December 2008
For professional investors and advisers only
Schroders
Global Active Value
Fund update
by David Philpotts, Senior Portfolio Manager
International equities performance
It would be an understatement to say 2008 has
been a challenging year, particularly for value
strategies. Chart 1 shows the return of various
market indices since 1 July 2007 and global
equity markets have fallen dramatically across
the board.
Chart 1: Performance of global equity markets: 30 June 2007 to 30 Nov 2008 (local returns)
130
Local
terms
120
110
World
- 41.3%
-21.1%
Value
- 43.7%
24.8%
Small
- 50.0%
-29.7%
100
90
80
In local terms, that is ignoring the impact of
exchange rates, the MSCI World index is down
41.3% while the Value style of investing has
fared worse at -43.7%. Small caps have also
been hit hard down 50%. Emerging markets
initially held up well but have fallen back
dramatically since April.
AUD
terms
Emerging - 40.2%
70
-28.6%
60
50
40
Jun
Aug
Oct
Dec
Feb
Apr
Jun
Aug
Oct
Source: MSCI
For Australian investors, the impact of these declines would have been lessened for those in unhedged global equity
products. Global returns in AUD terms have been approximately 20% better because of the massive depreciation of
the AUD.
Global Active Value strategy recap
A review of the three main building blocks of the Global Active Value strategy will assist to understand recent
performance.
– A deep Value strategy: looking to buy cheap and sell expensive stocks. The value premium is to a large extent
a risk premium and performs much better when there is a greater tolerance for risk. It’s therefore pro-cyclical,
underperforming in economic downturns and outperforming when markets recover.
– Benchmark unaware. Strategically the strategy avoids mega-cap stocks that lag behind on average.
– Exploits huge breadth and taps companies from both developed and emerging markets to maximise opportunity.
Global Active Value is a long term strategy and over the course of the cycle we would expect to make 3 to 4%
above global cap weighted indices. However, as it is a benchmark unaware strategy and completely bottom-up, it
can look very different to the benchmark in the short-run however and we should not be surprised by significant
volatility in short-term relative performance.
Chart 2: Performance of popular global equity managers
Performance and positioning
The absolute performance of Global Active Value
as well as these other popular global equity
products have struggled over the last 12 months.
No-one has escaped the massive market sell off
that has occurred. The underperformance of value
based strategies in general is to a large extent a
reflection of the economic backdrop. The scale of
the relative performance given the bottom up
nature of the fund is certainly not extreme or even
unusual given the market environment.
-28.0
Schroder Global Active Value Fund
-8.7
-8.8
-9.1
Morgan Stanley Global Franchise
Walter Scott Global Equity Fd
Platinum International Fund
-13.2
Perpetual's Ws International Share Fd
-26.3
-26.3
-29.5
-31.8
-32.2
Fidelity Global Equities Fund
Templeton Global Equity Fund
Dimensional Global Value Trust
CFS FC Inv - CFS Acadian Global Equity
GVI Global Industrial Share Fund
DWS Global Equity Thematic Fund
-32.8
-38.5
AXA W Global Equity - Value Fund
-39.3
-40.0
-42.3
%-50
-40
T. Rowe Price Global Equity Fund
AXA - Ws Global Equity - Growth Fund
Hunter Hall Value Growth Trust
-30
-20
-10
0
Source: Morningstar, As at 30 November 2008
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December 2008
For professional investors and advisers only
Chart 3: Key size exposures as at 30 November 2008
Chart 3 shows just how large the Global Active Value
strategy’s anti-mega cap and pro small and mid cap
exposures are compared to MSCI World.
100%
Global Active Value
80%
57.6%
60%
On average, mega cap stocks lag behind but the
market has clearly expressed a preference for such
companies recently as this part of the market is
dominated by the big defensive companies within
consumer staples and healthcare. Brand name stocks
are generally expensive and do not typically form part
of a Value fund. Conversely, performance of small
and mid caps have lagged and this has been a
significant headwind for GAV.
