Value Investors Believe Their Long Winter May Soon End

Their strategy can be summed up as bargain hunting. They buy stocks trading at low prices based on earnings or the underlying of a business. Although this makes powerful intuitive sense—paying less should lead to gaining more—the Russell 1000 Value index has trailed its counterpart benchmark of high-priced growth stocks in nine of the past 11 years. Since the end of 2016, growth stocks have returned a cumulative 100%. Value stocks? Just 15%.

The weak performance of is particularly challenging for asset managers who’ve adopted what’s known as factor investing, also known as “smart beta.” It’s a hybrid of active and passive approaches. Managers don’t try to select specific winning stocks, but they statistically tilt their portfolios to those with certain characteristics. Many of these funds lean toward .

Consider the case of Dimensional Fund Advisors, a firm in Austin that pioneered factor investing. Its funds were inspired by the academic work of Eugene Fama, a University of Chicago economist who won a Nobel Prize in 2013, and Kenneth French of Dartmouth. David Booth, Dimensional’s chairman and co-founder, was once Fama’s research assistant, and Fama and French are both directors at Dimensional.

In a landmark 1992 paper, Fama and French found that stocks as well as smaller companies appeared likely to outperform the market, based on data from 1963 through 1990. But a new paper published by the pair in January suggests the advantage of investing has declined, though it hasn’t disappeared. Why? One possible answer is a little counterintuitive: In the past, investors may have seen stocks as unusually risky, so they built an extra discount into prices to account for that. When the companies did better than expected, the cheap prices gave investors an extra pop. But once investing became mainstream, that discount may have gotten smaller, so the stocks had less room to rise.

Dimensional’s U.S. Core Equity 1 fund, which favors as well as other factors, has an annualized return of about 9% over the past five years. It trails its benchmark, the Russell 3000 Index, which earned an annualized return of almost 11%.

Booth is resolute that still makes sense. He notes that even the best investments have lengthy dry periods, pointing to the long underperformance of stocks compared with Treasuries in the 1970s. “Markets are going to do what they do,” he says. “But if you have a sensible idea that’s backed up with a lot of good research, that’s going to give you an edge over the long haul.”

Dimensional says the premium is still strong when looking beyond the U.S. “This reminds us of the importance of a globally diversified investment strategy when seeking drivers of expected return,” says Wes Crill, a senior researcher at the firm.

Some market watchers say may be about to have its moment. They’re looking for the rebound from the Covid-19-induced hit to the economy. If things go better than expected, some of the most beaten-down companies could rally. In June strategists at Goldman Sachs Group Inc. and Morgan Stanley predicted the market would start to favor .

Complicating this theory is the idea that the definition of may be changing, making true stocks harder to spot. “In the fastest-growing segments of the global economy, intangible assets are becoming the main generators for a majority of companies and industries,” JPMorgan Chase & Co. strategists, led by Dubravko Lakos-Bujas, wrote in a June 22 note to clients. Intangible assets include things such as patents, brand names, and other intellectual property. If these aren’t properly measured, some stocks might appear more expensive than they are, and investors may be missing the best opportunities.

Booth agrees that identifying may change over time. “Undoubtedly there will be new wrinkles,” he says. But he’s sticking with the idea that paying less for stocks makes sense and that the long-run data still back that up.

“The alternative is to believe in magic,” he says. “Either you believe in science, or you believe in magic.”
 
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