Investment Professionals


How to invest in the value rotation


Value investing, which involves buying beaten up and unloved stocks, has underperformed for years now. With central banks keeping interest rates low and global technology giants on a tear, growth stocks have thoroughly outperformed. But are things about to change?

Steepening yield curve may mean a higher discount rate

The yield curve has steepened sharply in recent months, as investors take stock of the coronavirus vaccine rollout and weigh fears that Biden’s stimulus package could trigger inflation.

US yield curve has steepened


Source: Bloomberg as at 7 April 2021

When interest rates rise, in theory at least, the way companies are valued changes. This is because when interest rates rise, the “discount rate” – which is the interest rate investors use to value companies’ future profits – also rises. The higher the discount rate, the more “a dollar today is worth more than a dollar tomorrow”. And the more a company’s share price should, in theory, reflect their profits today over their profits tomorrow. 

Higher discount rates can be a good thing for value stocks. This is because their valuations tend to be more heavily determined by their near-term profits. And indeed, over the past six months as the curve has steepened, we have seen value stocks outperform.

Value has outperformed growth in recent months


Source: Bloomberg as at 7 April 2021

Value stocks love a vaccine

Another potential signal of a value stock recovery may be vaccine rollouts. Value stocks tend to be concentrated in sectors hard hit by lockdowns; oil, utilities, travel and entertainment. And as such, according to Goldman Sachs, they have “the highest correlation to vaccine distribution probabilities.” Said more simply: the better chances of reaching herd immunity via a vaccine, the better the chances value stocks have of outperforming. The below chart from Goldman shows the sensitivity of value stocks to vaccine rollouts in the US.

Value stocks have been more sensitive to vaccine news

Correlation to 10pp increase in COVID-19 vaccine distribution probability


Source: Goldman Sachs Global Investment Research and GSAM. As at January 31, 2021

Yield – a real value strategy

There are many ways to define and access value stocks. But one common way is to use dividend ETFs. This is because they tend to have lower price-to-dividend, price-to-earnings and price-to-book ratios than the total market. After all, this is what allows them to sustain their higher dividend payouts. Here, ETFS S&P 500 High Yield Low Volatility ETF (ASX Code: ZYUS) offers a solution.

How the fund works

ZYUS invests in the 50 least volatile high yielding S&P 500 stocks. This means that the primary filter for the index is yield (initially ranking the 75 highest yielding stocks) and the secondary filter is volatility (removing the 25 most volatile of these). These rules result in a 50 stock portfolio that targets high yield and that has an embedded value tilt, which is particularly meaningful in the current market.

2021 outlook

The heavy impact of COVID-19 on high yielding sectors and the oil crash took a large toll on ZYUS’s performance last year, along with the fund's heavy underweight to the top performing tech sector.

As we start to see early signs of a rotation to value, in the last 6 months ZYUS has begun to outperform the S&P 500 Index. Whilst ZYUS’s performance significantly drags over 12 months, particularly due to the big tech underweight vs the S&P 500, if the rotation to value continues there’s potential for a continued recovery in ZYUS.