What Ever Happened to Value Investing?

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This article is about an exception to a rule – an exception that, I believe, has ceased to be. And so the rule has become stronger, and there is a little less joy in the investing world.

Over the last decade or so, the broad public has come to recognize what academic economists have been proclaiming for several decades: It is extremely difficult and unusual for even dedicated professional investors to “beat the market,” that is, to get better returns than the market as a whole over the long run. (Sure, in the short run, it happens all the time. There are always folk with good luck. And greenhorns and carnival barkers will still have their fun on Robinhood or the next brokerage that comes along to serve the masses.) And when I say “market,” I mean not just the stock market; it’s also very difficult to beat other large financial markets, like, for example, the market for government and corporate bonds. This is why index funds have become so popular. Index funds represent markets (or segments of markets) in their entirety, and the managers of these funds don’t try to pick the best in class. They simply buy stocks (or if they’re bond index funds, then bonds) that represent the market, thereby earning the same return, less the tiny percentage of the funds’ value they take as their fee. (An index or benchmark is the representation, by a list of specific financial securities weighted in proportion to their values, of an entire market, or of a carefully defined segment of a market, and an index fund holds all the securities on that list in the same proportions, or, if the list is enormous, then a large representative sample of those securities.) So, for stocks, you’ll do better if you own a representation of the entire stock market than you will if you own only the stocks that you or your advisor have persuaded yourself are better than the rest.

But academic economists have also known, for nearly as long as they have proclaimed that it’s very hard to beat the market, that market indexes, at least the ones that are commonly used and that feature in nightly business news (the Dow and the S&P 500), are imperfect representations of the market.

And so, within the broad asset class that is stocks, some of us professionals, including me, who agree that the stock market is hard to beat, nevertheless try to improve returns beyond what a simple S&P 500 index fund (a fund that replicates the familiar benchmark of U.S. stock market returns) would achieve. We do this by relying upon a continuation of long-term historical stock behaviors that have been validated by conventional statistical analyses. One of these stock behaviors is the subject of this essay: The tendency of so-called “value stocks” to produce superior returns in the long run.

The reason that I am writing this article is that I’ve concluded that the long history of superior performance by value stocks now has much less relevance to the future of stock investing, and I am decreasing, although not eliminating, my reliance upon value stocks. Our reliance on value investing has caused some amount of underperformance of Peabody River’s equity allocations for some time, and our clients are owed an explanation. Our clients are hardly alone in having been hurt by value investing in recent years. Value investing has caused major hedge funds to bleed assets (which is the melodramatic way we investment professionals talk about losing clients) and some to go out of business, and caused many of our peer investment advisors to sweat and to swear to their clients that if they just wait long enough, value investing will reward them in the end.