MCA looks deeper for value

Australia Value Equity strategy

23 July 2018

MCA looks deeper for value
Key points
  • Despite the better outcomes that P/E and P/B measures do indicate, and the lower opportunities shown by quant measures, we do see that valuation spreads have somewhat widened, but only at the extremes.
  • This does not mean that our Value approach is compromised. Our multi lensed investment process allows us to carefully assess the potential reward versus risk on offer, regardless of the prevailing conditions.

FULL REPORT (PDF) | ARTICLE SUMMARY

Martin Currie Australia's investment team of 17 conducts fundamental, forward looking risk adjusted analysis on the broad Australian market considering cashflow, quality, growth, cyclicality, and environmental, social and governance (ESG) risks.

This fundamental research, combined with 24 years of proprietary data, puts us in a great position to consider valuation opportunity across the Australian market.

In our ongoing analysis, we compare the valuation of the 90th percentile stock (representing the cheapest stocks) versus the median but also the 80th percentile (the next cheapest) versus the median based on our in house Valuations.

MCA valuation spreads

Past performance is not a guide to future returns.
Source: Martin Currie Australia; as at 30 June 2018.

In the preceding chart you can see that, in the years pre-GFC, there was less dispersion between the 90th and 80th percentile stocks vs the median stock in the ASX200.

Following the GFC, these value spreads have been much wider generally and also relative to each other. This was as a result of greater uncertainty about world growth drivers.

However, since 2009, these spreads had narrowed significantly, and in February 2017 reached their lowest post-GFC levels.

It is only recently have the spread for cheapest stocks begun to really look cheap again. However you can see that this hasn't spread to next cheapest stocks yet.

FOCUSING ON THE FUNDAMENTALS – A BETTER WAY TO FIND VALUE

So our analysis supports the thesis' of good and poor valuation opportunities discussed earlier.

Despite the better outcomes that P/E and P/B measures do indicate, and the lower opportunities shown by quant measures, we do see that valuation spreads have somewhat widened, but only at the extremes.

So, if value spreads, by our measures, are in fact generally still low – and only in certain pockets – is our Value approach compromised? In a word, no.

We believe the combination of our collective analysis of the market environment and our multi-lensed investment process (Valuation, Quality, Direction and Sustainable Dividend) places us in a unique position to assess the potential reward versus risk on offer of individual stocks, broad factors and the market regardless of the prevailing conditions.

For example, valuation spreads approached their lows in early 2017, we viewed the risk/reward skew of holding lower Quality/deeper Valuation names as inadequate, and we moved the portfolio towards higher Quality companies with stronger earnings Direction characteristics that also offered superior risk adjusted value opportunity.

IS IT STILL VALUE THEN?

Notably, our approach to risk-adjusted value led to our Barra Value exposure (similar to p/b) going negative over 2017 and into 2018.

This was not a break in process or philosophy. On the contrary, it was due to the consistent application of our Valuation, Quality, Direction process, considering the potential reward versus risk on offer at both the stock and factor level, that took us away from naively cheap stocks (such as the banks) in 2017.

Risk exposures

Past performance is not a guide to future returns.
Source: Martin Currie Australia, MSCI Barra; as at 30 June 2018. Data shown for a representative Value Equity account for illustrative purposes only.

Holistically, you can see in the chart below that as Valuation has narrowed for the portfolio, we have been able to improve the portfolio’s Quality and Direction characteristics, ensuring strong expected return characteristics of the portfolio.

Risk exposures based on MCA research lenses

Past performance is not a guide to future returns.
Source: Martin Currie Australia; as at 30 June 2018. Data shown for a representative Value Equity account for illustrative purposes only.