- A continuous and careful value focus best positions you to capture value premiums when they appear for a greater expected return than focusing on growth stocks.
- Value stocks have surged in the past year, but the resulting performance lift has varied widely across active value managers.
- The relative outperformance of Dimensional portfolios since 2020 reflects a superior management process to deliver on value exposures.
Value is an asset class, not an investment strategy. Identifying low relative price stocks is only one step toward effectively designing and structuring value tilted portfolios. Moreover, differences in managers’ implementation can lead to a wide range of value outcomes in active portfolios.
For systematic investing through Dimensional Fund Advisors, very strong value performance during periods of value outperformance signals a superior ability to reliably capture value premiums. However, only those investors remaining invested during a preceding slump are likely to be fully rewarded. Greater relative outcomes are much more likely for those with consistent equity value allocations.
Swings in Equilibrium
For several years, growth stocks strongly outperformed value stocks. Some speculated whether evidence for a value premium was still valid. The three-year period ending June 2020 was the worst recorded for the US value premium. The Russell 1000 Value Index underperformed the Russell 1000 Growth Index by 17.2 percentage points annualized. This was unprecedented. Of the 1,093 rolling observations in US history, the three years ending in June 2020 ranked dead last. That is the very definition of an outlier.
Since June 2020, value has made a decisive comeback, beating growth by 8.1 percentage points annualized through June 2022. Historically, value stocks have outperformed their growth counterparts by 4.1 percentage points on average in all years from 1927 to 2021, as Exhibit 1 illustrates.
Exhibit 1: Yearly Observations of Value Premiums
Value minus Growth in US Markets (1927 – 2021)
In US dollars. In US dollars. Yearly premiums are calculated as the difference in one-year returns between the two indices described. Value minus growth: Fama/French US Value Research Index minus the Fama/French US Growth Research Index. Past performance is no guarantee of future results. Investing risks include loss of principal and fluctuating value. There is no guarantee an investment strategy will be successful. Indices are not available for direct investment. Their performance does not reflect the expenses associated with the management of an actual portfolio.
To suggest that the value premium no longer exists based on a short 3-year period abandons a sensible economic theory — the valuation model: paying less today for future company cash flows is associated with a higher expected returns to be realized in the future. The firm’s cost of capital is the investor’s return.
Investor outcomes through the last decade negatively impacted a strong value emphasis. However, we know the more a portfolio methodology deviates from a strict market weighting like an index fund, the greater the tracking error relative to the market that may occur from time to time — but the greater the expected outperformance when targeted value premiums finally do reappear.
A Difference of Opinion
Extensive research from Dimensional’s team shows over and over that a value emphasis reliably increases portfolio expected returns for long-term planning. Research further suggests that a positive value premium can occur regardless of good or bad value performance in the prior year. Exhibit 2 illustrates this.>
Exhibit 2: Annual Value Premium and Following Year Value Premium
US Market (1927 – 2021)
Past performance is not a guarantee of future results. Actual returns may be lower. Investing risks include loss of principal and fluctuating value. There is no guarantee an investment strategy will be successful. Indices are not available for direct investment; therefore, their performance does not reflect the expenses associated with the management of an actual portfolio. In USD. Annual value premium is the return difference between the Fama/French US Value Research Index and the Fama/French US Growth Research Index. Yearly premiums in top chart are arranged from low to high rather than chronologically, covering 1927-2021. Premiums in bottom chart are arranged in the order of the top chart, but one year later in each instance, to show next-year performance.
The exhibit looks at the value premium’s performance from one year to the next. Years are arranged based on annual value premium, and then compares the next year’s performance. The top quartile years — those with the strongest value premium performance — were followed by an average annual value premium of 4.74%. The bottom quartile — or the weakest years for the value premium—on average were followed by an annual value premium of 4.35%. The average differences are not much.
It’s very important to point out how often active managers don’t capture the full return. Within Morningstar’s value category, exposure to low relative price (“value” stocks) varies substantially across funds. For example, the 200-plus funds in Morningstar’s large cap value category over the 10-year period ending March 31, 2022 had fund price-to-book ratios ranging from 1.3 to over 6.6. Such a wide variation means that those “value” funds had inconsistent exposures to value. In months when the Russell 1000 Value Index outperformed the Russell 1000 Growth Index, the average monthly net return for these funds ranged from 0.41% to 2.44%. Such fund uncertainty is not acceptable for anyone’s planning.
Buyer Being Aware
Informed planning invests in a way that puts the odds in your favor. There’s never a “right” or “wrong” time for value investing. Varying value premium tilts during a period of disappointing underperformance may forfeit part or all of a future value rebound. Similarly, we can’t predict how long current value outperformance will continue. What we do know is that one key thing an investor can control is to decide to stick with their investment policy.
The Dimensional solutions that Professional Financial employs systematically target value stocks, day in and day out. We expect a positive value premium for clients every day. While frequently daily realized premiums will be negative, bearing those occasional negative premiums is the price an investor must pay.
A disciplined allocation targeting value stocks for investing boosts the odds your portfolio will deliver on that premium when it materializes. Sticking with a professionally informed approach, sensibly diversified, especially one based on the science of capital markets, we believe is the best approach for most families to confidently plan successful outcomes with their hard-earned life savings in the face of all the uncertainty we must endure today in a changing world that is constantly in flux.
Source: CRSP and Compustat data calculated by Dimensional. Fama/French data provided by Fama/French. Fama/French US Value Research Index: Provided by Fama/French from CRSP securities data. Includes the lower 30% in price-to-book of NYSE securities (plus NYSE Amex equivalents since July 1962 and Nasdaq equivalents since 1973). Fama/French US Growth Research Index: Provided by Fama/French from CRSP securities data. Includes the higher 30% in price-to-book of NYSE securities (plus NYSE Amex equivalents since July 1962 and Nasdaq equivalents since 1973). This information is intended for educational purposes and should not be considered a recommendation to buy or sell a particular security. Returns for 2021 are through the year-to-date period ending November 30, 2021. Returns less than one year are not annualized.