The Real Reason Value Has Been Lagging Growth
Value stockshave trailed growth stocks for years. But Dimensional argues that it’s not because the strategy has gone out of favor.
Portfolio managers that invest in undervalued stocks have lagged funds that hold growth stocks over the past decade — leading market commentators to speculate that value investing is dead.
Not so fast, argues asset manager Dimensional Fund Advisors.
Yes, investors holding U.S. value stocks — those trading at a low price-to-book value — have produced an annualized compound return of 12.9 percent. That compares with a 16.3 percent annualized return for growth stocks, or those with a relatively high price. But Dimensional has published new research showing that it’s not the performance of value stocks that has been out of whack — rather, the performance of growth stocks has been abnormally high relative to historical levels.
Critics have attributed the shortfall in value performance to everything from unprecedented changes in global monetary policy to overcrowding from the popularity of systematic strategies used to invest in stocks with value characteristics.
But according to Dimensional, growth’s annualized compound return of 16.3 percent over the ten-year period ending June 2019 was much higher than its 9.7 percent return since July 1926.
“On the other hand, value performance over the past decade has been more or less in line with its historical average: 12.9 percent versus 12.7 percent. We can see value has performed similarly to how it has historically behaved,” wrote the authors of Dimensional’s research, called “Value Judgments: Viewing the Premium’s Performance Through History’s Lens.”
In other words, growth has been the outlier compared with its historical performance.
“We get so many questions from clients — ‘What’s wrong with value?’ Well, we thought maybe it’s not value, maybe it’s growth,” said Marlena Lee, head of investment solutions at Dimensional, in an interview.
Lee said she doesn’t know why growth has outpaced value over the past ten years. Dimensional has analyzed almost every theory that analysts have proposed to explain the relationship between value and growth. But Lee said the data do not support any of the theories, including low interest rates, quantitative easing programs by central banks, and the outsize influence of the so-called FAANG stocks, a group of stocks that include Amazon, Apple, and Facebook.
“Investors maintaining an emphasis on growth stocks may be hoping this departure from the trend will endure, despite the historical long-term averages,” the researchers wrote.
But they warned investors that value can turn quickly.
“Some of the weakest periods for value stocks when compared to growth stocks have been followed by some of the strongest,” according to the research.
Dimensional, which was one of the first asset managers to focus solely on academic factors like value and growth, recalled times in investing history when some value managers have thrown in the towel on the strategy.
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“On March 31, 2000, growth stocks had outperformed value stocks in the US over the prior year, prior five years, prior 10 years, and prior 15 years. As of March 31, 2001 — one year and one market swing later — value stocks had regained the advantage over every one of those periods,” the paper’s authors wrote.
And ten years, which may feel long to some investors, is still a relatively short time period.
“The theoretical support for value investing is longstanding — paying a lower price means a higher expected return,” concluded Dimensional. “However, realized returns are volatile. A 10-year negative premium, while not expected, is not unusual.”