That’s quite the dramatic title and one which, in some ways, feels like I’m going against the founding fathers of factor investing such as Nobel laureate Eugene Fama and Kenneth French – two academics who published a series of seminal papers providing a lot of the empirical basis for value investing in the 1990s (although it had been around before this). My view, however, is that there are questions to ask before thinking about utilising the value factor when investing. Simply relying on historic data showing that value has outperformed growth over the very long term is a risky strategy, definitely—in my humble opinion—over the current short to medium term. However, even if you put performance considerations aside, one could suggest that investors have simply moved on from wanting to seek value investments and strategies, particularly in their current form. Low interest rates, greater technology disruption and more specifically a focus on responsible investing are all more reasons why interest in value may at least be broken, if not dead.
First, let’s look at performance. Value investors have had a very rough ride in the last decade. In fact, based on one measure, the last decade’s negative returns have cancelled out all of the value’s positive performance going back to the mid-1990’s. However, many proponents of value will argue that there must be a reversion to normality, when value will prosper again, and the continuation of poor performance further amplifies this view.
But what would be the trigger for reverting to ‘normal’ given there’s limited expectation for increasing inflation expectations and even less expectation for rate rises anytime soon? What even is “normal” anyway? Without any evidence, one would have to go back to using a long-term view rationale of, “value" has always done better over the very long-term” or, “it’s cheap because it’s done badly” argument which seems a little like putting money on the 100/1 outsider just because you like the name; a strategy built purely on luck.
The crux of value investing is that while stocks tend to be cheap for a reason, the market often overshoots valuations so bargains can be discovered. For this reason, value investors can be found in untrendy industries—the big innovators and dynamic companies of the day are rarely available at prices attractive to value investors—but value portfolios getting backed further into oil, mining and airline stocks look especially vulnerable, and it’s harder than usual to see these sectors enjoying a resurgence to what value investors would consider ‘fair value’ anytime soon.
Betting against clear disruptive trends is another issue. In an age characterised by disruption, can value perform well? value investors find themselves long bricks and mortar retailers like Walmart and short (on an index relative basis) Amazon; long traditional communications stocks like Verizon and short Netflix. Yet, one could argue that creativity destroys existing business models as discussed in a research paper “Value is Dead, Long Live Value”, July 2019, OSAM. Their research suggests that we are in a technological revolution noting a similar fate fell on Value investors in prior revolutions and that these periods can last for 45 to 60 years. Our current revolution follows previous ages defined by key elements such as the automobile, steel, steam and factory production/mechanization. One well-trodden example talks of the rise of automobiles (growth) providing headwinds for railroads (value). Their view, however, is that there is reason for the poor performance of value investing and that it will eventually return to favour.
Looking at it another way whether the new faith in interventional support from the central banks could continue to hold back value investing, even into the medium to long term, furthering the platform for disruptive Growth businesses and other factor driven opportunities. Covid-19 is yet another headwind in getting back to anything that remotely looks like normal in the world of value investing.
It may also be worth considering whether the sheer size of recent underperformance has dented investor confidence, seriously tarnishing value’s once admirable reputation, and maybe to such an extent that it will take a very long time before interest will recover. Simply put, investors have more confidence in other ideas. It definitely offers a real test for the caveat that “past performance is no guide to the future”. Further still, value investing is also typically going against current key investor themes such as reducing carbon exposure and investing responsibly. Potential investors may simply shy away and seek other opportunities.
If you are thinking of allocating to value, it would definitely be a bold contrarian view at the moment for a whole host of reasons; importantly, beyond the investment case. For me, Value investing seems to be a bit like your English stay-cation; you’ve just spent hours blowing up your rubber 'dinghy “for the kids” but have now realised that the tide has gone out. You could stay and hope it comes back high enough soon—it is the tide after all so will do at some point—but by then, it might be getting dark and everyone’s going home.
Like several fashion trends, investment markets tend to move in cycles. Those who hadn’t lived through the 90s would assume popular brands such as Dr. Martens were a recent innovation as opposed to one that had simply been dormant for 25 years. “Value” investing appears to have gone out of fashion just like Dr. Martens had in the 90s, with some commentators even pronouncing it dead altogether.
Put simply, “value” investing involves buying stocks that appear “undervalued” relative to some fundamental anchor, typically a measure of intrinsic “value”.
Historically, the “value” approach has been rewarding – “value” stocks outperformed “growth” stocks by 4% pa between 1926 and 2008, outperforming in 90% of 10-year periods.
However, “growth” stocks are currently enjoying their longest rally on record, significantly outperforming “value” stocks since the market lows seen in the financial crisis. The market has been dominated by a handful of the very largest “growth” stocks. Take Tesla for example, up almost 400% since the beginning of 2020! In his staunch defence of systematic “value” investing, Cliff Asness, co-founder of AQR Capital Management, has shown that “value” stocks sit at an extremely cheap level even after carving out the very biggest tech-related names. The market is simply paying a lot more for “growth” stocks than ever before. To name just a couple: Shopify (online shopping) valued at over $110bn with revenues of just $1bn; and Domino’s (pizza-delivery) which has traded at a tasty price earnings ratio above 30 for many years.
Whilst I can’t deny that “value” investing has not performed well over the last decade, I think you need to make some fairly bold assumptions to say “value” investing won't ever work again.
“Value” investing works because investors exhibit behavioural bias, such that market risk premiums differ from one investor to another, and prices represent under and overreactions to news relating to fundamentals, such as earnings. There is very little evidence to suggest that investors are now much more rational and less error-prone than they used to be. A myriad of behavioural pitfalls, such as greed and fear, still cause investors to underperform the stock market, by buying and selling at the wrong time.
These behavioural tendencies pave the way for “value” investing to work. One of the features of “value” investing is long periods of being out of favour. Indeed, this has led several “value” investors to suggest that the extra return attributable to “value” is connected to the “pain” of holding in down periods, which can be prolonged.
“Value” investors caution that with such apparent growth exuberance in the market, a return to fundamentals is warranted and overdue. So the prices of “value” stocks, which have been driven to extreme levels, will revert, but you just can’t say when.
Even this year, “value” stocks, which typically exhibit cyclicality, have had their expectation of recovery either delayed or even reversed because of the global pandemic. The traditional argument is that “value” stocks tend to lag during periods of economic slowdown due to their capital-intensive nature. So many “value” investors are now looking to the recovery from the Covid-19 shock as an opportunity for “value” to outperform.
In essence, the core beliefs of “value” investing are that fundamentals, like earnings and cashflow, do matter, and that investors irrationally react to new information. These are timeless truths that remain relevant and the current run of “growth” performance simply makes “value” more attractive.
I definitely think it’s wrong to say “value” investing is dead. “Value” sceptics will never let you forget the significant underperformance of the last decade, but if periods of underperformance like this did not occur, there would be no risk, and therefore no risk premium, which simply isn’t true. Being able to stay the course during long periods of relative underperformance is what led Warren Buffett to assert that successful investing has a lot more to do with temperament (ie discipline and patience) than intellect.
For the other side of this argument, check out Stephen Budge’s counterpoint to this: “value” is Dead.