Is There Still Value in Pursuing Value?
The year 2017 tested the patience of US value investors. While US value stocks returned a decent 13.66% (as measured by the Russell 1000 Value index), they were overshadowed by the phenomenal 30.21% return of US growth stocks (as measured by the Russell 1000 Growth index) – an underperformance of 16.55%. This negative value premium marked the fifth worst year since 1979 and pulled the five-year rolling premium into negative territory. Ouch.
The pain for US value investors has persisted into 2018, with US value stocks underperforming US growth stocks by 6.01% 1. Despite this seemingly relentless underperformance, we believe there is still value in pursuing value for the long-term investor. Here’s why:
We have seen this movie before. Even over extended periods, underperformance of the value premium (or any other return premium) is not unusual. For example, over the 10-year period ending in March 2000, US value stocks underperformed US growth stocks by 5.61% per year (on an annualized basis). But this underperformance quickly reversed course. By the end of February 2001, US value stocks had outperformed US growth stocks over the previous one-, three-, five-, 10-, and 20-year periods.2
Return premia are nearly impossible to predict and relative performance can change rapidly. This underscores the need for discipline in an investment strategy.
Value rewards long-term investors. Empirical evidence dating back to 1926 shows that US value stocks typically beat US growth stocks, with the odds of outperformance increasing as the time period lengthens, as illustrated in the chart below3. For example, US value stocks beat US growth stocks in 61% of the 1-year rolling periods since 1926, while over the 15-year rolling periods the odds of outperformance increased to 94%. Similar track records have been exhibited in other markets, with value beating growth in developed ex-US markets in 95% of 10-year rolling periods since 19754. In emerging markets, value beat growth in 86% of 10-year rolling periods since 19895.
Beware the allure of growth trends. We’ll admit it: value investing can seem boring compared to its trendier growth counterpart. Take the popularity of FAANG (Facebook, Apple, Amazon, Netflix and Google’s parent Alphabet) stocks. FAANG investors were undoubtedly well-rewarded last year, receiving a simple average of 49% (versus the S&P 500 at 22%); but merely latching on to the latest investment catchphrase does not an investment strategy make. Sure, the FAANGs do have their merits, but investors should not allow their allure to result in an overly tech-concentrated portfolio (remember the dot-com bubble?). Broad diversification across sectors and markets is a much more prudent investment strategy.
Bottom Line: Discipline and diversification are the name of the game. While there is empirical evidence to support our expectation that value stocks will outperform growth stocks over longer periods, there will be periods of underperformance. Discipline and diversification across multiple sources of return premia will lead to a more positive investment experience.
1 Year-to-date total return of Russell 1000 Value index and Russell 1000 Growth index as of market close, 9 March, 2018.
2 Source: Dimensional Fund Advisors LP; total returns quoted are for the Russell 1000 Value and Russell 1000 Growth indexes.
3 Source: Dimensional Fund Advisors LP; Value is Fama/French US Value Research index. Growth is Fama/French US Growth Research index. There are 919 overlapping 15-year periods, 979 overlapping 10-year periods, 1,039 overlapping 5-year periods, and 1,087 overlapping 1-year periods.
4 Source: Dimensional Fund Advisors LP for the period ending December 31, 2017.