Distinguished academics find ‘much lower’ premiums, though there’s much room for interpretation
The years-long stretch of underperformance in value stocks could mean that the premium has disappeared permanently, or just temporarily. Many factor-investing advocates want to settle the question once and for all, especially as value believers struggle to keep the faith.
On the list of authorities in a position to give a definite answer, Eugene Fama and Kenneth French, the academic duo whose work paved the way for modern factor investing in 1992, should be near the top. And that’s what they set out to do in a new paper published by the University of Chicago’s Fama-Miller Center for Research in Finance.
As reported by Institutional Investor, the two professors, along with board members of Dimensional Fund Advisors, examined the performance of the value factor — which they defined as the ratio of a company’s book value to its market price — over the 28 years that have elapsed since their original study, which analyzed market data covering a 28-year period from 1963 to 1992. Their objective, according to the paper, was to determine whether they could “confidently conclude that the expected value premium in the U.S. declines or even disappears.”
Looking at the actual returns of a value portfolio between July 1963 and June 2019, Fama and French found that value premiums — returns in excess of those achieved by the broader market — were “much lower” on average in the second half of the period. Larger value stocks, whose market capitalizations were above the median, plummeted from 0.36% per month to 0.05%. Monthly premiums for smaller value stocks, meanwhile, went from 0.58% to 0.33%.
While the declines may appear substantial, the two could not decisively determine whether they spelled a complete change in the premium that investors could expect from focusing on value. The problem, as explained in the paper, was excessive volatility in monthly return values.
“Comparing the first and second half-period averages, we don’t come close to rejecting the hypothesis that out-of-sample expected premiums are the same as in-sample expected premiums,” Fama and French wrote. “But the imprecision of the estimates implies that we also can’t reject a wide range of lower value for second half expected premiums.”
In an interview with Institutional Investor, French said that even 28 years of data going back to 1992 was not enough to resolve the ambiguity in value’s years-long performance drought, which isn’t predicted to end soon.
“It drives many investors nuts,” he said. “The reality is you can’t look at what turn out to be pretty brief periods from a statistical perspective.”
