FOR PROFESSIONAL CLIENTS/QUALIFIED INVESTORS ONLY NOT FOR RETAIL USE OR DISTRIBUTION.

The case for value in Europe

February 2017

IN BRIEF
The value style has had a strong rebound since the summer of 2016. However,
this pick up in value returns follows a decade of underperformance vs. growth.
When considered over the long term, values underperformance vs. growth is
still significant.
There are signs that the recent value revival may be the beginning of a more
sustained rally. The dispersion in valuations between value and growth remains
wide a situation that has previously been a strong signal for future value
outperformance. Also, value sectors are clear beneficiaries of a reflationary
environment, while market-implied earnings growth rates still appear overly bearish
for several value sectors.
We believe that the Europe Strategic Value Fund is well placed to tap into any
AUTHORS
upturn in the performance of the value style. The fund provides investors with style
purity regardless of market environment, and was in the top percentile of all
offshore European equity funds the last time that the value style had a sustained
period of outperformance (2000-2006). The fund has also outperformed the MSCI
Europe Value index in 14 of 17 calendar years since inception.

Ian Butler
Portfolio Manager THE CASE FOR THE VALUE STYLE

Introduction
Value investing has been advocated by investors as far back as Benjamin Graham and
David Dodd in the 1930s. However, it was not until the 1970s that academics began to
empirically examine the performance of value investing. In a prominent early paper,
S. Basu1 found that stocks with low price-to-earnings (P/E) ratios outperform high P/E
Michael Barakos stocks by an average of 10% per year.
Portfolio Manager
Using data courtesy of Kenneth R French, we now have some 90 years of evidence in
support of value investing. J.P. Morgan research from 20132 showed that since 1927, one
dollar invested in the cheap portfolio (low price-to-book) would have grown to more
than $3,200 compared to $515 for the expensive portfolio.

S Basu, Investment performance of common stocks in relation to their price-earnings ratios: A test of the efficient
1

Tom Buckingham market hypothesis, The Journal of Finance Vol. 32, No.3 (June 1977); pp. 663-682.
Portfolio Manager 2
J.P. Morgan research: Kenneth R. French, Dartmouth University, 2013.
 THE CASE FOR VALUE IN EUROPE

But what is behind these returns to value investing? When considered over the long term, values
Lakonishok, Shleifer, and Vishny3 find that value stocks are underperformance vs. growth is still significant
not fundamentally riskier than faster growing glamour EXHIBIT 1: MSCI EUROPE VALUE VS. MSCI EUROPE GROWTH
CUMULATIVE EXCESS RETURN
stocks. Lakonishok et al. also find that the differences in the
200
growth rates between glamour and value companies do not
c. 50% underperformance
persist. In practice, the growth rates of value companies tend 180 of value until December 2016
to improve as companies divest underperforming units,
restructure operations, bring in new management, and 160

emulate competitors.
140
We believe investors tend to be overly pessimistic about
value companies, extrapolating earnings trends into the 120

future, which in turn drives a wedge between price and fair

100
value, creating buying opportunities. The important thing is
to stick rigidly to a value style to benefit from the strategys 80
long-term performance potential, especially when it feels 2000 2002 2004 2006 2008 2010 2012 2014 2016

emotionally most uncomfortable (for example, in early 2000).

Source: Factset, MSCI, J.P. Morgan Asset Management; data from 31 January 2000
to 31 December 2016.

Long-term underperformance of value

vs. growth
of December 2016. The most recent outperformance of value
The last value cycle lasted from 2000 to late 2006 following appears modest when considered in a longer-term context.
the bursting of the technology bubble. In fact, this was the
In addition, it is important to note that since the beginning of
most powerful value rally since the Great Depression of the
1975 the average duration of value outperformance relative
1930s. However, this value outperformance of the early
to growth (using the MSCI Europe style indices as proxies) is
2000s was followed by a near decade-long period of value
approximately 28 monthswith values longest period of
underperformance (other than a short, sharp rally in 2009)
outperformance lasting 80 months. The current rally has
until the summer of 2016.
lasted six months so far, which would suggest this recent
As Exhibit 1 shows, even after the strong recent rebound, the value revival may be just the beginning of a more sustained
MSCI Europe Value index has underperformed the MSCI Europe rally, especially when put in the context of a 10-year value
Growth index by approximately 50% in the decade to the end bear market.

