“If you stop believing in value [investing], you stop believing in lots of what makes the world go ’round.” — Gerard O’Reilly, Dimensional Fund Advisors
As a high-achieving professional, you’ve worked hard to capture your stellar earnings. Naturally, you want to put the financial rewards you’ve reaped to good use, investing a portion of them toward achieving future financial goals for you and your family – including value investing.
But how do you do that? A winning investment strategy should help you convert your hard-won dollars into durable wealth. Except there’s a catch: The more long-term returns you hope to earn, the more investment risk you should be prepared to endure along the way. Like gravity, that’s pretty much the law when it comes to investing: No risks = no expected returns.
Value investing is one such two-sided risk/reward coin. Unfortunately, it’s been taking its time to show up “heads” for value investors, tempting many to abandon the strategy altogether.
Before we continue, what is value investing? Value stocks are those trading at a low price relative to a measure of its company’s fundamental value, such as its book equity. They’re the opposite of growth stocks, which are trading at a high price relative to the same measure. As such, value stocks are expected to deliver a value premium (higher relative returns) over time.
Hint: This Is What Risk Looks Like
So, what do you do if your well-structured, evidence-based value strategy has disappointed you for some time? What if it has underperformed a more traditional growth strategy for five, 10 … even 15 years? What if your own doubts are fueled by increasing media coverage, asking questions like: Is Value Investing Dead?
Well, to use a phrase we’re hearing a lot right now, we’re in this together. At Cogent, we have looked to decades of rigorous academic evidence suggesting that value and a handful of other factors offer higher expected returns. We have structured our globally diversified portfolios accordingly, by overweighting into the value factor. Our system is premised on accepting that it may take some time for value’s expected premiums to play out.
Said another way, we look to the academics to discover, test, and deliver exposure to market factors that have higher expected returns. Then we lean in, and do more of that, hoping to realize higher returns than the broad market has to offer.
So, yes, value investing has had a challenging stretch over the last 10 years or so, particularly in the U.S. market. The critical question is: Is value investing dead, or merely slumbering? By revisiting the long-run data, we can put current conditions into proper context. When we do, we continue to see good reasons to stick to plan.
History Suggests Have Patience With Value Investing
When comparing the historical returns for value vs. growth, history is on value’s side. While past performance does not guarantee future returns, the long-term arithmetic average remains robust. The data also illustrates how an investor’s experience can vary widely from year to year.
Past performance is no guarantee of future results. Actual returns may be lower.
In USD. Indices are not available for direct investment. Index returns are not representative of actual portfolios and do not reflect costs and fees associated with an actual investment. Yearly premiums are calculated as the difference in one-year returns between the two indices described. Value minus Growth: Fama/French US Value Research Index minus the Fama/French US Growth Research Index. See “Index Descriptions” in the appendix for descriptions of Dimensional and Fama/French index data.
We believe you should rely on the evidence. Historically, value stocks have outperformed growth stocks in the U.S., though recently that hasn’t been the case. While disappointing periods emerge from time to time, the principle that lower relative prices leads to higher expected returns remains the same. Nearly a century of data backs up the notion that value stocks—those with lower relative prices—have higher expected returns. On average, they have outperformed growth stocks by 4.54% annually since 1928.
We rely on the evidence to form our expectations. In a recent webcast, Dimensional Fund Advisors Co-CEO and Chief Investment Officer Gerard O’Reilly spoke on the performance of value stocks relative to growth stocks, addressing the theory and data supporting a value premium.
At Cogent, we are firm in our beliefs that value investing will have its day. Logic and history argue for a commitment to value stocks, so investors can be positioned to take part when those shares outperform in the future.
While many investors are well aware of diversification in terms of investments, it is also important to understand diversification in terms of time. We diversify our investments as a risk control. Because we do not know with a high degree of certainty which area of the market is going to be the next winner, we hold many different types of stocks. Time diversification is the idea of following a particular investment style over time. As we mentioned before, market factors that have higher expected returns do not always show up in any given year, but the longer we hold onto them, the likelier we are to capture their benefits.
The Future Arrives Fast
Essential to our strategy is the understanding that growth stocks have recently outperformed value stocks – but that outperformance has been a stark departure from long‑term averages. Moreover, value has trailed growth in the past, and then strongly rebounded.
At the same time, like many things in life, there are no guarantees, and results vary over time. As Buckingham Strategic Partners’ Larry Swedroe often says: The improbable is not impossible.
Cliff Asness, a University of Chicago PhD and co-founder of AQR, a fund company we look to for research and investing solutions, has written in his piece, Is (Systematic) Value Investing Dead:
As my colleagues show with both data and economic argument, this is very unlikely to be the result of common “the world has changed” arguments that you often hear today – and, frankly, you always hear such stories about whatever strategy has been going through very tough times.
