Value has underperformed for so long that even the most ardent value investors start to wonder if it will ever recover. And in the current crisis, value has underperformed even more, which led Cliff Asness to suspend his Twitter hiatus and come back with this:
Campbell Harvey, Yan Liu, and Caroline Zhu have shown that the historical evidence in favour of a value premium is amongst the strongest of all the factors ever discovered and rivalled only by the momentum factor.
But, if even the people who formally discovered the value factor start to have doubts, it is worth paying attention. Eugene Fama and Ken French recently re-examined the data of their ground breaking 1991 publication. They discovered what is today known as the Fame-French Three-Factor Model using US stock market data from 1963 to 1991. By now, we have an additional 28 years of out-of-sample data and the chart below, taken from their paper, shows that the value premium has significantly declined since then.
Size of the value premium before and after the original publication by Fama and French
Source: Fama and French (2020).
The decline in the size of the value premium has been quite dramatic. The monthly premium of large cap value stocks has declined from 0.36% to 0.05% (a decline of 86% in the size of the value premium). For small cap value stocks, it has almost halved from 0.58% to 0.33%. It will be of little consolation to value investors that the return of growth stocks still is not superior to overall market returns.
While these differences are economically significant, they are not (yet?) statistically significant. Because the value premium comes in lumps, it takes a long time of underperformance or extreme underperformance before one can say that it is statistically significant. And given the statistical robustness of the original data we shouldn’t throw the value factor overboard, yet. There is an argument that can be made that we are estimating the size of the value factor at the trough of a cycle and thus, it should per definition be close to zero. In 1991, when the original study was made, the value factor was close to a cyclical peak and so it was easier to detect.
But similarly, one can make the argument that many factors have disappeared after they were discovered in the literature and the value factor may just be another victim of this publication effect.
Personally, I think that the value factor has diminished because of the low interest rate environment we live in for a decade now. As I have explained here, in an environment of low interest rates, overleveraged companies can survive much longer. Unfortunately, I think that interest rates will remain at a very low level for a very long time. This means that while value may not be dead, it may be in hibernation.
Investors should thus use the value factor with caution. Ideally, you pair it with other factors like quality or even momentum to make sure you do not rely solely on one factor alone. Companies with an attractive combination of value and quality earnings may be preferable, because if value comes back, it will help your investments but if it doesn’t you at least have profitable companies with a solid balance sheet in your portfolio that may benefit from a continued outperformance of the quality factor. In a low interest world, betting on the value factor alone is a dangerous proposition.