MSCI World Index ex Australia
37.4%
40%
25.2%
27.2%
17.5%
20%
14.6%
13.6%
5.8%
0.6%
0.0%
0%
Mega > $20bn Large $5bn $20bn
Mid $1bn $5bn
Small >
$250m
Micro < $250m
Source: Schroders
Chart 4: Key regional exposures as at 30 November 2008
60%
Global Active Value
52.0%
MSCI World Index ex Australia
40%
29.9%
22.1%
20.7%
21.7%
20%
11.5%
7.2%
5.1%
4.2%
6.8%
10.1%
4.7%
Chart 4 shows the key regional exposures for the
strategy. It is immediately apparent that GAV has a
huge underweight to US stocks which still trades at a
premium to other markets. Also of note is the
exposure to emerging markets. In recent months
sentiment towards emerging markets has turned sour
and investors have been pulling money out despite
the fact that many of these markets still retain quite
sound fundamentals.
1.5%
0%
0%
Source: Schroders
US
Europe ex
UK
Japan
Emerging
Markets
Canada
UK
Pacific ex
Japan
Chart 5: Key sector exposures as at 30 November 2008
Looking at sector exposures in Chart 5, the standout is
the overweight to financials which have been one of the
hardest hit sectors over the recent global financial crisis.
The portfolio only holds very high quality companies
within financials and did not hold Lehman Brothers, AIG,
Merrills etc during the worst of the sub-prime crisis
earlier this year.
Global Active Value
30%
MSCI World Index ex Australia
25.0%
20%
18.0%
14.7%
12.6%
10.5%
9.7%
10%
Elsewhere, the Fund is underweight the 3 big defensive
sectors (utilities, health and staples) which have
outperformed strongly this year. These sectors have
become relatively expensive hence the underweight
exposures in the Fund.
9.0%
10.5%
10.3%
10.8%
9.3%
8.1%
5.5%
5.3%
11.2%
11.3%
5.7%
4.3%
3.9%
2.3%
0%
Financials Teleco
Energy C. Disc
Tech
Material Industrials Health
Staples Utilities
S
Source: MSCI, Schroders
AUD returns to 30 November 08
Schroder Global Active Value
-28.0
MSCI World ex Aus
-22.4
Excess
-5.6
AUD returns to 30 November 08
1 year (%)
Schroder Global Active Value (Hedged)
-47.0
MSCI World ex Aus hedged
-40.2
Excess
-6.8
Source: Schroders, MSCI
2
1 year (%)
The Global Active Value strategy has underperformed by
around 5-6% over the year to November 2008 with most of the
underperformance occurring in the last 3 months. A key risk
with this strategy is that performance can deviate quite
significantly from market cap based benchmarks.
Removing the impact of currency, the MSCI World ex Australia
hedged index returned -40.2% over the past year. Financials
have declined by a massive -54.5%, emerging markets have
fallen 48% and small and mid caps have clearly
underperformed large caps. Global Active Value has
experienced the perfect storm where all of these exposures
have worked against the performance of the Fund.
December 2008
For professional investors and advisers only
Market returns to November 2008 (local) 1 year (%)
MSCI World ex Aus hedged
-40.2
MSCI World Financials
-54.5
MSCI Emerging markets
-48.0
MSCI World ex Aus Large cap
-39.0
MSCI World ex Aus Mid cap
-44.5
MSCI World ex Aus Small cap
-42.7
MSCI United States
-38.7
This economic and market environment is indicative of a
period of extreme risk aversion. Investors have been
particularly severe in dumping the riskier asset classes.
However markets always move in cycles and this period of
underperformance is setting the strategy up for strong returns
going forward.