“Regarding timing, could systematic value come back very quickly over say a few months, or slowly over a few years? We don’t know. Good investing isn’t about sure things and certainly rarely about precise timing…Good investing is about being on the right side of the odds and sticking with good strategies, if (a big “if” we have hopefully taken great strides to dispelling), after careful examination, you are convinced they are not broken.”
In other words, while stock returns are unpredictable, there is precedent for the value premium to reverse course after periods of sustained underperformance … often with astounding and unpredictable speed.
For example, some of the weakest periods for value stocks vs. growth stocks have been followed by some of the strongest. On March 31, 2000, growth stocks had outperformed value stocks in the U.S. over the prior year, prior five years, prior 10 years, and prior 15 years. But as of March 31, 2001—one year and one market swing later—value stocks had regained their advantage over every one of those periods.
Unfortunately, those who had given up the value ghost just prior to that recovery would have bailed on the strategy at the absolute worst time for their own portfolio’s well-being.
Again, we turn to Gerard O’Reilly, who speaks further on how investors seeking to capture the value premium must stick with a long-term focus.
Value Investors: Let’s Walk Together
So, there is hope. While times are challenging for value investors, we are relying on the evidence and staying with these convictions. And this isn’t just talk. At Cogent, we invest our own capital in this strategy, through our personal portfolios and our Cogent Retirement Plan. We also recommend it across our clients’ portfolios according to their unique circumstances. In this and many other ways, we are walking the walk along with you.
At Cogent, investing is about implementing great financial ideas for our clients and ourselves. By sustaining an enduring, evidence-based belief in the power of markets, we don’t try to predict the future or outguess others. Instead, we draw information about expected returns from the market itself.
There’s another benefit to entrusting markets to do what they do best (which is to drive informed pricing). It lets us build efficient portfolios for capturing what the market has to deliver by adhering to a less subjective, more systematic investment approach. This, in turn, frees us to dedicate more time to investor education, as well as our clients’ greater wealth management needs.
This is why, even in challenging market environments, we challenge investors to remain committed to capturing value and similar factors offering higher expected returns over the long-term – even if it’s hard to see their expected premiums from one day to the next.
Let us know if you want to know more about why we choose evidence-based investing with appropriate factor tilts. Or, if you are a value investor and suffering alone, join us in a conversation. We can review your financial plan with an eye toward helping you realize your financial goals, without you having to manage every aspect by yourself.
Don’t manage your financial future all on your own. Sit down with our team today for a Cogent Conversation. We’ll listen to what success looks like for you, build a plan tailored to you, and help you execute that plan every step of the way.
The opinions expressed by featured authors are their own and may not accurately reflect those of Cogent Strategic Wealth®. This article is for general information only and is not intended to serve as specific financial, accounting or tax advice. By clicking on any of the links above, you acknowledge that they are solely for your convenience, and do not necessarily imply any affiliations, sponsorships, endorsements or representations whatsoever by us regarding third-party Web sites. We are not responsible for the content, availability or privacy policies of these sites, and shall not be responsible or liable for any information, opinions, advice, products or services available on or through them.
© 2020, Cogent Strategic Wealth®
Global Performance of the Premiums
Past performance, including hypothetical performance, is no guarantee of future results. Actual investment returns may be lower. Filters were applied to data retroactively and with the benefit of hindsight. Groups of stocks and their returns are hypothetical, are not representative of indices, actual investments or actual strategies managed by Dimensional, and do not reflect costs and fees associated with an actual investment. One-Month US Treasury Bill is the IA SBBI US 30 Day TBill TR USD, provided by Morningstar. The market is the eligible universe for each country. REITs, tracking stocks, and investment companies are excluded from the universe. In addition, stocks need to meet certain minimum market capitalization and liquidity requirements. Profitability is measured as operating income before depreciation and amortization minus interest expense scaled by book. Asset growth is measured as year-on-year growth in assets.
Simulated returns based model/back-tested simulations. These are not live strategies managed by Dimensional Fund Advisors LP or any of its affiliates. The performance was achieved with the retroactive application of a model designed with the benefit of hindsight; it does not represent actual investment performance. Back-tested model performance is hypothetical (it does not reflect trading in actual accounts) and is provided for informational purposes only. The securities held in the model may differ significantly from those held in client accounts. Model performance may not reflect the impact that economic and market factors might have had on the advisor's decision making if the advisor were actually managing client money. These strategies were not available for investment in the time periods depicted. Actual management of these types of simulated strategies may result in lower returns than the back-tested results achieved with the benefit of hindsight. Past performance (including hypothetical past performance) does not guarantee future or actual results. The simulated performance shown is "gross performance," which includes the reinvestment of dividends but does not reflect the deduction of investment advisory fees and other expenses. A client's investment returns will be reduced by the advisory fees or other expenses it may incur. For example, if a 1% annual advisory fee were deducted quarterly and a client's annual return were 10% (based on quarterly returns of approximately 2.41% each) before deduction of advisory fees, the deduction of advisory fees would result in an annual return of approximately 8.91% due, in part, to the compound effect of such fees.