Value investing is a beautiful thing - in the long term

Value investors are again an endangered species.

The recent success of growth investing - albeit labelled as a "smarter" derivative of plain vanilla or "dumb" value investing - has gathered increasing amounts of followers.

It helps that the recent results of those asset managers who practice value investing are decidedly pedestrian compared with the success of the growth evangelists. This makes sense, considering that success is an attracter and success in financial markets is directly correlated to increased wealth - an almost irresistible incentive to join the herd.

But as a value investor, one needs to decide sooner rather than later whether your boat is actually sinking. If it is, the sooner you jump the better.

To make a sound call and not jump - when it seems everyone around you is jumping - one needs to understand why this massive performance divergence is happening.

Some macroeconomics is needed here.

Debt levels are extremely high and acts as a drag on growth.

To counteract the resulting deflationary effect, monetary and fiscal authorities, on behalf of their political employers, are trying to inflate economies by printing money, competitively devaluing currencies and setting interest rates at low levels.

Again, this makes sense, but as with most bureaucratic interventions there are unintended consequences.

For example, low interest rates result in certain assets being valued at a premium to their historical valuation levels. This is because the intrinsic value of an asset - such as a business, for example - is the present value of all the future cash flows it will deliver to its owners, the shareholders.

To calculate this intrinsic value is a simple matter of establishing all the future cash flows, expressing them in today's money terms and adding them up. With low interest rates, the discount factors are large and the present value of future cash flows is high.

The bottom line is that investors should then rationally expect to pay up for assets which produce positive cash flows in these tough times.

Cash-positive assets are generally called defensive and operate in sectors such as groceries, beverages, medical and property.

Historically, these sorts of companies were the domain of value investors as they have the characteristics of low but steady growth. But in a world where everyone is struggling for growth, even growth investors now find them very attractive.

Conversely, cyclical assets, with low or negative cash flows in the foreseeable future, will correctly attract low valuations. This is the domain of the "true" or (as the public discourse will have it) the "dumb" value investor.

But here's the interesting, unintended consequence: the low level of interest rates is forcing conservative investors out of low-risk interest-bearing investments into long-duration, high-risk, dividend-paying assets.

To justify this shift they are extending the horizon over which they are willing to discount the positive cash flows of defensive equity assets, many times into unreasonable durations. Interestingly, this implies that growth investors - who have historically been characterized as short-term players - have now moved into the realm of the ultra-long term.

So growth investors are buying good quality, defensive stocks using long-term assumptions. This results in them having taken the high ground in terms of relative performance, which always lends credence to an unlikely story (remember how we all believed in the technology revolution?).

No wonder true value investors are on a hiding to nothing - the cheap assets are exactly the ones that historically have been the hunting ground for growth jockeys - resources, construction, selected technology stocks and retail.

There is one additional piece of information, though: over the long term, value investing outperforms growth investing.

As value investors, we know it works. Now, of course, we just need patience to let the cycle of human behavioural patterns run its course.

Viljoen is MD of Regarding Capital Management