discussing traditional value investing and common

Investing Where It Counts

High-Conviction Investing | Outcome-Oriented Solutions westwoodgroup.com

Discussing Traditional Value Investing and Common Misconceptions

September 2020

Philip DeSantis, CFA®

Senior Vice President, Head of Product & Client Solutions

2 Investing Where It Counts

Our goal for the session

What are the key

factors in making an

asset allocation and

manager decision

going forward?

How can you achieve

better performance during

periods of economic

distress with more

consistent performance

long term if you want

to twist to Value?

Help advisors

understand what’s

changed with value

investing over the last

40 years



Level setting:

Defining traditional

value

Morningstar Style Box™

Large

Medium

Small

Value Blend Growth

Price-to-Book

Price-to-Earnings



Value stocks historically outperformed up until 2007

$0

$5,000

$10,000

$15,000

$20,000

$25,000

$30,000

$35,000

$40,000

'80 '81 '82 '83 '84 '85 '86 '87 '88 '89 '90 '91 '92 '93 '94 '95 '96 '97 '98 '99 '00 '01 '02 '03 '04 '05 '06

Time Period: January 1980 – December 2006. Data Source: eVestment. Past performance is not indicative of future results.

Growth of $1,000

1980-2006

Russell 1000

Growth

Russell 1000

Value


$500

$1,000

$1,500

$2,000

$2,500

$3,000

$3,500

$4,000

$4,500

'07 '08 '09 '10 '11 '12 '13 '14 '15 '16 '17 '18 '19 '20

Since 2007, Value stocks have underperformed

Time Period: January 2007 – June 2020. Data Source: eVestment. Past performance is not indicative of future results.

Growth of $1,000

2007-2020

Russell 1000

Growth

Russell 1000

Value


Accounting practices have failed to keep up with how companies invest and grow

As companies have shifted

their investments away from

old-world factories and

plants, so too have markets,

as those sectors most

exposed to cyclical industries

have decreased in weight

over the last two decades

As of June 30, 2020. Data Source: Cornerstone Macro.

Structures + Industrial Eqp

+ Transportation Eqp

Software + Tech Eqp + R&D

Capex

0

10

20

30

40

50

60

70

80

198

0

198

2

198

4

198

6

198

8

199

0

199

2

199

4

199

6

199

8

200

0

200

2

200

4

200

6

200

8

201

0

201

2

201

4

201

6

201

8

202

0

Capex Components% Total Capex

Since 1980


Price-to-book is no longer a predictive metric and has become distorted

1975 1985 1995 2005 2018

Tangible vs. Intangible Assets for S&P 500 Companies, 1975-2018

• IBM

• Exxon Mobile

• Procter & Gamble

• GE

• 3M

• IBM

• Exxon Mobile

• GE

• Schlumberger

• Chevron

• GE

• Exxon Mobile

• Coca-Cola

• Attria

• Walmart

• GE

• Exxon Mobile

• Microsoft

• Citigroup

• Walmart

• Apple

• Alphabet

• Microsoft

• Amazon

• Facebook

Source: 2019 Intangible Assets Financial Statement Impact Comparison Report, Aon and Ponemon Institute. April 2019.

Tangible Intangible

$715B

Intangible: $122B

Tangible: $594B

$1.5T

Intangible: $482B

Tangible: $1.02T

$4.59T

Intangible: $3.12T

Tangible: $1.47T

$11.6T

Intangible: $9.28T

Tangible: $2.32T

$25.03T

Intangible: $21.03T

Tangible: $4.00T

5 L

arg

es

t G

lob

al

Co

mp

an

ies

by

Ma

rke

t C

ap


Corporate buybacks have distorted price-to-book as a value metric

As of June 30, 2020. Data Source: Strategas, Compustat and FactSet.

Between 2009 and 2018,

465 companies in the

S&P 500 spent $4.3 trillion

on buybacks.

Buybacks can warp the

value metrics, making

price-to-book a useless

measurement for valuing

many stocks.

