Recent underperformance has led some to declare the death of value investing, but don’t be so quick to dismiss it.
As of this writing, recent jobless claims in the U.S. are zeroing in on 40 million. The S&P 500, while rallying over 30% since March 23rd, 2020, is still negative for the year1. Mathematically, we have seen the end of one of the longest bull runs in history. And after a bounce-back from growth and innovation heavy industries like technology and healthcare, some investors today are doubling down on their belief that the value factor may in fact be dead.
Don’t count it out yet. We have seen flickers of value’s reemergence. After outperforming momentum by roughly 6% in September 2019, value has staged another noteworthy rally, outperforming momentum by over 2.5% in just one week2. The real question is: when will the value rally stick?
For those skeptical that the value phoenix will rise from its ashes, it’s important to remember three key tenets to factor investing:
- Factors have been cyclical
- Factors have delivered premia over the long term
- Factors have been diversifiers
Value underperformance: cyclical, not structural
Investors have expressed concern that the value factor is “broken” due to a structural change. They point to the price-to-book ratio3 (P/BV), a common fundamental metric used by traditional value strategies to identify undervalued companies. They highlight P/BV’s inability to account for things like brand value and invested R&D, causing it to underestimate a company’s worth.
While this critique is certainly valid, and one reason the indexes underlying our iShares value factor ETFs are screened for multiple value fundamentals simultaneously, we don’t believe that any single fundamental should be a scapegoat for an entire investment style. After all, value can be found in all sectors and segments of the market, even in those that may not screen well on one individual metric such as P/BV. Rather, we would reiterate that the value factor, like all factors, typically exhibits cyclicality. While factors have tended to outperform over the long-run, in the short-run, they can have periods of underperformance based on the current phase of the economic cycle.
Due to the capital-intensive nature of many value-oriented companies, this factor has tended to outperform during recovery periods and may lag during periods of economic slowdown when flexibility is key. (See below.) As such, we would argue that recent underperformance of the value factor is not caused by a structural change, but instead can be explained by where we are in the economic cycle.
Factors for the long run
In September of 2018, my colleague Andrew Ang explained why he still believes in the value factor. He discussed its academic foundations and noted that while recent underperformance of value is historic – as of this writing, the aggregate value drawdown is the worst in magnitude and the longest going back to the 1920s – he also emphasized that there is no reason to think that the long-term premium is gone.
To support these claims, we looked at the value premium (using Ken French’s data) since the 1920’s to see just how often cheap U.S. stocks have outperformed expensive ones.
Interestingly, value has historically had a positive premium only 50% of the time when looking at daily data. However, as the periods observed increase, so too does the percent of times value has outperformed. Over rolling 20-year periods, the value premium has been positive every time, highlighting the potential benefit of sticking with value strategies for the long run.
Don’t forget diversification
While it’s true that value is currently in the throes of a historically significant drawdown, it’s important to realize this shorter-term underperformance is standard factor behavior. The evidence supporting the value factor is still convincing and abundant. All historical return-enhancing factors — value, size, quality, and momentum — have experienced periods of out- and underperformance at different times. Therefore, much as investors diversify across stocks and bonds, they may want to consider having exposures across multiple factors, to balance the prolonged drawdowns of any one individual factor. They also may look to tactically tilt to one or more factors based on the current economic environment.
From a factor perspective, while BlackRock continues to advocate for portfolio resilience through allocations to quality and minimum volatility, our views on the value factor have become increasingly more constructive, and some are taking notice. In my experience, in anticipation that the value phoenix may soon rise from the ashes, stalwarts and skeptics alike are beginning to increase allocations to a neutral or even overweight position in value in anticipation of a sustained, cyclical and, for many, long-overdue recovery.
Holly Framsted, CFA, is the Head of US Factor ETFs within BlackRock’s ETF and Index Investment Group and is a regular contributor to The Blog. Elizabeth Turner, CFA, Vice President and Christopher Carrano, Associate are members of the Factor ETF team and contributed to this post.
1 Source: Morningstar as of 6/11/2020
2 Source: Morningstar, pertains to the week of 5/25/2020. Value represented by the MSCI USA Enhanced Value Index, and momentum by the MSCI USA Momentum Index
3 Price-to-book ratio is a commonly used financial ratio to determine the value of a company. It is calculated by dividing a company’s stock price by their book value per share.
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