Please refer to the glossary for an explanation of the investment terms used throughout this article.
At M&G, we pride ourselves in taking a long-term approach to investing.
While the market value of an investment may rise or fall from day-to-day, its fundamental value should prevail over many years. Where assets with robust long-term prospects are undervalued by today’s market, it follows that there might be buying opportunities.
This strategy of buying desirable assets when they are out of favour, and therefore cheap, is commonly known as ‘value investing’.
The price of an investment should reflect both prospective returns and the risk that these will not be achieved, or that it will lose value over time.
The key to value investing is identifying assets – be they bonds, property or equities (company shares) – that are trading at a price below what’s considered to be their 'fair' value, taking into account all the risks and rewards. Doing so accurately requires market expertise and skilled analysis.
Value investors believe that markets are moved away from 'fair' long-term valuations by short-term factors. It is common for investors to react disproportionately to news events or policy changes, losing sight of the fundamental value of assets.
As a result, opportunities arise where assets become undervalued. Investors focused on achieving long-term value aim to buy assets when they judge the market price to be cheap, and profit when the assets move back towards their 'fair' value once short-term factors recede.
If successful, a strategy of buying low and selling high will deliver a capital gain for the astute value investor. This is not all, however. Where an asset generates income, such as the coupon on a bond or rent from a property, the value investor will also receive higher total returns (the combination of income and growth of capital) as a percentage of their investment. Of course, if the price of an asset falls over time then the investor will make a capital loss and might have overpaid for any income that it delivered.
Over the long run, value investing has tended to slightly outperform the market, although it is worth remembering this is no guarantee that it will continue to do so.
From 1975 to the end of 2016, total returns from the MSCI World Index – a benchmark for stockmarket performance in developed economies – have averaged 10.7% a year. The MSCI World Value Index, which includes companies from the same markets that satisfy ‘value’ characteristics, has delivered total returns of 11.8% a year.
The chart below compares the performance of the two indices between 2002 and 2016.
Source: MSCI, 3 January 2017.
This analysis indicates that value investing has outperformed the market when the global economy has been growing strongly – as in the mid-2000s – but has underperformed in the downturns, such as 2007 to 2010. One explanation for this underperformance could be that the market tends towards assets perceived to be 'safer' investments when confidence in the economy is low.
The nature of value investing means that it is more appropriate for investors whose circumstances allow them to take a long-term approach. After all, it might take years before the market value of an asset returns to its fundamental value.
Investing is no exception: patience always is a virtue.
Important information
When you're deciding how to invest, it's important to remember that past performance is not a guide to future performance, and that the value of investments can go down as well as up. So how much your investments are worth and the income from them will fluctuate over time, and you may not get back the amount you originally invested.
We are unable to give any financial advice, and the views expressed in this article should not be taken as any kind of recommendation or forecast. If you are unsure about the suitability of your investment, please speak to a financial adviser.