Has Value Investing Gone Out Of Style?

Is value dead? Or do the enthusiasts of the Russell index family and the Fama-French Factor Model need to re-evaluate price-to-book ratio (P/B) as the primary metric used in defining value stocks?

The decade ending September 2018 was the single worst decade in history for P/B as a factor-sort of the market.

Rolling 10-Year Return Differentials: Cheap vs. Expensive Price-to-Book

Rolling 10-Year Return Differentials_Inexpensive vs. Expensive PtB

 

Deteriorating Power?

In their seminal factor paper, Fama and French wrote: “there is no evidence that its explanatory power deteriorates through time.”1

Perhaps they will consider the new evidence.

In 616 of the 679 10-year periods from 1926 through to the end of 1992, the cheap stocks outperformed the expensive stocks, with the median performance advantage greater than 500 basis points (bps) per year.

But recent returns have been trending down as we saw earlier with the recent single worst decade for low-P/B stocks compared to high-P/B stocks.

This is not just an academic exercise on the limits to valuation-oriented investing.

The Russell family of indexes, established in 1979—ahead of the Fama-French research—utilizes P/B as the primary determinant of what defines a value stock. It now has been 40 years since the creation of that index family and the Russell 1000 Value Index has outperformed the Russell 1000 Growth Index.2

But consistent with the recent downward trend in relative performance, over the past 30 years, the Russell Value has lagged the Russell 1000 Growth by 21 bps annualized, with more recent underperformance significantly greater.3

What Caused Recent Underperformance of Value?

It was primarily sector tilts that caused the lagging performance for Russell Value. P/B sorting of the market as a value strategy results in chronic sector tilts, particularly toward Financial stocks and away from Technology stocks.

On average, the Russell 1000 Value Index has been overweight Financials by 11%, and underweight Information Technology by 10% over last decade. These bets are persistent and likely will continue for some time.

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