Many asset owners still look at value as a core portfolio exposure despite recent underperformance, but will their patience be rewarded? Head of Multi-Asset Strategy Adam Berger and Equity Portfolio Manager Nataliya Kofman offer their thoughts, including on “resilient” value stocks, disruptive themes, and attractive sector- and country-level opportunities. 

Adam: As a long-time value investor, how do you make sense of what’s been a pretty anemic period for value returns? And what might change the results going forward?

Nataliya: I think there are a number of factors to consider. We’ve been through a decade of historically low interest rates. The lower cost of capital made it easier to justify investments with a long growth horizon and without current free cash flows. It was also an era of innovation, as we saw in big tech, pharmaceuticals, biotech, and other areas. And the resulting disruption had an impact across the market, but on value-oriented industries in particular. To give a few examples, we’ve seen disruption in the consumer discretionary space, with the shift to online retail; in auto manufacturing with the move to electric vehicles; in the financial sector with the emergence of digital banking alternatives; and in energy and utilities amid the growth in renewable energy.

In terms of what will change the trajectory for value, I think the market hasn’t fully recognized that within these industries, there’s been an emergence of resilient companies — battle-tested franchises with scale, expertise, and balance sheet flexibility. They are investing in innovation just as growth companies have, and they have the balance sheets and the capacity to sustain those investments. So, I think we’ll see a separation between these resilient companies and the rest, which could make the next decade very different from the prior one. For example, we’ve seen signs of this in the retail space, with the emergence of a few stronger brick-and-mortar retailers, and in the auto industry, with the EV upstarts facing stronger competition from existing players. But again, the market is hanging on to the idea that legacy companies cannot compete and create value over the long run. I think that’s where the importance of valuation comes in, and so I’m excited about the opportunities ahead.

Adam: As you note, disruption was a prevalent theme over the past decade. But there’s more where that came from, as we saw in 2023 — from concerns about the US banking system to the rise of generative AI and a whole new class of weight-loss drugs. How do you think about the value universe when there’s so much change afoot?

Nataliya: Value investing requires a long-term perspective, and that applies to today’s disruptive themes. The US banking sector was certainly tested in early 2023, and I think it proved to many investors and to regulators that there are resilient companies out there and that patience is required for those companies to emerge. So again, leaning into resilient companies can be critical when managing a value portfolio through a period of change.

Health care is another sector where I believe there’s a level of resilience and innovation that isn’t being fully rewarded by the market. With the GLP-1 weight-loss drugs being such a focal point for the market, many other areas of innovation are being overlooked to some extent, in treatments for rare diseases and in immuno-oncology, for example. 

And the last point I’d make is that while disruptions like AI technology are exciting, as a value investor I have some concerns about the high prices and expectations for some of the direct plays in these areas over the last 12 months. But I do think there are interesting opportunities in the ecosystems that are growing around those direct plays, including less-recognized companies that may emerge gradually and grow earnings over a longer horizon.

Adam: I’m often asked by asset owners about the sectors that matter most in the value space. Can you talk about how you think about sectors? 

Nataliya: As a bottom-up investor, I’m more focused on individual ideas than sector-level decisions. But it can be helpful to step back and look at the market and sectors more broadly. I tend to think of it in the context of cycles and super cycles. We’re seeing a super cycle right now driven by technology and new applications for AI. But there are also multiple, very interesting cycles globally that are helping to drive individual investment opportunities. I already mentioned health care, for example. And I would include some technology industries such as analog semiconductors and networking equipment — areas I think could benefit when AI penetrates the broader market but that are currently outside of the market’s interest.

I would also mention consumer stocks, especially in Europe, as well as energy, transportation, utilities, and financials broadly.

Adam: You mentioned Europe. Is the search for value outside the US different than in the US right now?

Nataliya: I think there is a lot more opportunity outside the US at the moment. Valuations tell part of the story. As shown in Figure 1, US valuations are well above their historical range (orange dot), while other markets, including Europe and emerging markets, are more attractive. Even if you remove the “Magnificent Seven,” US valuations remain on the high side (second bar from the left).

Figure 1

I’d also note that US versus non-US leadership has historically come in very long cycles. The last time we saw the rest of the world underperform the US to the degree it has recently was in 1998. At that point, following the Asian financial crisis, a period of non-US outperformance began, and it peaked during the 2008 global financial crisis, after which the US regained leadership. Of course, a low starting point for valuations is not a guaranteed predictor of future returns. But based on the fundamentals, I do believe there are a range of attractive opportunities outside the US, including companies with good corporate governance, balance sheets, and dividends.