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.
Carefully consider the Funds’ investment objectives, risk factors, and charges and expenses before investing. This and other information can be found in the Funds’ prospectuses or, if available, the summary prospectuses which may be obtained by visiting www.iShares.com or www.blackrock.com. Read the prospectus carefully before investing.
Investing involves risks, including possible loss of principal.
There can be no assurance that performance will be enhanced or risk will be reduced for funds that seek to provide exposure to certain quantitative investment characteristics (“factors”). Exposure to such investment factors may detract from performance in some market environments, perhaps for extended periods. In such circumstances, a fund may seek to maintain exposure to the targeted investment factors and not adjust to target different factors, which could result in losses.
Diversification and asset allocation may not protect against market risk or loss of principal.
Index performance is for illustrative purposes only. Index performance does not reflect any management fees, transaction costs or expenses. Indexes are unmanaged and one cannot invest directly in an index. Past performance does not guarantee future results. Index performance does not represent actual iShares Fund performance. For actual fund performance, please visit www.iShares.com or www.blackrock.com.
This material represents an assessment of the market environment as of the date indicated; is subject to change; and is not intended to be a forecast of future events or a guarantee of future results. This information should not be relied upon by the reader as research or investment advice regarding the funds or any issuer or security in particular. This document contains general information only and does not take into account an individual’s financial circumstances. This information should not be relied upon as a primary basis for an investment decision. Rather, an assessment should be made as to whether the information is appropriate in individual circumstances and consideration should be given to talking to a financial advisor before making an investment decision.
This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of the date indicated and may change as subsequent conditions vary. The information and opinions contained in this material are derived from proprietary and nonproprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by BlackRock, its officers, employees or agents. This material may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any of these views will come to pass. Reliance upon information in this material is at the sole discretion of the viewer.
The iShares Funds are distributed by BlackRock Investments, LLC (together with its affiliates, “BlackRock”).
©2020 BlackRock, Inc. iSHARES and BLACKROCK are trademarks of BlackRock, Inc., or its subsidiaries in the United States and elsewhere. All other marks are the property of their respective owners.
ICRMH0620U-1216425-1/4
© BlackRock
Read more commentaries by BlackRock