Price / Book

(LHS)

Price

(RHS)

500

1000

1500

2000

2500

3000

3500

200

300

400

500

600

700

800

900

1000

1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 2020

S&P 500 Book Value Per Share vs. S&P 500 Price


Traditional Value Hasn’t

Worked

-600

-400

-200

0

200

400

600

800

1000

EV/EBITDA P/Book Forward P/E

Value Factors

Traditional Value Hasn’t

Worked

Data run: August 2020. Source: Strategas Research Partners. The averages referenced above are the averages of the three previous 10-Year Treasury / 2-Year Treasury inversion periods that occurred in 1998, 2000, 2005 and 2019.

U.S. All Cap Universe is represented above by the Russell 3000. The U.S. Small Cap Universe is represented above by the Russell 2000. High Debt refers to the highest leverage quintile.

The big miss: Traditional Value factors haven’t worked during downturns

Factor Performance Following 10-Year

Treasury / 2-Year Treasury Yield Curve Inversion

U.S. All Cap and Small Cap Universes

-600

-400

-200

0

200

400

600

800

1000

1200

1400

EV/EBITDA P/Book Forward P/E

Value Factors

Alp

ha

(bp

s)

Alp

ha

(bp

s)

U.S. All Cap (WTD Avg Market Cap $368B) U.S. Small Cap

3-Mo. Avg. 6-Mo. Avg. 12-Mo. Avg.


Traditional Value has become riskier for investors

As of June 30, 2020. Data Source: Cornerstone Macro.

-1

-0.8

-0.6

-0.4

-0.2

0

0.2

0.4

0.6

0.8

1

199

9

200

0

200

1

200

2

200

3

200

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200

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200

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9

201

0

201

1

201

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201

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201

7

201

8

201

9

Correlation of Low P/E Stocks to High Beta Stocks

Correlation Visual AidBeta

1.15 1.19Beta of High P/E Stocks Beta of Low P/E Stocks

0.70

0.80

0.90

1.00

1.10

1.20

1.30

1.40

1.50

1.60

0.70

0.80

0.90

1.00

1.10

1.20

1.30

1.40

1.50

1.60

199

9

200

0

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201

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201

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201

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201

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201

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201

5

201

6

201

7

201

8

201

9

Beta of Low P/E StocksSince 2000


Quality: The key to mitigating downside risk and creating more consistency long term

As of March 31, 2020. Data Source: Jefferies, using the Russell 1000 Index.

Value factors alone

generated 88% cumulative

return over the last 10 years

Value + Quality factors

added additional 35%

for a total of 123%

cumulative return

88%

123%

0%

20%

40%

60%

80%

100%

120%

140%

Value Value + Quality

Value Factor Alone vs. Value and Quality TogetherCumulative Return Last 10 Years


Quality factors:

What are they?

Profitability


Stability

Financial strength

Quality companies…

Offer a long-term

return premium

due to sustainable

competitive

advantages and

pricing power

Maintain higher

profitability with

less cyclicality and

strong balance

sheets than

traditional value

stocks

Demonstrate high

returns on capital

that compounds

wealth over the

long term, creating

shareholder value

by reinvesting

profits, M&A and

paying dividends

Typically perform

better during periods

of economic

uncertainty with

better consistency

and lower downside

risk; all of which

traditional value

stocks lack


Data run: August 2020. Source: Strategas Research Partners. The averages referenced above are the averages of the three previous 10-Year Treasury / 2-Year Treasury inversion periods that occurred in 1998, 2000, 2005 and 2019.

U.S. All Cap Universe is represented above by the Russell 3000. The U.S. Small Cap Universe is represented above by the Russell 2000. High Debt refers to the highest leverage quintile.

Periods of distress: Quality factors, on the other hand, worked

Factor Performance Following 10-Year

Treasury / 2-Year Treasury Yield Curve Inversion

U.S. All Cap and Small Cap Universes

U.S. All Cap (WTD Avg Market Cap $368B) U.S. Small Cap

3-Mo. Avg. 6-Mo. Avg. 12-Mo. Avg.

