Value investing, which had been labouring in the shadow of growth investing for several years, has begun to have its day, argues Colum McKinley, a portfolio manager at Toronto-based CIBC Asset Management Inc. who oversees the $788.2-million CIBC Canadian Equity Value. Indeed, based on his view that global markets are in a challenging and precarious state, McKinley maintains that value investing will help investors get through uncertain times.
"If you look at the long-term empirical data, value investing has outperformed other styles," says McKinley, a 23-year industry veteran who assumed the fund in 2010 when he joined CIBC Asset Management, after working for such Toronto-based firms as Sionna Investment Managers and TD Asset Management Inc. McKinley notes that between 1995 and 2015 value stocks outperformed growth stocks by nearly one percentage point per year.
"But there are periods of significant under-performance," McKinley says. "One of those was in the late 1990s when we saw the tech-and-telecom bubble; growth stocks did incredibly well, but value stocks delivered lacklustre results. We have seen that unwind over time."
In late 2000, as tech-and-telecom valuations became excessive, they corrected sharply and value stocks outperformed handily until about 2002. "One of the realities of being a value investor is that there are periods when you are out of step with the market," says McKinley, who has long identified with the value style. "You have to be patient and focus on long-term returns and own good quality businesses that have sustainable business models and good balance sheets which gives companies time to make things happen. You also need good management teams to execute against their long-term strategic plan. Ultimately, that is reflected in stock prices."
McKinley argues that markets have lately experienced the second largest divergence between growth and value. In 2015, global growth stocks, as measured by the MSCI World Growth Index (in local currencies), had a total return of 6.5%, while value stocks lost 1.2%. Yet 2016 is already shaping up as a better year for value.
Through the first seven months of 2016, the benchmark MSCI Canada Value Index has a total return of 15.5% and the MSCI Canada Growth Index is up 8.6%. Meanwhile, CIBC Canadian Equity Value is up 14.9%, or four percentage points ahead of the Canadian Equity category average. Over a longer time frame, with value out of favour, the fund had an annualized 2.2% return for the five years ended July 31, versus 6.0% for the category average.
McKinley admits that the divergence between value and growth is not as extreme as what existed in the late 1990s. "I don't look at the market and say, 'we have one group that is massively undervalued and the other group is overvalued,'" observes McKinley. "But my broader concern is that we have moved to record-high prices in an environment where there is a long list of significant macro risks to digest. This is a period when we are quite cautious in our portfolios."
Based on concerns about the impact of Brexit, among other worries, McKinley has put a greater emphasis on downside protection and has raised cash to about 8%. "We are being as defensive as we can. Value portfolios are one way to achieve that. They tend to be a collection of companies that have higher yields, are large-cap in nature and have lower valuations. If we see a market schism, where valuations correct, the low valuations of our stocks will help provide downside protection."
"We don't spend a lot of time trying to predict where markets are going tomorrow. We spend a lot of time building a portfolio of good quality business that are trading at a discount, knowing that over time we will see a revaluation and it will be recognized in the stock price. It has actually been happening," says McKinley, who is also lead manager of the $4.5-billion CIBC Monthly Income, which he assumed in 2013.
A bottom-up investor, who has about 50 positions in CIBC Canadian Equity Value, McKinley is relying on names such as 
Magna International Inc. (MG) that will ride out potential storms and deliver attractive total returns. "Investors are concerned about Magna's near-term cyclical risks. But its management team has a long track record of delivering strong returns on capital and continues to grow market share. And the CEO, Don Walker has done a very good job of re-focusing capital allocation," says McKinley, noting that the firm has a share buy-back program and made some well-timed acquisitions.
Magna is trading at a price-earnings multiple of about 7.8 times, or about a 40% discount to its peers. It also pays a 2.8% dividend yield. "As it executes its strategy, long-term returns will be quite attractive for investors."
Another favourite name is AltaGas Ltd. (ALA), a leading Alberta-based utility. "It's a very well managed company," says McKinley, noting that the firm has developed new power projects in British Columba. "It has long-term assets with strong contracts and built-in pricing escalation. What's attractive is its sustainable and predictable growth over time." The stock, which trades at 12 times enterprise value to earnings before interest taxes depreciation and amortization, pays a 6% dividend. "That dividend has grown in the past and will continue to grow in the future."
Looking ahead, McKinley remains upbeat about the defensive posture he's adopted. "We always articulate to our clients that we use a disciplined approach to investing: buy high-quality companies trading at a discount, and embed in the portfolio an above-average dividend yield," says McKinley. "If we do this over the cycle, investors will be rewarded. We've seen the strategy work in a more constructive market year-to-date. And we are very well positioned to weather some of the uncertainty that we are seeing."
