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Successfully through the crisis with US value stocks

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Authors: Dr. Christian Funke, Source For Alpha


18. July 2022

  • Retail funds
  • Institutional funds
New York Investing in the US equity market Photograph: Mihai Andritoiu Source: iStock.com

So far this year, value stocks have clearly outperformed growth stocks, which had been the driving force behind the equity market in the last few years. Growth stocks have taken a recent hit and are currently suffering from rising interest rates. Empirical evidence based on capital market research shows that value stocks also deliver a premium over the long term. In order to exploit this, Source For Alpha relies on its investment process that is used in the S4A US Long fund (ISIN DE000A112T67 (share class I) / DE000A1H6HH3 (share class R). Risky stocks as well as "value traps” should be avoided. During turbulent times advantages of opportunities should be taken in an anticyclical manner. And the success proves S4A right for over ten years.

After the markets were driven by the excellent performance of growth stocks in recent years, the tide has clearly turned for growth stocks in 2022. Some of the very high valuation levels achieved by some of these growth stocks have now experienced sharp corrections in the face of rapidly rising interest rates. Meanwhile, during these turbulent times, investors are looking for the security of value stocks, which in the past have been able to deliver good returns even in an environment of higher inflation. This has led to the strong outperformance of value stocks this year, which in turn further attracts the attention of investors and increases the relative return of these stocks. From a scientific point of view, it makes sense to invest in attractively valued stocks rather than in highly valued growth stocks: a number of research studies show that value stocks have significantly higher returns over the long run. These empirical studies prove that a value premium exists in almost all developed capital markets. But how exactly can capital market research be used in practice?

Christian Funke
Empirical studies show that a value premium exists in almost all developed capital markets.
Dr. Christian Funke, Source For Alpha; Photo: Annika List
Photograph: Annika List Source: Source For Alpha

Success through capital market research: The S4A US Long Fund

The winning formula of one of the best retail funds in its peer group*: The investment strategy of the S4A US Long Fund pursues a consistent value approach in order to be able to profit from the long-term outperformance of value stocks in the S&P 500 investment universe. Within the investment process, a combined value indicator is first calculated for all stocks, which is derived from a series of balance sheet ratios. Many asset value-based investment strategies focus almost entirely on this valuation aspect. They filter with increasing precision those stocks that are the most attractively valued in the market. However, the interaction of company valuations with other factors is much more important: there is a significant correlation between the valuation level on the one hand and risk, as well as historical price development (momentum), on the other. Value stocks often face higher risks than the market. In addition, low-valued value stocks are often loser stocks, i.e. stocks whose prices have fallen sharply in the past. Capital market research shows that both value traps and risky stocks underperform on average. To manage the portfolio successfully it is therefore important to break the connection between valuation levels on the one hand and risk and momentum on the other. Within the investment process, this is done by filtering out and removing companies with high risk or poor price performance (low momentum) from the portfolio.

It is also important to consider time variability: The described average underperformance of risky shares as well as value traps does not apply continuously. Crash situations that are accompanied by very high levels of risk aversion displayed by market participants are an exception. During times of very high-risk aversion, risky stocks become very cheap. Over the long run, however, risk aversion always returns to a normal neutral level and valuations equalise (creating a "mean reversion" situation). On the way to normalisation, the returns of cheap, risky stocks are significantly higher than the returns of the overall market. Within the investment process, this is an important aspect that is taken into account by entering into a more offensive, riskier orientated portfolio during "fear phases". This implies that the S4A US Long fund often experiences above-average risk after crash phases and benefits disproportionately from an incipient market recovery. Examples of such recovery rallies from which the fund benefits are for instance demonstrated by the high levels of outperformance experienced after the initial phase of the Pandemic (March 2020) and the US-China trade war (December 2018).

Source For Alpha's US equity fund - the S4A US Long Fund - is one of the best performing funds within the peer group. In the Morningstar category "Equities Standard Stocks US Value", it belongs to the top percentile of equity funds over three, five and ten years (as of 31 May 2022). In addition to this the fund receives a five star performance rating from Morningstar regularly.


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