Relative valuations signal a potential opportunity for value investors

EXHIBIT 2: RELATIVE VALUATION OF MSCI EUROPE VALUE VS. MSCI EUROPE GROWTH
4
Tech
bubble
3

Global Today
Financial
2 Crisis Eurozone
Crisis

-1

-2
1975
1976
1977
1978
1979
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016

Source: MSCI, J.P. Morgan Asset Management; data from January 1975 to December 2016. The relative valuation is based on the price-to-book ratio and dividend yield of
the Europe Value index compared to the Europe Growth index normalised for comparison.
3
Josef Lakonishok, Andrei Shleifer, Robert W Vishny, Contrarian investment, extrapolation, and risk, The Journal of Finance, Vol. 49, Issue 5 (December 1994); pp. 1547-1578

2 T H E C A S E F OR V A L U E IN EURO PE
 THE CASE FOR VALUE IN EUROPE

Value spreads look attractive at current levels Wide valuation spreads may predict stronger
performance ahead for value stocks
The underperformance of the value style has in turn caused the EXHIBIT 3: FORWARD PERFORMANCE OF MSCI EUROPE VALUE VS.
relative valuation between the MSCI Europe Value index and the GROWTH INDICES CONDITIONAL ON RELATIVE VALUATION

MSCI Europe Growth index to widen significantly. As Exhibit 2 % 8

Forward 12 month return: MSCI Europe

shows, although the relative valuation of the value index has
6

Value vs. MSCI Europe Growth

come in from its widest point (in the summer of 2016), value
stocks are still trading at a discount to growth stocks that was 4

last seen at the extremes of the eurozone crisis. 2

0
Valuation spreads suggest positive returns from
value -2
Today
One of the best predictors of future returns to the value style -4 Valuation 2 3 4 Valuation
dispersion dispersion
is the valuation spread (which measures the difference in wide narrow
valuation between the value and growth indices).
Source: MSCI, J.P. Morgan Asset Management. The chart shows the forward
12-month return of the value index relative to the growth index conditional on the
Exhibit 3 shows the expected forward 12-month return of the relative valuation from 30 November 1984 to 31 December 2016. The quintiles are
based on an expanding window with an initial 10 year period. Forecasts, projections
MSCI Europe Value index relative to the MSCI Europe Growth and other forward looking statements are based upon current beliefs and
index, conditional on the relative valuation of the two indices. expectations. They are for illustrative purposes only and serve as an indication of
what may occur. Given the inherent uncertainties and risks associated with
Expected returns are highest when the valuation dispersion forecasts, projections and other forward statements, actual events, results or
performance may differ materially from those reflected or contemplated.
is widest.

Driven by the underperformance of the value style in recent
years, valuation dispersion is still in the widest quintile
compared to history. This wide dispersion in valuations would
suggest a positive outlook for the performance of the value
style on a 12-month forward looking basis.
Market-implied earnings growth rates appear
overly bearish for value sectors
Relative valuations appear to suggest an attractive outlook
for the value style. Exhibit 4 shows the market implied long-
term earnings growth rates by sector and the relative
valuation if you apply this growth rate using a dividend
discount model. The chart shows that for a number of
sectors the market is pricing in negative implied long-term
earnings growth.

Earnings growth expectations may be too pessimistic for several value sectors
EXHIBIT 4: EUROPEAN INDUSTRY VALUATIONS AND IMPLIED ANNUAL GROWTH RATES
Materials Household Prod
Cons Serv Health Care
Cap Goods Real Estate
Food & Bev Food & Bev
Retailing Software
Cons Dur Cons Dur
Semis Semis
Health Care Cons Serv
Real Estate Retailing
Transport Comm Serv
Food Retail Cap Goods
Autos Materials
Energy Tech Hardware
Telecomms Telecomms
Comm Serv Media
Div Fin Food Retail
Software Pharma
Pharma Transport
Household Prod Utilities
Banks Div Fin
Media Energy
Insurance Banks
Utilities Insurance
Tech Hardware Autos
-1.5 -1 -0.5 0 0.5 1 1.5 -6 -4 -2 0 2 4 6
Z-score %

