Daniel Needham, Global CIO of Morningstar Investment Management
Value investing is a fairly simple concept. It's purchasing an asset at a price that's below what you think the intrinsic value or the fundamental value of that asset is. It's very difficult to assess the underlying value of an asset, and so it requires judgement and analysis to do that, but in general that's the concept. There are many different ways to assess the underlying value, but generally if you are conservative and buy an asset for less than its estimated price, then you are a value investor.
Value-driven asset allocation is applying that same concept of trying to buy assets for less than what you think they’re worth, but doing it at an asset class level. So that is saying, do I think UK equities are cheap or expensive, do I think UK bonds are cheap or expensive, do I think European equities are cheap or expensive? And so it’s applying that same valuation discipline, but across asset classes.
Michael Keaveney, Director of Investment Management, Morningstar Canada
Morningstar favours a valuation-driven approach to investing.
The valuation-driven approach to investing is seen in our equity research, manager selection and investment management work around the world. The approach boils down to determining what an investment is worth and getting it at a discounted price.
Let's paint a very simple picture of the worth of an investment and compare it to the ups and downs of market price. We can see both the advantages and challenges for a valuation-driven investor. The major advantage is that this approach has the potential for delivering excess returns and can also reduce risk.
Valuation-driven investors describe their entry points as having a "margin of safety" or a discount to intrinsic value; this can reduce the downside of making the investment. Another advantage is that it provides discipline, allowing investors to reduce the emotional roller-coaster effects of the markets. Investors can make poor decisions when short-term sentiment is their main guide.
One challenge is really the flipside of that discipline. Valuation-driven investors are contrarian, often buying when sentiment is poor, and selling when sentiment is too positive. It can be tough to maintain a contrarian discipline: People don't like to differ too much from the crowd, but it is needed with this approach.
Another related challenge is that valuation-driven investors must take a long-term view, which isn't easy in our modern world. Finally, the work of establishing true worth is easier said than done. Deep fundamental analysis on the key drivers of returns, is an ongoing requirement.
We believe that valuation driven investing can work for individual securities and asset classes to deliver better risk adjusted returns to investors.
In the words of famed investor Warren Buffett, "Price is what you pay. Value is what you get."
View the videos of Michael Keaveney and Daniel Needham.
Tanguy De Lauzon, Head of Capital Markets and Asset Allocation, Morningstar Investment Management EMEA, shares interesting perspectives on the subject: Patience is rewarding in investing.
