Brandes Letter Time to Remember First Principles

Brandes Letter: Time to Remember First Principles



NOVEMBER 2019

Dear Clients and Friends,

As 2019 winds down, we once again want to express how honored we are when clients entrust us with managing their investments. We take this responsibility very seriously and as stewards of your investments we believe it’s our duty to deliver a consistent, style-pure application of our stated value investing approach. In short, we must do what we told you we would do.

As you are well aware, value as an investing style has been meaningfully out of favor for most of the past dozen years.1 Many have questioned the future of value with some pundits declaring that value is dead.

Obviously, we don’t believe that value is dead and are confident that the basic principle of buying what we believe is worth a dollar for 70 cents will never not make sense. However, we do acknowledge that current geo-political and macro-economic issues have created a difficult period for value which could persist for some time to come. Given that, how should investors think about value now?

When faced with situations that don’t behave as expected, we think it’s important to always return to “first principles.” In this context, first principles of investing, in our opinion, include diversification and prudent asset allocation.

We have the privilege of serving clients all over the world from our offices in the United States, Europe, Asia and Canada, and we are seeing some common tendencies that include a broad rejection of the value investing style and an over-embracing of styles that have worked lately.

Here are some observations from our global perspective:

In the United States:

  • Active value as a percentage of total equity assets under management (AUM) stood at 16% in 2008; it fell to 9% in 2018.2
  • This apparent rejection of value comes when valuation dispersion is at extreme levels. At the end of 2018, value stocks traded at a 90% discount to growth stocks based on price/earnings (P/E).3

In Canada:

  • Six of the country’s 10 largest global equity funds were in the value category in 2006 with only one in the growth equity fund category. Thirteen years later, there is only one fund in the value category and six in the growth category.4
  • We believe Canadians, on average, are historically over-allocated to the U.S. markets and under-allocated to the value investing style.

In Europe:

  • Local stocks (as measured by the MSCI Europe Index) are trading at among their widest discount to U.S. stocks (S&P 500 Index) in over 30 years based on cyclically adjusted P/E.5
  • Value stocks (MSCI Europe Value Index) are trading at 26% below their 20-year P/E average, while growth stocks (MSCI Europe Growth Index) are trading above their 20-year average.6

We have observed that many “value” funds display characteristics more akin to quality- or growth-oriented strategies. Value-focused funds (i.e., those with net value exposure of 60% or more) now only account for 3% of global and international equity AUM.7  While the markets have generally rewarded this over-concentration away from value, this has led to a potential lack of diversification that has generally not served long-term investors well in previous market cycles.

Whether it is truly ”different this time” and a strategy of “buy high and sell higher,” which has worked for much of the past decade, continues to outperform is open for debate. However, our experience in navigating global markets for 45 years leads us to believe that the success of such a strategy is not likely to persist. This is why we believe prudent asset allocation is more important than ever and is a way to help protect from unpredictable markets. 

As we travel the world to visit clients and to research businesses, it’s no surprise to us that allocations to value investing have declined dramatically in recent years. As this cycle persists, some investors are taking a wait-and-see approach to value investing. In our conversations with investors, some are aware of their historical under-allocation to value, and want to know when value will rebound and what catalyst will cause this to occur. Others have capitulated entirely and succumbed to the idea that value is dead and, by extension, that traditional asset allocation is no longer necessary. In recent months, as value showed promising signs of a rebound, questions changed from a focus on the resilience of value to concerns over the fact that some value managers are not providing the level of exposure to value that was expected.  

While the past decade has been challenging for the value style, when you consider first principles, we think that not putting all your eggs in the same basket (prudent asset allocation) and buying a dollar for 70 cents (the core of value investing) are enduring. At times, staying consistent with such principles can be difficult, but our experience tells us that this discipline has been rewarded in the long run.

We will leave you with a quote from a legendary Canadian value investor, Peter Cundill (1938 to 2011), “Sooner or later, the market will do what it has to do to prove the majority wrong.”

On behalf of the entire Brandes team, we wish you a very happy and prosperous 2020.


1 Source: MSCI via FactSet as of 9/30/19. On a rolling 3-year basis, MSCI World Value has underperformed MSCI World Growth for 143 months as of 9/30/19.