Source: Morgan Stanley, MSCI, J.P. Morgan Asset Management. Relative valuation chart (left hand side), data as of 31 December 2016. Valuations are a composite based on
price-to-book ratios, price-to-earnings ratios and dividend yields, and are relative to each industry groups 20-year history. Market implied earnings per share (EPS) growth
rates chart (right hand side), data as of 6 January 2017. Implied growth rates are for the next 10 years using a two-stage Gordon Growth Model assuming financial year
three as the base year.

J.P. MORGAN ASSE T MAN AGE ME N T 3

 THE CASE FOR VALUE IN EUROPE
In many cases, earnings expectations are pessimistic. For
example, the markets earnings growth expectations imply a
4% earnings decline per year for the next 10 years for autos,
a 2% earnings decline per year for the next 10 years for
insurance, and a 1% earnings decline per year for the next 10
year for banks.
Value tends to be a beneficiary of inflation
It is also worthwhile considering the macroeconomic regime
change that currently appears to be taking place.
Over the last five years, as both interest rates and inflation
have fallen, it has been the high duration bond proxy assets
that have outperformed. This sustained outperformance
means that these stocks are now trading near historical
extremes. However, we appear to be reaching the end of a
30-year bull market in bonds as inflation expectations begin
to rise and interest rates increase from near-zero levels.
Historically the value style has outperformed in periods of
rising inflation and we believe that this relationship remains
valid today. At a style level, value stocks are lower duration
assets compared to growth stocks, which have a valuation
that is more sensitive to cash flows further in the future. As
the yield curve steepens the cash flows of growth stocks will
be more heavily discounted and therefore value stocks
should be expected to outperform.
THE CASE FOR JPMORGAN FUNDS EUROPE
STRATEGIC VALUE FUND
Introduction
The JPMorgan FundsEurope Strategic Value Fund aims to
invest in the most attractively valued stocks in the market,
ensuring that each stock selected is fundamentally sound
through further analysis of its quality and momentum
characteristics.
We apply a consistent and disciplined approach to research
and identify these characteristics across a universe of
approximately 1,800 pan-European stocks.
4 T H E C A S E F O R V A L UE IN EURO PE
A disciplined investment process ensures
style purity
To identify attractively valued stocks we focus on the
cheapest 30% of the market based primarily on a
combination of the price-to-earnings (P/E) ratio and free
cash flow yield. To ensure the companies we invest in are
fundamentally sound we look to avoid those companies that
are very low quality and have poor momentum. These stocks
are deemed value traps, i.e. are cheap for a good reason.
We define poor quality as those companies that are not
profitable, have unsustainable earnings and have a
management team with poor capital discipline. We seek to
avoid companies whose profit growth and margins are not
sustainable. We expect management to be prudent with
shareholder funds and are wary of companies that have a
track record of issuing shares to make acquisitions, rather than
financing growth through internally generated cash flow.
We also try to avoid those stocks with the weakest share
price and earnings momentum. Stocks that have performed
well over the last 12 months tend to continue to perform well
and conversely stocks that have performed poorly tend to
continue to underperform. When examining earnings
momentum, our decision making isnt impacted by what a
sell side analysts recommendation is for any given company,
but we do analyse the direction of underlying forecasts in
detail. Strong downward revisions are often an indicator that
a stock will underperform as analysts typically under react
and dont fully incorporate the new information into their
forecasts. Hence, there will often be further downward
revisions along the road.
Consistent performance and significant
outperformance when value style in fashion
As Exhibit 5 shows, the funds returns have been very
consistent, having outperformed the MSCI Europe Value
Index in 14 of 17 calendar years since inception despite the
value style having underperformed growth since 2007. The
only three calendar years that the fund has underperformed
have all been years in which the growth style has
outperformed value, and were therefore difficult periods for
a pure value fund to outperform.
 THE CASE FOR VALUE IN EUROPE

