One critique of market efficiency was has been that buying a basket of value stocks and shorting expensive stocks offered superior returns over time to the overall market, on average. In recent decades, the returns to that simple value investing strategy have faded. Does that mean that value investing no longer works? A recent study suggests its too early to call the death of value investing.
The Value Premium
Recent research by Eugene Fama and Kenneth French, two of the major proponents of factor-based investing, have found that the returns to value investing have fallen sharply in the second half of the 1963-2019 period.
Basically, it appears value investing was a great idea before it was popular, but now as its perhaps more mainstream and more completely documented, returns have reduced. Maybe the literature on the effectiveness of value investing is its own worst enemy. Perhaps value investing is now a crowded trade, reducing its effectiveness.
However, it may be too early to write off value investing. Returns to value are historically volatile. This makes it hard to measure the impact of value investing precisely, even over a decade, because a apparently random bad run for value investing can last for some time, and the returns to the strategy are only a few percent a year in good times. Hence even a positive return can be swamped by volatility, or happening to pick a bad decade for value.
For example, consider that in 2020 the S&P 500 fell in value by around a third in a single month, only to then bounce back, recovering its value in roughly the next four months. Against highly volatile backdrops such as that, identifying small variations in asset pricing can become problematic.
That said, despite the nuances of statistical analysis, it does seem that returns to value investing are a lot lower from the 1990s onward than they were before.
There is a legitimate debate as to whether returns to value are still measurably positive for investors, but they do appear a lot smaller than they once were. In volatile markets, proving that something doesn’t work, even over years, is a challenge. Still, on the other hand, evidence of real success isn’t that evident either. Much of the success of value investing rests on data from the 1960s to 1980s. That trend may return, but value returns in recent decades overall are nothing to brag about.
Aside from its glory days, the other reason to have faith in value is that there are credible reasons why it may work, as documented by Ben Graham, and reinforced by the great investor Warren Buffett. So value isn’t just an output of statistical number crunching, it has a logical backbone to it as well.
Still, given that many value strategies that may have in the past been implemented through complex and intensive strategies are now available buy owning a low-cost Exchange Traded Fund could have diluted returns to the value investor. Ironically, maybe more investors need to get truly fed up with value investing for it to really work again.
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