10.9.2020 Pasi Havia

HCP Quant 8/2020 +0.34% | How would a coronavirus vaccine affect investors?

HCP Quant 5/2020 -2,99% | Small-cap value stocks in recession turnarounds | Fund’s country allocation

HCP Quant increased +0.34% in August. Benchmark index MSCI ACWI SMID Value Total Return performed better and increased +3.88% in euros. US S&P 500 Total Return increased +5.82% in euros and Europe’s S&P Europe 350 Total Return +2.99%.

Since the beginning of 2020, HCP Quant has still outperformed its benchmark index by more than ten percentage points, as the fund yielded -9.19% and the benchmark index -19.42%. HCP Quant has also outperformed S&P Europe 350 Total Return. Meanwhile, the US S&P Total Return has increased approximately three percentage in euros. The strong performance of S&P 500 is mostly explained by a handful of companies. Year to date return of S&P 495 is negative as well.

The difference in ten year annualized returns between value stocks and growth stocks. Source: Bank of America

Value stocks have had incredibly hard times. According to Bank of America‘s recent report, value stocks experienced their worst decade ever of performance relative to growth stocks.

A combination of low interest rates, little to no inflation, and a global economic slump account for 79% of the return difference between growth and value stocks. Hence, BofA suggests four changes for value investors to improve their returns. BofA’s tips are listed below with my own comments on how they reflect in HCP Quant’s strategy.

  1. Go small
    Value premium of small-cap value companies is bigger than large-cap companies. Small-cap value companies have yielded 5.5% p.a. better than growth companies since 1926. Hence, BofA believes they will continue to be the better alternative in the future.

    Comments: HCP Quant invests in small- and mid-cap value companies, so this is part of the fund’s strategy.

  2. Go for quality
    In order to avoid value traps and dead industries, BofA urges value investors to focus on the quality of the companies. Historically, adding high quality has meant an additional percentage point better annual returns.

    Comments: HCP Quant measures the quality of companies with Piotroski F-Score and Beneish M-Score. A company has to reach a certain level of quality in order to fulfil the fund’s investment criteria.

  3. Watch macro conditions
    Investors need to follow macro economic conditions to avoid false starts and get confirmation of a change in trend. For example, a coronavirus vaccine would likely boost unloved financials and hurt growthy, overbought lockdown portfolios. According to BofA, this trend was evident during last week’s market sell-off, as the Russell 1000 Value index outperformed its growth counterpart by the most since 2008 (see the picture below).

    Comments: Personally, I think investors should avoid market timing. According to several academic studies, investors who do not time the market have better profits. For these reasons, HCP Quant does not try to time the market in any way. An investor who wishes to time the market can, instead, buy or sell shares in the fund according to their view of the macro economic conditions.

  4. Intangible assets
    Investors should abandon the traditional P/B-ratio. Nowadays, intangible assets, such as intellectual property, intellectual property rights and brand value, play a big part, and P/B-ratio does not take them into account. In 2018, a total of 84% of S&P 500 member companies assets were intangible. Hence, BofA urges to prefer adjusted book value over the traditional one.

    Comments: P/B-ratio is not used in HCP Quant’s investment strategy when defining a company’s valuation.

Russell 1000 value and growth index performance for the last ten years.

Since day one, HCP Quant has implemented most of BofA’s views on how to improve profits in value investing. Trying to time the market according to macro economic conditions is up to the investor. However, it is quite obvious that during the last ten years, the market cycle has been favourable to growth stock investors.

According to BofA, a potential trigger for a turn in macro economic conditions could be a successful coronavirus vaccine. The first vaccine can potentially be available as soon as late autumn, and many investors are trying to figure out how it will affect the markets. After interviewing several strategists and portfolio managers about the subject, Bloomberg Businessweek presented three possible scenarios.

If successful, a corona virus vaccine could lead us back to “normal life”, meaning a shift in policymakers’ attitudes toward the extraordinary economic stimulus they’ve poured on. A turnaround in the current politics might end the market celebration of succesful corona vaccine quickly. New central bank money has flooded the markets which has kept stocks flying high. If they change their attitude we might even see a replay of 2013, when investors took fright as the central bank signaled it would wind down the quantitative easing program it began after the financial crisis. Back then, both stocks and bonds fell.

The second scenario would mean a significant boost for stock prices. “If there is anything that would cause a major rally, that (corona vaccine) would have to be it,” says Randy Frederick, vice president of trading and derivatives for Schwab Center for Financial Research. Anyway, it would take a lot of time for the unemployment rate to get back to normal after a vaccine. Central banks would keep the rates low and credit conditions easy in order to revive the economy, whereby the already expensive stocks would continue climbing.

The last scenario would the best one for HCP Quant’s investors: the comeback of value stocks. The current bull market is strange in that most of the gains have been concentrated in a handful of (tech) stocks that investors see as particularly well-suited for the stay-at-home economy. Most of the other stocks have missed out the rally. The vaccine could benefit the markets laggards, for example, airlines and consumer companies selling nonessential items.

A big question for the investors is whether a successful vaccine is already baked in the stock prices. In addition, what will happen if we see a major set-back in the process of producing a vaccine?

September’s subscription date is approaching. You can make a subscription online by clicking the button below. Please remember that the money has to be in the subscription account by September 30th at 4 pm at the latest.

Your value investing optimist,
Pasi Havia
HCP Quant portfolio manager

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“Let’s be careful out there.”
Phil Esterhaus, Hill Street Blues
HCP Quant 5/2020 -2,99% | Small-cap value stocks in recession turnarounds | Fund’s country allocation

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