The fund has outperformed in 14 of 17 calendar years since inception

EXHIBIT 5: EUROPE STRATEGIC VALUE FUND EXCESS RETURNS VS. MSCI EUROPE VALUE NET INDEX TO DECEMBER 2016
Outperforming Style Value Growth Value Growth Value Growth Value

20.0%
16.1%
15.0%
11.8%
10.0% 8.7%
5.6%
4.4% 3.8%
5.0% 3.1% 2.4% 2.6% 3.3%
1.9% 1.4% 1.6% 1.8%
0.0%
-1.4%
-5.0% -3.6% -3.9%
-10.0%
2000* 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
Fund (%) 18.6 -0.7 -19.5 25.1 20.1 30.7 24.0 -5.9 -48.6 36.6 6.9 -10.8 20.2 28.2 7.3 9.4 9.28
MSCI Europe Value
Index (%) 13.6 -11.2 -30.7 21.3 15.8 28.2 22.3 -2.4 -46.5 33.5 4.1 -9.5 16.4 21.4 5.6 0.7 7.41

Source: J.P. Morgan Asset Management; data as of 31 December 2016. Fund=JPMorgan FundsEurope Strategic Value A (acc) - EUR Fund. Performance calculated on a NAV
to NAV basis, gross of fees in EUR excluding ongoing charges and any entry and exit fees, with any income (net) reinvested. Excess return calculated geometrically, in euros.
From launch on 14 February 2000 to 1 June 2008 the official benchmark of the fund was FTSE Europe Index. On 1 June 2008 the benchmark was changed to MSCI Europe
Value Index. Gross fund returns are calculated from net returns by applying the fund total expense ratio (TER) which includes operating & administrative expenses
(O&A). The O&A fees are accrued at the maximum rate, according to what is stated in the fund prospectus. Where the O&A fees incurred are actually lower
than the accrual, this would lead to a minor overstatement of gross returns. Net returns are not impacted. Past performance is not necessarily a reliable indicator for current
and future performance. *From 14 February to 31 December 2000.

The fund was launched in February 2000 during a period
that was dominated by the growth style, with little interest in
value. However, five years later the fund was in the top
percentile of all 192 offshore European equity funds, having
returned +41% over the period vs. the median funds -34%
return (source: Morningstar, European offshore equity
universe, five years to 28 February 2005).
Style purity regardless of market environment
Clients should be reassured that regardless of the market
environment, or which style is currently outperforming,
the fund will always maintain its pure value style exposure,
as evidenced by its portfolio characteristics over the past
17 years.

With hindsight, the year 2000 was the perfect time to invest
in the value style, and the funds performance in the
following five years shows that it has the potential to
outperform significantly when the value style works. As
further evidence of the funds ability to outperform when
value is in fashion, in the latest value rally in the second half
of 2016 it outperformed the MSCI Europe Value index by
more than 350 basis points (bps) and the broad market
(MSCI Europe index) by more than 1000bpsplacing the fund
comfortably in the top quartile of the Morningstar Europe
Large-Cap Value sector over the second half of 2016.
Exhibit 6 shows the weighted average P/E of the Europe
Strategic Value Fund and the MSCI Europe index since 2000.
Over this time, the fund has consistently maintained a
healthy valuation discount to the broad market and this style
purity sets it apart from its competitorsmany of whom
have, in recent years, tended to drift away from the value
style as it has underperformed. In fact, we believe that our
Europe Strategic Value Fund is one of the only pure value
funds left in the market.

The fund has also performed well vs. its peers for several
years. The fund is top quartile over one year, three years and
five years (to end of December 2016, Morningstar Europe
Large-cap Value peer group).

