The Australian share market in 2016 is an interesting illustration of how investment styles come and go and the importance of constructing balanced portfolios. Last year was a reminder that in the market, inflection points can be sudden and are notoriously difficult to predict.
Value investing entered 2016 as the underdog investment style. It had endured a prolonged period of relative underperformance which had delivered poor results for most active managers focussed on the style. However, a strong shift in market sentiment during the year saw the value style come roaring back into vogue.
2016: a year of contrasting halves
Performance for Australian shares was strong in the 2016 calendar year, with the benchmark S&P/ASX 300 Accumulation Index returning 11.8% despite significant periods of volatility. While periods of heightened volatility are fairly common, less typical is the significant rotation within the market that began in the March quarter and gathered momentum through the second half of the year. Chart 1 compares the differences in sector performance in the first and second halves of 2016.
Chart 1: Australian shares sector returns in 2016
Note: S&P/ASX 300 Accumulation Index. Source: JANA Investment Advisers Pty Ltd/FactSet.
Most of the significant sector laggards in the first half (eg Financials, Consumer Staples) were among the strongest performers in the second half, while some of the more defensive/yield sectors (eg listed property trusts or LPTs, Health Care, Telecoms) were the reverse. The Materials sector was the clear outlier, delivering strong returns in both halves, with many stocks in the sector experiencing a significant re-rate during the year due to a rise in commodity prices.
From a style perspective, value benefitted from the rotation in the market, which was driven by two main factors:
1. Investors selling relatively expensive defensive companies and stocks considered to be ‘bond proxies’ as bond yields rose through the second half of the year, and
2. Investors rotating into exposures with greater valuation support and more leverage to economic growth, notably in the Materials (resources) sector, but also in Financials (banks).
The prevailing market environment had driven most value managers to be positioned underweight the stocks in the first category and overweight one or both of the sectors in the second group.
The favourable environment for value investing was largely a reversal of headwinds over the previous few years, so the strong year for value meant recouping lost ground compared to the growth style. This is highlighted in Chart 2, which illustrates the relative performance of value and growth stocks since June 2014.
Chart 2: Relative performance of value and growth stocks since June 2014
Note: Cumulative outperformance versus the market. Source: JANA Investment Advisers Pty Ltd/MSCI.
Cyclicality of styles and importance of ‘holding the line’
At 30 June 2016, a number of value managers in JANA’s Australian shares research coverage had experienced their largest ever underperformance over any one year period. However, just six months later, many of these managers populated the top quartile of the performance tables for one year results to 31 December 2016. Things can turn so quickly!
While prolonged underperformance of an investment manager is difficult to tolerate, it is important to understand the cyclical nature of investment styles and the biases in manager investment processes that can drive results at certain points in the cycle. The relative performance of value and growth stocks was roughly even over the two and a half year period to the end of 2016 (as shown in Chart 2). However, the result could have been much worse for your portfolio if your conviction for your value manager had wavered mid-year and you made a decision to terminate the allocation in favour of a manager who had delivered strong performance over one and three year periods. There is a high likelihood this would have been a growth manager.
Looking over a longer period adds to the picture for the cyclical nature of the two styles. Chart 3 shows the cumulative performance of both value and growth styles to 31 December 2016, as well as the relative performance on a rolling one year basis. It illustrates that since 1990, the value style has outperformed growth, but there have been periods where each style has underperformed for long periods before reverting.
The chart highlights that gravitating toward ‘yesterday’s winners’ is a strategy that is likely to deliver a disappointing outcome.
Chart 3: Performance of value and growth styles to 31 December 2016
Note: MSCI Australia – Value/Growth relative price performance. Source: JANA Investment Advisers Pty Ltd/MSCI.
Style balance in portfolios
JANA generally favours broadly style neutral portfolios with no significant biases when recommending a structure for a client’s Australian shares portfolio. Diverse and complementary approaches are important, as different styles will be in and out of favour at various points in the cycle. Timing a move is typically challenging. Building a balanced portfolio to start with helps to provide a robust long-term outcome for the whole portfolio, as a complementary mix of styles should provide ‘winners’ at most points in the cycle.
This information has been provided by JANA Investment Advisers Pty Ltd (ABN 97 006 717 568, AFSL 230693) (JANA), investment adviser to NULIS Nominees (Australia) Limited (ABN 80 008 515 633, AFSL 236465) (MLC) and MLC Investments Limited (ABN 30 002 641 661, AFSL 230705) (together “MLC”) and a member of the National Australia Bank Limited (ABN 12 004 044 937, AFSL 230686) group of companies (NAB Group), 105-153 Miller Street, North Sydney 2060. An investment or any product or service offered by JANA, MLC or MLCI does not represent a deposit or liability of, and is not guaranteed by, the NAB Group.
This information may constitute general advice. It has been prepared without taking account of individual objectives, financial situation or needs and because of that you should, before acting on the advice, consider the appropriateness of the advice having regard to your personal objectives, financial situation and needs.
Past performance is not a reliable indicator of future performance. The value of an investment may rise or fall with the changes in the market. Please note that all performance reported is before management fees and taxes, unless otherwise stated.
While JANA has taken all reasonable care in producing this communication, subsequent changes in circumstances may occur and impact on its accuracy.
JANA relies on third parties to provide certain information and is not responsible for its accuracy. JANA is not liable for any loss arising from any person relying on information provided by third parties.