Value investing has faced a crisis of confidence after five tough years. Here’s why we think the behavioral investing principles that underpin the discipline are more relevant than ever.
It’s been nearly 80 years since the tenets of behavioral investing were first described by Benjamin Graham and David Dodd, the forefathers of value investing. And over the last four decades, value investing has been highly successful. But perhaps, argue critics, after five years of subpar returns, the fundamental drivers of value stock performance may no longer work.
We think the opposite is true. Traditionally, value opportunities are created when a company faces a controversy that triggers a decline in profits and its share price. Value investors use research to determine whether the market reaction has been exaggerated, meaning the stock is likely to rebound in time, or whether the company’s troubles are likely to continue to push the stock down further into a value trap. Behaviors that create opportunity include:
• Loss aversion: The pain of losing money is often perceived as greater than the pleasure from making money.
• Trend extrapolation: Investors may wrongly conclude that a recent negative trend will have enduring consequences for the future.
• Short-term focus: During times of crisis for a company or for markets, it becomes more difficult for investors to establish confidence in long-term forecasts.
Investor loss aversion was heightened by the severe crash of 2008 and the ensuing volatility. An abundance of bad economic and corporate news has made erroneous trend extrapolation even more ubiquitous. And as markets have lurched from crisis to crisis, with recurrent spikes in volatility, investors’ time horizons have become extremely short.
In other words, markets are saturated by behavioral biases that are likely to eventually correct themselves and reward investors who have stuck to their knitting and dared to defy the crowd.
Many things have changed in the markets in recent years. Trading costs have fallen and technology has made it easier than ever to buy and sell stocks quickly. Instant information on economic developments and companies flows around the world, often adding unreliable noise to markets. Since these changes promote emotional reactions by investors, we think that traditional research-driven behavioral investing makes more sense than ever in the 21st century.
The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AllianceBernstein portfolio-management teams.
Joseph G. Paul is chief investment officer of North American Value Equities and Kevin Simms is chief investment officer, International Value Equities, both at AllianceBernstein.