By Cornelius Zeeman,
Fairtree Portfolio Manager

Identifying styles in our market.

Value vs growth investing is a debate practically as old as investing itself. The dispersion of returns of the S&P Growth and Value indices over the last four years have further muddied the waters to determine which style is better, as depicted in Graph 1 below. Growth outperformed Value by 31% in 2020 when interest rates were cut to zero to stimulate economies and markets after the COVID-19 crash. In this low cost of equity environment, managers who had a bias to invest only in quality growth companies delivered stellar returns.

2022, conversely, was the opposite market environment because interest rates in the US hit 5%, and the consensus view was that the economy was heading for a recession in 2023 – this was an environment where value managers comfortably outperformed because longer duration cash flows stocks came down to earth in dramatic fashion. Consequently, the S&P Value Index outperformed the S&P Growth Index by 22% in 2022.

Graph 1: S&P Growth & Value indices returns (USD)

Source: Bloomberg

The Morningstar rankings (shown in Table 1 below) depict the performance of global equity funds on a yearly basis and show how this dynamic played out.

Notably, the majority of the top 20 performing funds in 2020 turned out to be the worst performers in 2022. However, this isn’t necessarily a bad thing. You would expect a manager who positions themselves with a strong growth-quality bias to anticipate how the pendulum can (and will) swing. Over the past 15 years, post the Global Financial Crisis (GFC), these managers have prospered as interest rates continued to drift lower over time, allowing for multiple expansions on top of earnings growth.

Table 1: Morningstar rankings – Top 20 global equity funds (in 2020)

Source: Morningstar, Bloomberg (as at 31 December 2023)

The same, but opposite, trend played out at the bottom of the rankings table (shown in Table 2). Most of the worst-performing funds in 2020 occupied the top spots in 2022. These managers can proudly state that they stuck to what they sell on the label despite going through a very difficult 2020 and the period before that.

Table 2: Morningstar rankings – Bottom 20 global equity funds (in 2020)

Source: Morningstar (as at 31 December 2023)

2021 and 2023 were years where both the Growth and Value indices posted returns above 20%, so they delivered more mixed outcomes as one would expect, although 2023, when the Magnificent 7 left the rest of the index behind, has a similar look to 2020.

The Fairtree Global Equity Fund is style agnostic. This is a function of two things:

• Firstly, the multi-factor quantitative model which we use as a screening, optimising and risk management tool. It looks at more than twenty metrics, which broadly falls under Growth, Quality, Value and Momentum. This results in our Fund always being overweight in all four of these styles.
• Secondly, our incorporation of macro views. Just as with sport, we think it makes sense to tweak the game plan so that it suits the conditions. In 2020, we recognised that growth was more important than value, so we tilted the portfolio towards those names. Emphasis on tilt. During 2022, we tilted the portfolio towards shorter duration cash flows because the cost of equity changed.

Warren Buffet once said, “Charlie Munger and I always have preferred a lumpy 15% return to a smooth 12%”. Although we agree with this statement, we believe that it is valuable to aim for the highest returns while reducing unnecessary volatility by adapting to the different economic and market cycles. Our top quartile position in 2020-2022 is therefore something that you would expect from a style-agnostic manager.

What happened in 2023?

Although the Fund delivered 31% in 2023, it was disappointing to underperform the benchmark by 2%. We got the macro call about calls for a recession being premature correct. We understood that the corporate and household balance sheets were strong and that interest rates have been fixed, meaning higher Federal rates will take time to slow down the economy.

One of the key reasons for the underperformance was us taking profits too early on our US tech (Meta, Adobe, Amazon, Nvidia, etc.) overweight and increasing our Chinese tech exposure throughout the year as the risk-reward became more attractive in our opinion.

Graph 2: Fairtree Global Equity Fund active exposure during 2022 and 2023

Source: Bloomberg, Fairtree (as at 31 January 2024)

Chinese technology stocks have suffered a severe derating over the last couple of years. It was difficult to imagine that the Nasdaq would rerate by 6 points to 28.8x forward price/earnings, while the Chinese names derate to the extent they have. The current ratings are more extreme if you consider that cash and equivalents is now equal to 93% of JD.com’s market cap and 63% of Alibaba.

Graph 3: Forward Price/Earnings Ratio

Source: Bloomberg, Fairtree (as at 31 January 2024)

Looking forward.

We believe interest rates over the next decade will be higher than the previous one. This means there is more value in shorter duration cash flows. The Fund therefore has a weighted P/E ratio of 14.3x, which is 5 points lower than the Index funds in our market. Graph 4 below illustrates that the best-performing funds over the last five years are generally funds that own a portfolio of expensive stocks. This makes sense because we know Growth has dominated Value. We also live in uncertain times – geopolitical risks and technological development can have major unforeseen impacts on companies. We therefore believe it is prudent not to be too generous with the price you pay for earnings streams at the moment.

Graph 4: Global Equity Funds – Current Valuation vs Historic Return

Source: Morningstar (as at 31 January 2024)

Disclaimer:

Fairtree Asset Management (Pty) Ltd is an authorised financial services provider (FSP 25917). Collective Investment Schemes in Securities (CIS) should be considered as medium to long-term investments. The value may go up as well as down and past performance is not necessarily a guide to future performance. CISs are traded at the ruling price and can engage in scrip lending and borrowing. A schedule of fees, charges and maximum commissions is available upon request from the Manager. A CIS may be closed to new investors in order for it to be managed more efficiently in accordance with its mandate. Performance has been calculated using net NAV to NAV numbers with income reinvested. There is no guarantee in respect of capital or returns in a portfolio. Prescient Management Company (RF) (Pty) Ltd is registered and approved under the Collective Investment Schemes Control Act (No.45 of 2002). For any additional information, such as fund prices. A Feeder Fund is a portfolio that invests in a single portfolio of a collective investment scheme which levies its own charges, and which could result in a higher fee structure for the feeder fund.