Dead, or just pining for the fjords? That's the debate at the heart of Monty Python's parrot sketch. In it, hilarity ensues when a pet-shop keeper tries to convince a customer that the parrot they purchased was, in fact, not an "ex-parrot."
A similar debate is currently being held among investors when it comes to value investing. After a decade of poor, relative returns, many people figure that value investing is pushing up the daisies while others cling to the belief that it's just resting.
I fall into the latter camp because the evidence for value's demise isn't as dire as it's often made out to be.
For instance, the accompanying graph shows the outperformance of U.S. value stocks over rolling 10-year periods against the market. As you can see, value is currently in one of its rare long-term slumps. Previous poor periods include the Internet bubble just before the turn of the century, a few rough patches around 1960 and the hard times leading up to the Second World War.
But it's important to know how the graph was made. In this case, value is represented by a portfolio composed of the 20 per cent of U.S. stocks with the lowest price-to-book-value ratios (P/B). The portfolio is rebalanced annually and weighted by size (market capitalization). By way of comparison, the market portfolio tracks the largest 30 per cent of stocks in the United States and is also weighted by size. It contains just over 500 stocks today and is similar to the S&P 500. The difference between the two is shown on the graph and the calculations use monthly data from Dartmouth professor Kenneth French.
The low-P/B value portfolio outperformed the market in 86 per cent of the rolling 10-year periods from the start of July, 1926, to the end of April, 2017. It underperformed in just 14 per cent of cases. Over all, that's a pretty good track record.
But it is easy to underestimate the pain and suffering caused by the long soft patches. They are a big reason why people bail out of value strategies and dump their value funds.
The carnage can be seen by the dearth of funds devoted to the deep value, or the Benjamin Graham, style of investing, which tends to focus more on balance sheets than on income statements.
I recently asked jovial money manager Tim McElvaine how many Graham-style fund managers there were in Canada. He pointed to himself and Francis Chou. Both have struggled over the past decade.
It's not just active managers who've run into difficulties. Many value index funds and exchange-traded funds (ETFs) follow low-P/B stocks. The iShares Russell 1000 Value ETF (IWD) is one such offering. It trailed the S&P 500 by an average of 1.8 percentage points annually over the 10 years through June 15, according to Morningstar.com.
Mind you, the low-P/B value effect tends to be stronger when it comes to smaller stocks. That can be a problem for funds (both active and index) that try to manage as much money as possible, which naturally pushes them to invest in larger stocks. It's also a reason why many index funds opt for size-weighted portfolios.
While the accompanying graph size-weights its value portfolio, a similar, equally weighted value portfolio fared even better. It lagged the market in only 3 per cent of the rolling 10-year periods – including a modest dip in recent times.
It is also important to point out that, while value investors who seek balance-sheet bargains have suffered of late, the quality-value approach espoused by Warren Buffett has fared better. Similarly, other measures of value – such as price-to-earnings or price-to-cash-flow ratios – have performed well.
As a result, it's a little early to put the final nail into value investing's coffin. Instead of being dead, it's probably just stunned. It should be up and flying again any day now. At least, that's the word from the value shop.
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