Value Investing During Inflation
Chair Powell’s Resolve is Good for Value
US stocks rallied in July and the first half of August, anticipating lower interest rates in 2023 from the Federal Reserve. The S&P 500 peaked around 4300 on August 16th, and then plummeted over 3% on August 26th when Federal Reserve Chair Jerome Powell publicly dashed hopes of rate cuts next year. Old habits die hard, and participants have been attempting to buy the bottom in unprofitable tech companies and meme stocks all year. However, this is a different world post-covid. Investors must adapt. There are currently high rates of inflation. Additionally, inflation could settle at a higher base-rate in the medium-term. Clearly, the Federal Reserve has declared inflation as public enemy #1. The Fed will also be aggressive! Inflation is a priority at the expense of the other half of its dual-mandate, employment. The rest of this post will show exactly why this environment is high conducive towards Frank Funds’ brand of value investing.
Not All Value is Equal
2022 has been an extremely difficult year for asset allocators. Not only are most styles of equity funds losing money, but fixed income strategies have abandoned their historical protection in equity bear markets, suffering some of their worst YTD losses in history. Even value-focused indices like the Russell Mid-cap Value Index have posted negative returns. How has Frank Capital Partners, LLC, the advisor to the Frank Value Fund, invested in numerous companies with positive returns YTD in 2022? Not all value is equal. Frank Capital has honed in on value catalysts that force the unlocking of value in stock prices. This focus is paying off in 2022.
Value Investing Catalysts
In a world of passive indexers, management teams must catalyze their own investment returns. We believe this so wholeheartedly, it is a core of our investment process. For specific examples see our thesis on renewable diesel here.
For the Frank Value Fund, August started with a compelling catalyst for one of our renewable diesel companies. Despite market volatility towards the end of the month, value holdings with clear, material catalysts managed positive returns. Of course, not every month will have value realization through catalysts like large special dividends or activist investors. Importantly though, over a period of time where indices struggle to make new highs, value-catalysts can add uncorrelated bursts of return to a portfolio. You just have to know where to look and what to avoid.
No Catalyst, No Returns
Unprofitable tech companies and meme stocks attempted a comeback starting in June of 2022, but as the end of August showed, this could be investors clinging to how things were in the past. Instead, in a world with high, persistent inflation, unprofitable businesses are at a large disadvantage. When rates were 0%, there was no opportunity cost to investing in an enterprise that while growing revenue quickly, may not have profits until ten or more years in the future. Currently, investors can hide in short-term US treasuries and collect around a 3% return with no risk. We detailed this setup in our first quarter update.
We Believe Value Will Outperform
Persistent inflation and low unemployment bolster the Fed’s resolve. Investors remain in a “show me” state, demanding cash payouts like special dividends and material stock repurchases. Unprofitable companies have difficulty competing with this dynamic as they lack the free cash flow to reward investors in the short-term. Value investing during inflation works.
Performance data quoted represents past performance and does not guarantee future results. The investment return and principal value of an investment will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original cost. Current performance may be lower or higher than the performance data quoted. You may obtain performance data current to the most recent month-end by calling the Fund at 1-888-217-5426 or visiting our website at www.frankfunds.com. Returns include reinvestment of any dividends and capital gain distributions.
Non-FDIC insured. May lose value. No bank guarantee. The Fund’s investment objectives, risks, charges and expenses must be considered carefully before investing. The prospectus contains this and other important information about the Fund, and it may be obtained by calling 1-888-217-5426. Please read it carefully before you invest or send money.
This publication does not constitute an offer or solicitation of any transaction in any securities. Any recommendation contained herein may not be suitable for all investors. Information contained in this publication has been obtained from sources we believe to be reliable, but cannot be guaranteed.
The information in this portfolio manager letter represents the opinions of the individual portfolio managers and is not intended to be a forecast of future events, a guarantee of future results or investment advice. Also, please note that any discussion of the Fund’s holdings, the Fund’s performance, and the portfolio managers’ views are as of September 5, 2022 and are subject to change without notice.