The Value Effect - With International Flavor (EFV, EFG)

By Katrina Lamb | June 24, 2007 AAA

Stock market observers have long spoken of a so-called "value style effect" in stock selection. This refers to the tendency of stocks with low valuation multiples, such as price-to-earnings and price-to-book, to outperform stocks that trade at higher multiples over the long term. Different theories exist as to why and if this is true.

The value camp does have some evidence on its side. Over a 28-year period starting January 1, 1979, and ending May 31, 2007, the Russell 3000 Value Index (PSE: IWW), a broad measure of value stocks, returned 14.79% on an annual, average basis compared to 11.92% for the Russell 3000 Growth Index (PSE: IWZ) and 13.59% for the S&P 500.

International Style
I thought it would be interesting to see if there is any evidence for a value style effect in international equities as well. Investors have a variety of options through which to obtain exposure to value or growth equities. Barclays (NYSE: BCS) offers two iShares exchange-traded funds (ETFs) that offer exposure to the MSCI EAFE Value (NYSE: EFV) and MSCI EAFE Growth (NYSE: EFG) indexes.

EAFE is a widely-known index for measuring equities performance in developed, international capital markets. Since its launch in September 2005, EFV returned an annualized 28.2% through May 31, 2007, while EFG returned 24.88% for the same period.

Value outperformed growth in the United States as well during this period. IWW, the ETF representing the Russell 3000 Value Index, returned an annualized 18.96% from the September 2005 to May 2007, while its counterpart IWZ, reflecting the Russell 3000 Growth Index, brought in 12.91%.

This brings us to another question: do value and growth tend to do well in the United States and overseas at the same time? I went back and ran total return data for the Russell 3000 Growth and Value Indexes and the MSCI EAFE Growth and Value Indexes for each full calendar year from 1979 (the first year of available performance data for the Russell indexes) to and including 2006.

The results were interesting. Of those 28 years, value outperformed growth in the international markets 20 times with growth coming out on top the other eight. In the United States, value came out on top 17 years with growth outperforming the other 11. During these years EAFE beat the S&P 500 15 times and U.S. stocks did relatively better 13 times.

The case for a global style effect seems fairly strong: on only three out of 28 occasions did one of the styles outperform the other in one market but not the other.

Conclusions
Portfolio managers employ a growth-value style matrix in the belief that it can offer attractive diversification benefits and be weighted to reflect the manager's strategic and tactical views. It is relatively uncommon, however, to see a portfolio explicitly divided along value and growth lines for international equity allocations.

"International" usually appears as a separate catch-all for non-U.S. equities, perhaps with a breakout for emerging markets. As the importance of international equities as an asset class increases, however, it may be worthwhile taking a closer look at style weighting beyond U.S. borders as well.

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