Value and Contra Funds — The Style That Tests Your Patience

A value manager looks for companies trading below what the business appears to be worth, usually because something has gone wrong or the sector is out of favour. The position is taken on the expectation that the gap closes over time.

A contra manager is doing something related but framed against the crowd: taking a position opposite to the prevailing consensus, which often means buying what everybody is selling. Under the scheme categorisation these are treated as distinct, and a single fund house may offer one or the other rather than both.

Either way, the scheme frequently looks unfashionable by design. If the holdings looked obviously attractive to everybody, they would not be priced the way the manager needed them to be.

The natural comparison is a growth approach, which buys companies expected to expand quickly and accepts paying more for that expectation.

The two behave differently at different times, and neither is permanently better. There have been long stretches in which growth companies led and value approaches looked obsolete, and stretches in which the reverse happened and the same commentators changed their minds.

That alternation is the whole reason to be careful about judging either on recent performance, as our page on the benchmark sets out. A style out of favour for four years is not a broken style.

This is the part that decides whether somebody should hold one, and it has nothing to do with the arithmetic.

The scheme will lag for stretches, sometimes long ones, while other categories are doing visibly well and somebody in your family is mentioning it. The manager reason for holding an unpopular company only pays off if the market eventually agrees, and there is no timetable for that.

An investor who exits during that stretch has taken the approach and inverted it, selling the unpopular thing at the point of maximum unpopularity. That is not a hypothetical failure mode; it is the usual one.

So the honest question is not whether the style works. It is whether you will still be holding it in year four when it has been dull for three, which our guide on why somebody else fund did better deals with.

Worth being even-handed, because patience is not a defence against every outcome.

A company can be cheap because it deserves to be. A business in permanent decline looks statistically attractive right up until it is not, and the difference between a temporary problem and a terminal one is only obvious afterwards. Judging which is which is the actual skill in this style, and it is not evenly distributed.

The other risk is that the view simply takes longer than the investor horizon. Being right eventually is no use to somebody who needed the money in year three, which is why the horizon rule matters here more than in most categories, as our page on asset allocation sets out.

A third category sits close to this one and gets confused with it, which is worth clearing up.

A dividend yield scheme selects companies that distribute a meaningful share of their earnings to shareholders. That often means mature, established businesses, and it frequently ends up looking similar to a value portfolio because such companies are often priced modestly.

The selection basis is different, though. A value manager is looking at what the business is worth against its price. A dividend yield manager is looking at distribution behaviour, which is a signal about the company rather than a judgement about its valuation.

The practical consequence is that these three categories can overlap heavily in what they actually hold, so somebody holding all three in the name of diversification may be holding one position three times. Our page on portfolio overlap covers how to check that rather than assume it.

For most households, as part of the equity allocation rather than as the whole of it.

A portfolio built entirely on one style is a position on that style continuing to be rewarded, which is a bet whether or not anybody described it that way. Holding schemes with different approaches means that a stretch unkind to one is not a stretch unkind to everything.

Check the actual holdings before assuming you have that spread, though. Two schemes with different style labels can hold much the same companies, which our page on portfolio overlap covers, and the label on the scheme is not the evidence.

Four questions, and the first two are about you rather than the scheme.

• Is your horizon genuinely long? This style needs more time than most, not less.
• What did you do last time something you held lagged for two years? The honest answer decides this.
• Has the scheme actually followed the approach, visible in the holdings on the fact sheet rather than in the name?
• Who is running it and since when, since this style depends heavily on judgement, as our page on the fund manager discusses?

We are distributors rather than investment advisers, we recommend no schemes, and we take no view on which style will do better. If you want to work out whether this belongs in your plan at all, get in touch.