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Where’s the Value?

The following article has been prepared by Dimensional Fund Advisors Ltd and is reproduced here with their consent.  Your attention is drawn to the risk warnings and important information at the end of the article.

The views and opinions expressed herein do not necessarily reflect the views of MASECO LLP and MASECO LLP accepts no responsibility or liability for any of the views or opinions expressed in the article and are not responsible for its contents.  The article is being made available for information purposes only and should not be construed as providing investment or other advice.

From 1975–2017 the value premium[1] in Europe has had a positive annualised return of approximately 2.2%.[2] In six of the last ten calendar years, however, the value premium in Europe has been negative. The same trend has been seen across developed markets globally.

This has prompted some investors to wonder if such an extended period of underperformance may be cause for concern. But are periods of underperformance in the value premium that unusual? We can look to history to help make sense of this question.

There are numerous empirical studies documenting the value premium using different empirical techniques on 90 years of US data as well as over 40 years of data for developed markets outside of the US that point to reliably positive premiums in the long term.

Short-term Results

Exhibit 1 shows yearly observations of the US value premium going back to 1928. We can see the annual arithmetic average for the premium is close to 5% in USD terms, but in any given year the premium has varied widely, sometimes experiencing extreme positive or negative performance. In fact, there are only a handful of years that were within a 2% range of the annual average—most other years were farther above or below the mean. In the last 10 years alone there have been premium observations that were negative, positive, and in line with the historical average. This data helps illustrate that there is a significant amount of variability around how long it may take a positive value premium to materialise.

Exhibit 1. Yearly Observations of Premiums, Value minus Growth: US Markets, 1928–2017

In US dollars. The one-year relative price premium is computed as the one-year compound return on the Fama/French US Value Research Index minus the one-year compound return on the Fama/French US Growth Research Index. Fama/French indices provided by Ken French. Indices are not available for direct investment. Their performance does not reflect the expenses associated with the management of an actual portfolio.   Past performance is no guarantee of future results.

Long-term Results

But what about longer-term underperformance? While the current stretch of extended underperformance for the value premium may be disappointing, it is not unprecedented. Exhibit 2 documents 10-year annualised performance periods for the value premium within the US market, sorted from lowest to highest by end date (calendar year).

This chart shows us that the best 10-year period for the value premium was from 1941–1950 (at top), while the worst was from 1930–1939 (at bottom). In most cases, we can see that the value premium was positive over a given 10-year period. As the arrow indicates, however, the value premium for the most recent 10‑year period (ending in 2017) was negative. To put this in context, the most recent 10 years is one of 13 periods since 1937 that had a negative annualised value premium. Of these, the most recent period of underperformance has been fairly middle-of-the-road in magnitude.

Exhibit 2. Historical Observations of 10-Year Premiums, Value minus Growth: US Markets 10-Year Periods ending 1937–2017

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

In US dollars. The 10-year rolling relative price premium is computed as the 10-year annualised compound return on the Fama/French US Value Research Index minus the 10-year annualised compound return on the Fama/French US Growth Research Index. Fama/French indices provided by Ken French. Indices are not available for direct investment. Their performance does not reflect the expenses associated with the management of an actual portfolio. Past performance is no guarantee of future results.

While there is uncertainty around how long periods of underperformance may last, historically the frequency of a positive value premium has increased over longer time horizons. Exhibit 3 shows the percentage of time that the value premium was positive over different time periods going back to 1926 for the US market and 1975 for developed markets outside of the US. When the length of time measured increased, the chance of a positive value premium increased.

Exhibit 3. Historical Performance of Premiums over Rolling Periods, US Markets, July 1926–December 2017

Historical Performance of Premiums over Rolling Periods, Developed ex-US, January 1975–December 2017

 

 

 

 

 

 

 

 

 

 

 

In US dollars. Based on rolling annualized returns using monthly data. Rolling multiyear periods overlap and are not independent. Fama/French indices provided by Ken French. Indices are not available for direct investment. Their performance does not reflect the expenses associated with the management of an actual portfolio. Past performance is no guarantee of future results.

For example, we can see that the realised value premium over a one-year horizon (using overlapping periods) has been positive around 61% to 69% of the time across US and developed ex US markets. When the time period measured is lengthened to 10 years, the frequency of positive average premiums increased to 84% and above.

Conclusion

What does all of this mean for investors? While a positive value premium is never guaranteed, the premium has historically had a greater chance of being positive the longer the time horizon observed. Even with long-term positive results though, periods of extended underperformance can happen from time to time. Because the value premium has not historically materialised in a steady or predictable fashion, a consistent investment approach that maintains emphasis on value stocks in all market environments may allow investors to more reliably capture the premium over the long run. Additionally, keeping implementation costs low and integrating multiple dimensions of expected stock returns (such as size and profitability) can improve the consistency of expected outperformance. Finally, after this extended period of underperformance of value stocks relative to growth stocks we are now in a position with a historically large valuation gap between value and growth stocks (difference in average value of the value stocks relative to the average value of the growth stocks).

[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 Europe and Scandinavian Value Research Index and the Fama/French Europe and Scandinavian Growth Research Index. Fama/French indices provided by Ken French. Index descriptions available upon request.

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Source: Dimensional Fund Advisors LP.

The views and opinions expressed in this article are those of the author and not necessarily those of Dimensional Fund Advisors Ltd. (DFAL). DFAL accepts no liability over the content or arising from use of this material. The information in this material is provided for background information only.  It does not constitute investment advice, recommendation or an offer of any services or products for sale and is not intended to provide a sufficient basis on which to make an investment decision.

The content, style and messages the material delivers are presented for consideration and should be tailored to your firms own beliefs, message and brand.

DFAL issues information and materials in English and may also issue information and materials in certain other languages. The recipient’s continued acceptance of information and materials from DFAL will constitute the recipient’s consent to be provided with such information and materials, where relevant, in more than one language.

Eugene Fama and Ken French are members of the Board of Directors of the general partner of, and provide consulting services to an affiliate of Dimensional Fund Advisors Ltd.

The Dimensional and Fama/French Indices reflected above are not “financial indices” for the purpose of the EU Markets in Financial Instruments Directive (MiFID). Rather, they represent academic concepts that may be relevant or informative about portfolio construction and are not available for direct investment or for use as a benchmark. Their performance does not reflect the expenses associated with the management of an actual portfolio. Index returns are not representative of actual portfolios and do not reflect costs and fees associated with an actual investment. Actual returns may be lower. Descriptions of the Dimensional and Fama/French indexes available upon request.

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Risk Warnings and Important Information

The value of investments can fall as well as rise.  You may not get back what you invest. Investments involve risks. The investment return and principal value of an investment may fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original value. Past performance is not a guarantee of future results. There is no guarantee strategies will be successful.

The above article does not take into account the specific goals or requirements of individual users. You should carefully consider the suitability of any strategies along with your financial situation prior to making any decisions on an appropriate strategy.

MASECO LLP is authorised and regulated by the Financial Conduct Authority for the conduct of investment business in the UK and is an SEC Registered Investment Adviser in the USA. MASECO LLP trades as MASECO Private Wealth. It is a partnership registered in England and Wales and has its registered office at Burleigh House, 357 Strand, London, WC2R 0HS. MASECO Private Wealth is not a tax specialist. We strongly recommend that every client seeks their own tax advice prior to acting on any of the strategies described in this document. This document does not constitute and should not be construed as investment or any other advice. The information contained herein is subject to copyright with all rights reserved.


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