Trends Watch: Value Investing

EisnerAmper’s Trends Watch is a weekly entry to our Alternative Investments Intelligence blog, featuring the views and insights of executives from alternative investment firms. If you’re interested in being featured, please contact Elana Margulies-Snyderman.   

This week, Elana talks with Joanna Wolff, Associate Portfolio Manager at Sionna Investment Managers.   

What is your outlook for value investing? 

We believe there are always opportunities for value investing, whether cyclical opportunities that most people would consider classic value investing but also quality on sale and special opportunities.  Value investing provides the flexibility to move within all pockets of the market to where value is showing best. 

In addition, we believe there has been a regime shift that favors value investing.  This occurred in 2020 when the response to the pandemic triggered wartime-like spending and reignited inflation after many years of disinflation.  Interest rates were quickly raised off historically low levels to combat inflation.  While almost all central banks have begun to reduce interest rates, history suggests that it takes on average ten years to contain inflation below 2% once it has breached 5%.  This shift from disinflation to inflation is in its early innings, and this cycle has averaged about 20 years historically.  Macroeconomic forces like aging populations, deglobalization, decarbonization, digitization, and high debt suggest that inflation is more likely to be above zero going forward.  Using the past as a guide, the value style tends to outperform growth under these conditions.   

For these reasons, our outlook for value investing is favorable.   

Where do you see the greatest opportunities and why? 

Value investors go where companies are overlooked.  We see opportunities in the Canadian and international markets at present.  To give you an idea, the MSCI All Cap World ex. U.S. next twelve- month price-to-earnings is two standard deviations cheaper than the S&P 500.  In fact, looking back at the past 20 years, it is at the biggest discount today.  In Canada, the TSX is also at a two standard deviation discount to the S&P 500 on the same metric.  It too is at the widest differential over 20 years. Even within the U.S. market, there are opportunities particularly in the cheapest 20% of the market.   

History shows that these valuation gaps shift over time and revert to their long-term average.  In fact, since rates bottomed in the summer of 2020, the value style has been outperforming both the broad index and growth index in Canada and internationally (EAFE). 

However, looking at markets is just a starting point.  A security also needs to be underpriced compared to its own history to outperform over the long term. Today at Sionna, we see opportunities in classic value, where historically depressed valuations provide an opportunity for outperformance in the periods ahead.   For example, we are finding opportunities in energy, mining, consumer discretionary retailers and auto parts companies, in which the fundamentals of the businesses are improving but this has not been reflected in their stock prices yet.   

What are the greatest challenges you face and why? 

Investing requires making decisions in the face of uncertainty.  With so much information available at our fingertips today, one of our greatest challenges is sifting through this information in a timely manner.  We believe it is important to do our own due diligence on every investment, one at a time, in order to understand the business drivers and risks.  Our research process is defined in a series of pre-defined questions.  We believe this is a valuable method to make sense of the information we gather, to make sure we cover key areas and to make these explicit.  It is a discipline that helps us reduce uncertainty, risk and failure and most importantly engage in what world-renowned psychologist Daniel Kahneman called slow thinking.  Of course, no investment is ever a sure thing, which is why we impose a margin of safety on each investment and have portfolio construction guidelines as well.  

What keeps you up at night? 

There are many trends in the world today that are troubling, including ongoing war, protectionist policies and slowing economies.  Using history as our guide, while workable resolutions are eventually found and economies rebound in due course, companies tend to adapt to operate within their new realities.   

In terms of making investments, what keeps us up at night is high financial risk.  As such, we avoid investing in companies that have taken on too much debt.  This is because, if the burden of debt is high, it can limit management’s ability to operate or grow the company and it might not be able to survive a crisis situation, which are difficult to predict.   

Risks that we do not mind taking on, if priced appropriately, are cyclical risk and operational risk.  Value stocks tend to be stocks that may have disappointed investors, perhaps because the industry is going through change, or the company is navigating a specific issue, making them unloved. As a result, these stocks tend to trade at lower valuation multiples. This is important for two reasons.  The first is if the company’s revenue underwhelms, its stock price tends not to fall as far since some of the disappointment was already priced in, providing us with downside protection.  Secondly, when the underlying company begins showing progress within its operations, we do not need to have a lot of things go well for the stock’s price to do well.  In effect, we are looking for temporary and resolvable issues that can be corrected over the mid- to long-term – and all we need to bring to the table is patience.   

The author has referenced information in this article which was provided by Sionna Investment Managers Inc. (Sionna) and includes the following disclaimer in that regard: Sionna has taken reasonable steps to provide accurate and current data.  The data has been gathered from sources believed to be reliable, however Sionna is not responsible for any errors or omissions contained herein. This material has been provided by Sionna and is for informational purposes only. It should not be construed as a recommendation to buy or sell. The foregoing reflects the thoughts, opinions and/or investment strategies of Sionna and are subject to change at their discretion and without prior notice, based on changing market dynamics or other considerations. 

The views and opinions expressed above are of the interviewee only, and do not/are not intended to reflect the views of EisnerAmper.