A few weeks ago, John Authers of the Financial Times wrote, “Amid one of the quietest sequences for the stock market on record, making money has proved painfully hard, especially for those who practice the art of value investing.”
Recent markets have indeed been painful – lacking conviction and meaning, but offering plenty of uncertainty and confounding price moves. And as Authers notes, these have been especially painful markets for value investors – those who buy unpopular assets with beaten down prices and then patiently hold on. Only companies that have demonstrated growth have been rewarded, while the cheap stuff has been getting cheaper.
However you define value, it is going through a rough patch. According to the Russell 3000 – if you accept the way it divides the world into value versus growth -- growth is up over 7% year to date, while value is slightly negative. Value also has underperformed growth for the 1, 3, and 5 year periods, though the difference isn’t as extreme as it’s been this year.
There are always periods when growth outperforms value and vice verse, but over long periods of time, value outperforms. Eventually, expectations for high-growth companies outpace reality, while what is cheap and shunned ends up doing far better than expected after it’s been written off by almost everyone.
Value investors must always endure short-term underperformance for long-term outperformance. Value investing keeps working over time because most people don’t have the patience to endure underperformance. It is too painful and lonely.
But value does come back. According to a brief piece by John Alberg and Michael Seckler, who use machine learning and take a systematic approach to value investing, there have been 6 periods since 1945 when growth outperformed value, and none have been worse than the current period, except for the dotcom boom of the 1990s. However, value always has recovered. The chart produced by Alberg and Seckler shown below, suggests that the current 5-year period of underperformance has good potential to recover this time around too.
[Source: John Alberg and Michael Seckler, “Why You Should Allocate to Value Over Growth,” 2015]
Authers of the FT wrote that value’s extreme underperformance now suggests “a turning point could be approaching.” He reminds readers that the dotcom boom was “brutal” for value investors, but “those who survived went on to make a killing in the decade after – so doubling down on value for those who can makes sense.”
A recent article by Antoine Gara at Forbes suggests the same while looking at famed value investor Joel Greenblatt’s funds. Greenblatt has had spectacular long-term results in the past but recently his funds have underperformed. Is this because something is wrong with Greenblatt’s strategy, or is it telling us that different pockets of overvaluation and undervaluation are approaching extreme levels that will eventually have to reverse? He seems to think it’s the latter – that value’s time is coming.
We agree. The prospectus for Greenblatt’s funds says that “If there were an investment strategy that worked every day, every month and every year, eventually everyone would follow it and it would stop working. . . In fact,” it goes on, “we strongly believe that short periods of underperformance are a major reason why more people do not adopt our logical, disciplined approach.” That’s the thing about value investing. It takes patience that most people do not have, but those who do have it can end up doing very well.