J.P. MORGAN ASSE T MAN AGE ME N T 5

 THE CASE FOR VALUE IN EUROPE

The Europe Strategic Value Fund has always maintained a The Europe Strategic Value Fund stands out from its
valuation discount to the market peers as a deep value portfolio
EXHIBIT 6: PRICE-TO-EARNINGS RATIO FOR EUROPE STRATEGIC VALUE EXHIBIT 7: MORNINGSTAR HOLDINGS-BASED STYLE MAP OF THE
FUND AND MSCI EUROPE INDEX LARGEST FUNDS IN VALUE PEER GROUP
25 Fund MSCI Europe

Giant
JPM Europe Strategic
Value C (acc) EUR
20 Fund A Fund F

Large
JPM Fund B Fund G
Price Earning (fwd)

Fund C Fund H
15
Fund D Fund I

Mid
Fund E Fund J
10 MSCI Europe Value NR EUR

Small
5

Micro
0 Deep- Core- Core Core- High
00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 Val Val Grth Grth

Source: J.P. Morgan Asset Management; data from 30 June 2000 to 31 December Source: Morningstar; data as of 31st December 2016 Based on the 10 largest funds
2016. For illustrative purposes only. Fund=JPMorgan FundsEurope Strategic in the Morningstar Europe Value Universe.
Value Fund. The forward price-to-earnings (P/E) ratio is the average of the fund
and the MSCI Europe Value Index respectively and has been calculated by
weighting the forward P/E of stocks in the fund and index by their weight in the
fund or index. These numbers are IBES estimates. Positioned to benefit if the reflationary
environment continues
Exhibit 7 shows a holdings-based analysis of the 10 largest The value style tends to outperform in periods where
funds in the Europe Large-Cap Value peer group (as at end of inflation expectations are rising and hence bond yields are
December 2016). The Europe Strategic Value Fund is the increasing. Exhibit 8 shows the correlation of European
deepest value fund of the group and the only fund that has sectors to changes in bond yields as well as the funds
more value than the MSCI Europe Value index. A number of positioning vs. the MSCI Europe Index. The fund is clearly
other funds in the peer group are positioned more as core overweight those sectors that are positively correlated with
funds. changes in bond yields (banks, insurance and basic
resources) and underweight those that have a negative
correlation (healthcare, food & beverages, and personal &
household goods). If the current reflationary environment
continues, the fund should continue to benefit.

Europe Strategic Value Fund has exposure to sectors that will benefit from a reflationary environment
EXHIBIT 8: PORTFOLIO EXPOSURE TO RISING YIELDS
50% Correlation to changes in bond yields < 5% (LHS scale) 15%
40% JPM Europe Strategic Value Fund active positions (RHS scale)
28% 28% 10%
30%
19% 19% 19%
20% 7% 15%
5%
10% 6%
1%
0% 0%
-10% -3% -1%
-15% -5%
-20% -18% -17%
-22% -21% -20%
-30%
-32% -10%
-40% -35%
-50% -15%
Inds Gds & Svs
Pers & H/H Gds

Financial Svs

Travel & Leis

Technology

Basic Resource
Food & Bev
Health Care

Auto & Parts

Utilities

Real Estate

Con & Mat

Chemicals

Banks
Oil & Gas

Insurance
Telecom

Retail

Media

Source: UBS Securities LLC, J.P. Morgan Asset Management; data as of 31 December 2016. The fund is an actively managed portfolio. Holdings, sector weights, allocations
and leverageas applicableare subject to change at the discretion of the investment manager without notice. Pas performance is not necessarily a reliable indicator for
current and future performance.

6 T H E C A S E F OR V A L UE IN EURO PE
 THE CASE FOR VALUE IN EUROPE
INVESTMENT IMPLICATIONS
Although the value style has underperformed growth over
the last 10 years, it has started to perform strongly since the
summer of 2016. Despite this recent rebound, value stocks
still look attractive relative to growth, with historically wide
valuation dispersion suggesting that the value rally could
be set to continue. Earnings growth expectations for value
sectors may also be overly pessimistic.
Investors looking to gain exposure to the value style should
look for funds with the proven ability, and disciplined process
necessary, to maintain style purity through changing market
conditions. The JPMorgan FundsEurope Strategic Value Fund
has a consistent track record and has produced significant
outperformance when the value style is in fashion.
J.P. MORGAN ASSE T MAN AGE ME N T 7
 FOR PROFESSIONAL CLIENTS/QUALIFIED INVESTORS ONLY NOT FOR RETAIL USE OR DISTRIBUTION.

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