reasons to turn to value today. The past few years and the strong performance of growth stocks have left many investors with portfolios that are pointed in one direction. It may be a particular problem for ESG investors. The vast majority of sustainable ESG funds are growth oriented. This growth skew could be a looming risk for sustainable investors.
As such, there is an important place for a value ESG fund within a portfolio. There are relatively few funds that fulfil this brief and value investing continues to be seen as focused on old-fashioned, carbon-intensive industries with little to tempt a sustainable investor. In reality, value and ESG investing are not incompatible and bringing in an ESG lens can help reduce the volatility associated with ESG investing.
This Trust seeks to have a stronger ESG score than the MSCI benchmark, while excluding some harmful sectors, such as controversial weapons or thermal coal. We also look to ensure that this portfolio has a higher score based on Scope 1, 2 and 3 greenhouse gas emissions.
In general, we would rather work with companies to improve their practices. In the energy sector, for example, not all companies are equal. When it comes to carbon reduction and future proofing their business, some companies have their head buried in the sand, but other companies are playing a vital role in the transition to clean energy. There are a lot of companies using the cash flows from energy production to invest in greener options. We need to provide them with the capital to make that change.
Diversity of opportunity
A final reason to consider value is that it is a far more diverse approach than investors have come to believe. The BlackRock Sustainable American Income Trust strives for balance and resilience, and we have no problems creating this within a value portfolio. We can find opportunities amid relatively cyclical sectors, such as energy, alongside more stable sectors, such as healthcare.
Perhaps surprisingly, technology is our largest relative weight. Technology stocks are becoming the new staples. Just like healthcare, people cannot shut off or stop buying technology just because the economy is in recession. On the flip side, the Trust also has a significant weight to consumer discretionary stocks. The US consumer is in good health, a very different position from its situation during the global financial crisis. House prices are rising, at the same time as income and wages, which should help support spending.
We’re excited by the outlook for value stocks. Over the long term, value outperforms, but the last 10 years or so, in the wake of the global financial crisis, have been very tough for value investors. That's an anomaly in history and has left value stocks on a significant discount. We're now in a real regime change and there's a lot of stored value in those value stocks. To our mind, the rotation that we’ve seen towards value stocks is only just getting started.
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Trust Specific Risks
Exchange rate risk: The return of your investment may increase or decrease as a result of currency fluctuations.
Risk to capital through derivative use: The Fund may use derivatives to aim to generate more income. This may reduce the potential for capital growth.
Capital growth/Income variation risk: Investors in this Fund should understand that capital growth is not a priority and values may fluctuate and the level of income may vary from time to time and is not guaranteed.
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Gearing risk: Investment strategies, such as borrowing, used by the Trust can result in even larger losses suffered when the value of the underlying investments fall.
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