It's been a long drought for many value managers, but a look at the past two decades hints at a revival
Value-focused managers have been struggling with underperformance, but that doesn’t mean that the factor is dead.
While they enjoyed a brief reprieve in September, money managers that follow a value investing strategy have had a tough time sticking to their convictions. It’s been a painful story especially for deep-value approaches, and there’s no shortage of theories as to why it hasn’t been working.
In a recent Morningstar article, analyst Linda Abu Mushrefova noted the widely-suggested possibility that traditional metrics of “value” are no longer enough. She cited the active team behind the Diamond Hill Large Cap fund, which “emphasizes the importance of network effects and other intangibles that traditional metrics like price/book and P/E fail to capture” as service-oriented tech companies like Google and Facebook have evolved into key market players.
Senior analyst Alec Lucas, meanwhile, referred to the approach taken by Mark Casey of Capital Group’s American Funds: rather than just focusing on companies that appear cheap based on book Value, Casey concentrates on the ability and likelihood of companies to generate enough cash in the near future to make their current share price a bargain in the end. Such an approach, Lucas said, could represent a valid take on traditional value investing as far as the Internet and other technological advances have allowed intangible assets to account for more of businesses’ value.
Senior Morningstar analyst Tony Thomas also noted weakness across traditional value-leaning sectors, including U.S. bank stocks, energy stocks, and certain segments of healthcare. That’s consistent with an analysis shared by MSCI, which found an underperformance of value relative to the broad U.S. market over the past decade.
“The MSCI USA Enhanced Value Index — a proxy for index-based value strategies — has limped through the past decade ending Sept. 30, 2019, when compared to the broad market MSCI USA Index,” said Anil Rao and Abhishek Gupta, representing MSCI’s Equity Solutions Research team, in a recent commentary.
In a survey of value’s performance across different sectors over the past two decades, they found that the fall in value from the 2000s to the 2010s was not consistent. “During that time, value’s return flipped from positive to negative in consumer staples, technology and health care,” they said.
And while the software and services industry registered elevated valuations, the sector outpaced the broad market by a cumulative 150% over the past decade.
Looking at how the value factor has slumped around the world, they also found that it has been “very nuanced.” Compared to the 2000s, they found that most of the fall happened in earnings yield as opposed to the book-to-price factor. The U.S. was the only region in which earnings yields turned negative in the decade from 2010 to 2019.
“Book values are backward-looking and driven by a firm’s return on equity,” they noted. “Earnings yield, as defined in MSCI risk models, contains both historical and forward earnings expectations.”
Despite the value factor’s underperformance, Rao and Gupta emphasized the historically cyclical nature of factor investing. The gap between then MSCI USA Index and the MSCI USA Enhanced Value Index over the last decade, while large, was still less than half the 25% rolling 10-year shortfall in late 1999 during the technology bubble, which was followed by a decade of above-market returns during the 2000s.
“It’s also important to note that value’s decline over the last 10 years was mirrored by momentum’s rise, and that factor behavior was not monolithic across region, sector or definition,” they added.
