There’s no doubt that it’s been a disappointing stretch for value investors who focus on relatively inexpensive stocks with lower valuations. But this doesn’t mean investing in value stocks has become a worthless pursuit.
In fact, when we consider performance over longer periods, value’s current streak of underperformance is somewhat rare—although not unprecedented in past 10-year periods. This suggests that value’s recent rocky stretch shouldn’t disrupt a long-term investment strategy. Also, diversifying factor exposure with a multifactor approach could make it easier for investors to stick with their long-term plan.
Where’s the value?
Based on the annual performance of the Russell 1000 Growth and Russell 1000 Value Indexes, growth has outperformed value in 7 of the last 10 calendar years. In particular, growth outperformed value by a wide margin in 2009, 2015, 2017, and 2018.
However, despite this disappointing result for value, the value factor has been a source of persistent outperformance versus the broader market over the long haul, according to academic research. From 1928 to 2017, the value premium¹ in the United States had a positive annualized return of approximately 3.5%, on average.² Factors are characteristics of stocks, such as size and valuation, that are persistent drivers of return and risk over long time periods. Some factors, such as value, have exhibited long-term outperformance, or a premium, versus the overall market as measured by market-capitalization-weighted indexes.
Still, that may be small consolation for value-oriented investors who have been frustrated since the 2007/2008 financial crisis. Explanations for the outperformance of growth stocks include low interest rates, slow and steady economic growth, low inflation, and investors chasing the performance of high-valuation technology giants. Conversely, value stocks tend to lead the way during the recovery phase of the economic cycle—and when investors are worried about a recession.
Whatever the reasons behind value’s lagging performance, history shows that extended underperformance in the value premium is actually not that unusual. In fact, from 1937 to 2017, there were 13 instances of 10-year annualized performance periods that had a negative value premium. The good news is that there were 68 instances when the value premium was positive in 10-year periods.³
Also of note, the value premium in U.S. stocks can be highly variable on a year-to-year basis. In other words, there's a significant amount of variability around how long it may take a positive value premium to materialize.
Although there's obviously no guarantee that history will repeat itself, this does suggest that a disciplined, long-term mindset is required to stick with any strategy that seeks to capture the value premium.
Multifactor: better together?
The recent underperformance of value stocks is a reminder that individual factors can remain out of favor for longer than investors expect. Also, it’s very difficult to correctly time investments in individual factors that are outperforming, which can be volatile on a year-to-year basis.
That’s why multifactor strategies may make sense for long-term investors. One example of a multifactor approach is combining value with other factors, such as size and profitability.
We continue to see evidence that exchange-traded fund (ETF) investors are using multifactor approaches. According to Morningstar, multifactor ETFs amassed $42.8 billion in 2018, capturing nearly 13% of gross flows to smart beta ETFs last year.⁴
Theory versus practice
Value stocks have a documented long-term performance premium, but investors have to be willing to accept periods of outperformance like the recent experience. Incorporating a multifactor approach may help smooth returns and improve diversification by adding factors that are uncorrelated with the performance of value stocks.
That’s why we think it makes sense for investors to partner with experienced factor-based managers who understand the opportunities and challenges of the approach. Also, various multifactor strategies can perform differently based on the metrics used to target individual factors, which factors are chosen, and careful design to limit unnecessary costs.
Learn more about multifactor ETF investing.
1 The value premium is the return difference between stocks with low relative prices (value) and stocks with high relative prices (growth). 2 Computed as the return difference between the Fama/French U.S. Value Research Index and the Fama/French U.S. Growth Research Index. Fama/French indexes are provided by Kenneth French; index descriptions are available on request. Past performance does not guarantee future results. 3 In U.S. dollars, 2017. The 10-year rolling relative price premium is computed as the 10-year annualized compound return on the Fama/French U.S. Value Research Index minus the 10-year annualized compound return on the Fama/French U.S. Growth Research Index. Fama/French indexes are provided by Kenneth French. Index descriptions are available on request. Indexes are not available for direct investment, and their performance does not reflect the expenses associated with the management of an actual portfolio. Past performance does not guarantee future results. 4 A Global Guide to Strategic-Beta Exchange-Traded Products, Morningstar, March 2019.