Morningstar - Q3 2020 - 60

Investors

higher-than-average returns over the long run.
Our recent contrarian tilt into it shows our
confidence in that long-term evidence rather than
the short-term performance.
Ang: I completely agree with Andrea. We
are value investors at heart. We believe in the
underlying economic concepts, and that
gives us confidence that value will be around for
decades to come. But to be better investors,
we do want our research to evolve.

I'll give you three examples of my personal
evolution. The first one is that growth
is not the opposite of value.3 There are reasons
why we might pay up for an expensive
company. It might have high-quality earnings,
or positive momentum, or stable returns.
These aspects of being expensive aren't
necessarily bad. Value versus growth doesn't
necessarily mean cheap versus expensive.
Conditioning, as we touched on before,
is another way we can better implement value.
With intangible information, we might
do this within and across sectors or industries,
or around the world. Finally, we have
dynamic notions of when we might want to tilt
into value, such as today, or tilt out of value,
such as the last two to three years.

There's a variety of reasons why that is reasonable.
One is the empirical data. Historically, buying
cheap securities within an industry has been
a better bet than buying cheap industries
and selling short expensive industries. You get
a better Sharpe ratio and a better return by
controlling for industry components.
There are also ex ante reasons. It's extremely
hard to compare a technology company
to a utility company or to a retail company. They
have different business models. They might
have different levels of cash flow, or leverage, or
macroeconomic exposure. You would ideally
compare companies that are selling an identical
product. Adjusting for industry is a way to
approximate that.
Another reason is macroeconomic exposure. If you
make industry bets based on which companies
are cheap versus expensive, you might end up
having large macro exposures. An example would
be interest-rate exposure, which has been
talked about a lot recently in the financial press.
Controlling for industry helps mute, if not eliminate,
that exposure. From a risk perspective, it allows
you to focus on what value investing is
really about: companies trading at different prices
relative to future fundamentals.
Bryan: Andrew, do you take a similar industry-relative

Apples With Apples
Bryan: How can you implement value in
a more thoughtful way than traditional value
indexes, many of which use low growth
as value signals? Andrea, can you talk more about
sector neutrality?

Frazzini: As I mentioned, we don't take
industry bets based on valuation
metrics. We place all our bets within an industry.
That means buying technology stocks
that are cheap relative to technology stocks
that are expensive, or utility stocks
that are cheap relative to utility stocks that
are expensive.

approach to value?

Ang: We also like to compare apples with apples.
We control for sectors, industries, and regions.

I'll give some examples of the way we've evolved
the value signals in our active portfolios. We talked
about the importance of intangible assets. A
lot of accounting rules tend to expense investments rather than capitalize them. To get a
better read on intangible assets, we can undo
some of those accounting transactions and
try to capitalize some things that generally have
been expensed.
One direct measure of intangibles is patents.
They directly measure intellectual property and the

ability of a company to innovate and offer new
technologies and services. This is another way that
we can capture intangible assets.
We're actively researching peer groupings.
Some of the most famous companies and the
largest ones, like Amazon.com AMZN, have
changed sectors just because the definitions of the
sectors themselves have changed. We can
find better peer groups for these companies.
One way, potentially an extreme case, is
to compare a company's value metrics with its
own historical value metrics-using a peer
comparison of itself as a comparable.
Intangible value and traditional value signals
sometimes go in the same direction, as
for, say, Merck MRK. In some cases, like Ford F,
the intangibles constitute a very small part.
But in other companies, like Uber UBER or some
of the technology names, we might see traditional
value signals score negatively, but intangible
signals or time series score positively.
They can attenuate the impact of traditional
value measures.

Man Versus Machine
Bryan: Fundamental stock-pickers who use a more
qualitative approach have been trying for many
decades to buy stocks for less than they're worth. Most
of them have failed to meet their benchmarks.
Why would a systematic approach to value investing
work better?

Frazzini: It's a good question that gets at the
heart of what we do. One thing to keep in
mind is that value is a factor that we think you
should be exposed to, but it's not the only
factor. Even in periods where value is attractive,
your portfolio should not be 100% value. Value
should be a part of what you do, and maybe today
a little bit bigger part.

Why would a systematic approach work better
than a fundamental approach on individual
companies? The approach is similar. Deep-value

3 Ang, A. 2018. "Growth Is Not the Opposite of Value." Nov. 7. https://www.blackrock.com/us/individual/investment-ideas/what-is-factor-investing/factor-commentary/andrews-angle/
growth-is-not-the-opposite-of-value

Morningstar Q3 2020

http://www.Amazon.com https://www.blackrock.com/us/individual/investment-ideas/what-is-factor-investing/factor-commentary/andrews-angle/growth-is-not-the-opposite-of-value https://www.blackrock.com/us/individual/investment-ideas/what-is-factor-investing/factor-commentary/andrews-angle/growth-is-not-the-opposite-of-value

Morningstar - Q3 2020

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