A man walks past a screen displaying the closing the closing figure of the Hang Seng Index at the Hong Kong Exchanges and Clearing Ltd. building in Hong Kong, China. (Photographer: Justin Chin/Bloomberg)
Growth Stocks Are Eating the World. Live With It
Ronald W. Chan
(Bloomberg Opinion) -- It's not hard to see why investors in Asia have been blindly chasing growth stocks. For the past 10 years, value has consistently underperformed. As the world goes through another round of stimulus, money will continue to flow to companies that promise the fastest expansion. This self-perpetuating trend is forcing a change in how some investors assess value.
There are many reasons why value stocks have lagged behind. Much of the phenomenon reflects the ultra-low interest rates that have prevailed since the global financial crisis. Lower rates make investing in growth stocks more attractive. At the same time, they hurt financial companies by compressing their net interest margins — the difference between the rates at which they can borrow and lend. This has depressed returns in a sector that's come to make up a substantial chunk of the value universe, defined by stocks with low multiples of price to earnings, book value or other measures.
While value has underperformed around the world, the drag from financial stocks has been even greater in Asia. The sector accounts for 28% of the MSCI AC Asia ex Japan Value Price Index, compared with 22% for MSCI's World Value Index and 18% for its U.S. value gauge. Information technology has the highest weighting in the MSCI USA Index at 28%, with financials accounting for less than 10%.
Over the past decade, the Asian value index has risen 5.3%, compared with a 97% advance for the equivalent gauge of the region's growth companies. During the March rout triggered by the coronavirus outbreak, the growth index fell less and then rebounded more than the value measure.
This can't be dismissed as irrational behavior by investors. After all, the low-interest-rate environment has materially harmed the earnings and prospects for financial companies. At the same time, the growth posted by leading Chinese technology companies such as Tencent Holdings Ltd. and Meituan Dianping is real. The pandemic has only accelerated the trend toward online working and commerce, as shown by the rally in Zoom Video Communications Inc., whose shares have jumped almost fourfold on the Nasdaq this year.
Stock of Tencent, the Shenzhen-based internet giant, has climbed 37% in 2020 and Beijing-headquartered Meituan, the world's biggest meal delivery business, has surged 82%. By contrast, Industrial and Commercial Bank of China Ltd., the country's largest lender, has sunk 19%.
A third reason for the persistent underperformance of value stocks is low trading volume. In Hong Kong, for example, there are roughly 2,500 listed stocks. The top 100 by market capitalization account for 70% to 75% of daily trading volume, with the next 200 taking 20% to 25%. That leaves the remaining 2,200 issuers competing for the scraps. On a typical trading day with $13 billion in turnover, that amounts to about $650 million for these companies — or about $300,000 apiece. Thin pickings indeed.
Liquidity is a big issue for institutional investors, who need to find companies where they can accumulate a stake without driving the price to an unreasonable level. The rise of exchange-traded funds and index-tracking strategies that require liquidity has helped to gradually crowd out value stocks. Many such companies are family-controlled, leaving few shares available for trading by outsiders. Value-oriented managers are reluctant to sell because the stocks are too cheap. This creates a vicious cycle where old money won't leave and new money can't enter. Over time, many of these stocks have been kicked off indexes because of anemic trading, further depriving them of liquidity.
This is the flip side of the growth paradigm, where the big simply keep getting bigger. Just as in the U.S. — where the top tech names such as Amazon.com Inc., Facebook Inc. and Apple Inc. have vastly outperformed benchmark indexes — growth behemoths in Asia have left their rivals in the shade. Tencent's gain this year compares with an 11% decline in Hong Kong's Hang Seng Index. Masayoshi Son's SoftBank Group Corp. has risen 35% in Tokyo, versus an 8% decline in Japan's Topix index.
It's getting harder and harder for value-oriented fund managers to ignore these stocks. In fact, value can be found in fast-growing companies on occasions — though such opportunities tend to be short-lived.
Value investing in Asia has been getting a bad rap, and that trend isn't going to change in the near future. The traditional way of hunting for bargains has stopped working in a world that's been turned upside down by the pandemic and more than a decade of easy money. To earn superior returns, investors will need to evolve with the changing environment.
Ronald W. Chan is the founder and CIO of Chartwell Capital in Hong Kong. He is the author of "The Value Investors" and "Behind the Berkshire Hathaway Curtain."
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