-400

-200

0

200

400

600

800

1000

1200

1400

1600

1800

FCF Growth ROE High Debt

Quality Factors

-400

-200

0

200

400

600

800

1000

1200

1400

1600

FCF Growth ROE High Debt

Quality Factors


Putting this into practice todayAs of June 30, 2020

Portfolio and index free cash flow excludes financial services and REITs due to cash flow statement calculation method within the sector. Free cash flow metrics are equally weighted. Portfolio forecasted growth rate and P/E reflect

Westwood’s analysts’ estimates. There is no guarantee that these forecasts and estimates will be accurate, or even approximately accurate, and the performance of the portfolio versus the benchmark may not correlate with the financial

results of constituent investments. Data Source: © 2020 FactSet Research Systems Inc. All Rights Reserved.

Quality Metrics

Free Cash Flow

MarginReturn on Equity Net Debt / EBITDA

Russell

1000 Value

___8.7% 15% 2.5x

Russell

2000 Value

___2.6% 2% 3.5x

Quality

and Value are always relative


Quality is deteriorating at an increasing rate

U.S.: Rising share of companies with debt servicing

costs that are higher than profits

U.S.: Share of “zombie” firms

Note: Firm-level data is used to calculate the share of listed firms that are more than 10 years old with an interest coverage ratio less than one for three years in a row.

Sources: DataStream, Worldscope and DB Global Research, 2020.


Small caps: An even worse picture if you buy fundamentals

Time Period: 1/1/1990 – 6/30/2020. Source: Strategas. Small Cap Universe shown above is represented by the Russell 2000 Index.

0%

10%

20%

30%

40%

50%

'90 '92 '94 '96 '98 '00 '02 '04 '06 '08 '10 '12 '14 '16 '18 '20

Percent of

Non-Earners

Percent of Non-Earners in Small Cap Universe(Based on Companies With Available Data)

27%

39%

44% 44%


Small caps: High leverage could impact earnings stability

Time Period: 7/31/2000 – 6/30/2020. Source: Strategas. Small Caps shown above are represented by the Russell 2000 Index. Large Caps shown above are represented by the S&P 500 Index.

Spread Between

R2000 and S&P 500

Spread Between Small Caps and Large Caps

Net Debt to EBITDA

2000 2003 2006 2009 2012 2015 2018

Largest

Spread in

20 Years


Invest at the

Intersection of

Quality and Value



SmallCap Value: Result of investing at the intersection of Quality and Value

Inception: January 1, 2004. Data Set: January 1, 2004 – June 30, 2020 (Quarterly). Past performance is not indicative of future results. Performance shown assumes reinvestment of dividends and capital gains and is net of investment

management fees. Please see appendix for full performance disclosure for the SmallCap Value strategy. Rolling 5-year returns graph calculated using quarterly data. The 5-year period was chosen as a proxy for a typical market cycle.

Market environment returns reflect an average of the 5-year annualized returns within each market environment category. *Overall batting average reflects the percentage of rolling 5-year periods in which Westwood SmallCap Value

outperformed the Russell 2000 Value Index on a net-of-fees basis.

21.1%9.9%

7.2%

2.7%

Westwood

SmallCap Value1.0%

Russell

2000 Value(2.1%)

Value Added 3.1%

18.3%

2.8%

Down Markets

(<0% Return)

Normal

Up Markets

(0-15% Return)

Speculative

Up Markets

(>15% Return)

*Overall Batting Average: 100%

Market Environment

Annualized Rolling 5-Year Returns

Net of Fees Since Inception Westwood SmallCap Value vs. Russell 2000 Value Index

Normal Up MarketsSpeculative

Up MarketsDown Markets

Westw

ood S

mallC

ap V

alu

e R

olli

ng

5-Y

ear

Annualiz

ed R

etu

rns (

%)

Net of F

ees

Russell 2000 Value Rolling 5-Year Annualized Returns (%)

Underperform

Outperform

-10

-5

0

5

10

15

20

25

-10 -5 0 5 10 15 20 25

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