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.