2 Source: Morningstar as of 9/30/19. Universe includes U.S.-based open-end funds and exchange traded funds (ETFs) on 12/31/2008 and 12/31/2018.

3 Source: Ken French Data Library at http://mba.tuck.dartmouth.edu/pages/faculty/ken.french/data_library.html.  Value stocks: Decile 10; Growth stocks: Decile 1. The deciles are based on the universe of US stocks from Ken French’s data library. The universe is sorted into deciles based on P/E ratio, with the cheapest being in decile 10 and the most expensive in decile 1.

4 Source: Morningstar as of 9/30/19 and 6/30/16. Based on all mutual funds in the Global Equity category as defined by Morningstar.

5 Source: Morgan Stanley, MSCI, S&P, various national sources. March 31, 1986 to September 30, 2019. Cyclically adjusted price/earnings attempts to show the relationship between price and multi-year average company earnings in order to better estimate long-term earnings power. This valuation measure seeks to smooth out earnings fluctuations caused by business cycles while also reflecting the long-term effects of inflation. MSCI Europe inception: March 31, 1986.

6 Source: MSCI via FactSet as of 9/30/19.

7 Source: Morningstar as of 9/30/19. Universe includes global and international open-end funds and ETFs. Net value exposure as defined by Morningstar.

8 Source: There’s Always Something to Do: The Peter Cundill Investment Approach by Christoper Risso-Gill, February 2011.

Price/Earnings: Price per share divided by earnings per share.

The MSCI Europe Index with net dividends captures large and mid cap representation of developed market countries in Europe.

The MSCI Europe Growth Index captures large and mid cap securities across developed Europe exhibiting growth style characteristics, defined using long-term forward earnings per share (EPS) growth rate, short-term forward EPS growth rate, current internal growth rate, long-term historical EPS growth trend, and long-term historical sales per share growth trend.

The MSCI Europe Value Index captures large and mid cap securities across developed Europe exhibiting value style characteristics, defined using book value to price, 12-month forward earnings to price, and dividend yield.  

The MSCI World Value Index with gross dividends captures large and mid cap securities across developed market countries exhibiting value style characteristics, defined using book value to price, 12-month forward earnings to price, and dividend yield.  

The MSCI World Growth Index with gross dividends captures large and mid cap securities across developed market countries exhibiting growth style characteristics, defined using long-term forward earnings per share (EPS) growth rate, short-term forward EPS growth rate, current internal growth rate, long-term historical EPS growth trend, and long-term historical sales per share growth trend.  

MSCI has not approved, reviewed or produced this report, makes no express or implied warranties or representations and is not liable whatsoever for any data in the report. You may not redistribute the MSCI data or use it as a basis for other indices or investment products. The benchmark returns are not covered by the report of independent verifiers.

The S&P 500 Index with gross dividends measures equity performance of 500 of the top companies in leading industries of the U.S. economy.

Rolling periods represent a series of overlapping, smaller time periods within a single, longer-term time period. For example, over a 20-year period, there is one 20-year rolling period, eleven 10-year rolling periods, sixteen 5-year rolling periods, and so forth.

This material is intended for informational purposes only. The information provided in this material should not be considered a recommendation to purchase or sell any particular security. It should not be assumed that any security transactions, holdings, or sectors discussed were or will be profitable, or that the investment recommendations or decisions we make in the future will be profitable or will equal the investment performance discussed herein. Strategies discussed herein are subject to change at any time by the investment manager in its discretion due to market conditions or opportunities. The Brandes investment approach tends to result in portfolios that are materially different than their benchmarks with regard to characteristics such as risk, volatility, diversification, and concentration. Market conditions may impact performance. International and emerging markets investing is subject to certain risks such as currency fluctuation and social and political changes, differences in financial reporting standards and less stringent regulation of securities markets which may result in greater share price volatility.

The foregoing reflects the thoughts and opinions of Brandes Investment Partners® exclusively and is subject to change without notice. Brandes Investment Partners® is a registered trademark of Brandes Investment Partners, L.P. in the United States and Canada.