Value-heavy industries have been in secular decline
Banks and energy are examples of value-heavy cyclical industries facing headwinds that are unlikely to reverse following an economic recovery. Banks, for example, have faced sustained low interest rates and tighter regulation. This has led to them scaling back on their trading activities and reducing their risk exposures to achieve financial stability.
These factors have put dividends under pressure. As such, for banks to become long-term winners, many are looking to diversify their revenue streams and build out digital capabilities in order to face newer and more agile players.
Digitisation - the fourth industrial revolution - has divided winners and losers
FAANG+M1 have blazed a trail in enabling key technology advances, such as high-speed mobile internet, artificial intelligence and automation, the use of big data analytics and cloud technology. As digitisation grows, industry boundaries may become blurred. Firms that have already begun diversifying outside of their main industry have seen their revenues grow 25% higher than the sector average2. This highlights that disruption and innovation aren't confined by value and growth labels.
Industry composition has narrowed
Industry composition has narrowed over time. Banks have remained dominant within the MSCI World Value Index over the last 20 years, shifting from 16.0% to 10.7%. However, within the MSCI World Growth Index, they have collapsed to just 0.2% (from 2.5%). Conversely, technology hardware has risen to become 9.0% of the global growth index (previously 5.1%) while remaining below 1% of the global value index over the last two decades. This not only makes diversification within style more difficult to achieve, but also suggests that secular changes - as they relate to industry - have become more influential for returns3.
Growth in intangible assets has made determining intrinsic value increasingly complex
The rise of the knowledge economy over the last three decades has led to a significant rise in intangible assets. For style investors, this challenges the ability to understand a firm's intrinsic value. This doesn't make traditional valuation approaches useless but does mean investors need to make adjustments to determine true value. Some have responded by attempting to systematise these adjustments4 , such as including R&D and even adding a proportion of operating expenses. However, as many of these items are difficult to measure, a bottom-up approach is warranted to benefit from company-specific analysis and qualitative judgement.
These secular shifts outlined above show that it is becoming more difficult to consider growth and value stocks as distinctly different. Instead, investors could consider looking within both value and growth universes to select stocks that meet their capital appreciation and income objectives.
1 Facebook, Amazon, Apple, Netflix, Google and Microsoft
2 Source: Twenty-five years of digitization: Ten insights into how to play it right, McKinsey Global Institute, May 2019
3 Data as at 31 December 2000 and 31 December 2020. Source: FactSet
4 Examples include initiatives from Research Affiliates and Empirical Partners Research