Source: Schroders, MSCI
Prospects for Value
Chart 6: MSCI World Value excess return over MSCI World
(USD returns)
15%
Value vs World
Long run Average = 1.27%
10%
5%
0%
Recession
-5%
Recession
Recession
Tech bubble/recession
-10%
75
78
81
84
87
90
93
96
99
02
05
08
Chart 6 shows the relative performance of MSCI
World Value vs MSCI World since 1975.
Despite the challenging environment over the
last two years, Value remains a winning long
term strategy outperforming 3 years in every 4.
Many studies show a premium attached to
Value investing and it is during these times of
distress that opportunities abound and set
investors up for the next rebound. Periods of
underperformance such as the recessions of
1980, 1990 and early 2000 have always been
followed by strong outperformance. Investors
need to constantly remind themselves of the
importance of being contrarian.
Source: MSCI, Schroders
Taking an even longer term perspective, Chart 7 shows the
relative performance of a Value strategy in the US back to the
1920’s, the benefit being that we can include no less than 13
recessions in the sample period. It is clearly apparent that
Value underperforms as the economy turns down but then
performs very well just after the onset of recession. This
performance is particularly strong when valuation spreads are
very wide – that is, the valuation gap in the market between
the most expensive and cheapest stock is at an extreme as it
is now.
Chart 7: Average performance of Cheap vs Expensive stocks
since 1926 in the USA before/after onset of recession
120
Onset of
recession
115
110
105
100
95
36
30
24
18
12
6
0
6
12
18
24
30
36
Months
Source: Schroders NBER, K. French, Based on 13 recessions since
1926. ‘Cheap’ based on a “High” minus “Low” Book Yield strategy.
Outlook
The market backdrop of the past 2 years has not been conducive to Value as an investment style which has
adversely impacted upon performance. However, this is entirely natural during a cyclical downturn and has
happened many times before. The recent underperformance of Global Active Value is not out of line with previous
cycles and is certainly not extreme.
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December 2008
For professional investors and advisers only
History has shown us time and time again that recessions create investment opportunities and a Value strategy is
one of the best ways of exploiting this over time. Indeed, it is the very source of the Value premium. As such, short
term comparisons with the index are not necessarily helpful or useful which is why we firmly position the fund as a
medium to long-term strategy. Whilst we expect the market to remain volatile in the short term as the economic
news is digested, the market has not historically had to wait for evidence of recovery to start pricing one in.
Typically, the best times to purchase value is at the nadir of recession.
A frequently cited phrase at moment is attributable to Warren Buffet says who argues that investors should be
fearful when others are greedy and be greedy when others are fearful. That is the essence of Value investing.
This paper is intended solely for the information of the person to whom it was provided by Schroder Investment Management Australia Limited
(ABN 22 000 443 274, AFSL 226473) (Schroders) for discussion purposes only. It does not contain and should not be taken as containing any
financial product advice, financial product recommendations or personal advice. This paper is based on the limited assumptions provided for and
does not take into account all relevant information and you should seek professional tax advice prior to making any investment decisions.
Schroders does not give any warranty as to the accuracy, reliability or completeness of information which is contained in this paper. Except
insofar as liability under any statute cannot be excluded, Schroders and its directors, employees, consultants or any company in the Schroders
Group do not accept any liability (whether arising in contract, in tort or negligence or otherwise) for any error or omission in this study or for any
resulting loss or damage (whether direct, indirect, consequential or otherwise) suffered by the recipient of this study or any other person. Returns
shown are before tax and fees and all income is reinvested. You should note that past performance is not a reliable indicator of future
performance. Opinions constitute our judgement at the time of issue and are subject to change. For security reasons telephone calls may be
taped. Investment in the Schroder Global Active Value Fund or the Schroder Global Active Value Fund (Hedged) may be made on an application
form in the Product Disclosure Statement dated 1 December 2008 available from Schroder Investment Management Australia Limited (ABN 22
000 443 274) (‘Schroders). This document is solely intended for the information of the person to whom it is provided by Schroders. It should not
be relied upon by any person for the purposes of making investment decisions.
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