While picking underpriced stocks with strong fundamentals may have helped Warren Buffett make billions, value investors have been having a rough go of late. ETFs and quant funds that invest in value stocks—stocks cheaply priced relative to their fundamentals—are bleeding billions of dollars, and the value-based strategy has generally performed poorly over the length of the current decade-long bull market, according to Barron’s.
“One of the enduring and puzzling features of this equity cycle has been value’s lacklustre performance,” wrote JPMorgan’s Dubravko Lakos-Bujas. “Despite intermittent reversal rallies (2009, 2012-13, 2016), value is currently trading at the biggest discount ever and offers the largest premium over the last 30 years.”
What It Means for Investors
Value-based investing strategies are based on the assumption that stocks trading below their intrinsic value will have to bounce back at some point by pure force of mean reversion. But despite the soundness of the logic, ETFs that use value-based strategies have been underperforming their respective benchmarks.
The iShares Russell 1000 Value ETF (IWD) has underperformed the Russell 1000 index by as much as 22 percentage points over the past six years and has already seen $4 billion of outflows this year. The iShares S&P 500 Value (IVE), iShares Russell Mid-Cap Value (IWS), and iShares Russell 2000 Value (IWN) have also seen similarly significant asset outflows in 2019.
Quant funds, which have grown significantly over the past decade with more than $1.5 trillion of assets under management (AUM), haven’t fared much better. Deriving their name from the word ‘quantitative’, these funds use data analytics and computing power to make bets on a variety of market factors, including value, size, volatility, yield, quality and momentum.
But of that list, it is the first factor—value—that appears to be the most important for many of the largest quant funds. Bank of America found that in comparison with their benchmarks, the holdings of the 29 largest quant funds were much more heavily tilted towards stocks trading at lower price-to-earnings and price-to-free cash flow multiples, an indication that the fund was using a value-based strategy.
But like the value-based ETFs, quant funds have struggled. Only 34% of quant funds beat their respective benchmarks last month, significantly lower than the above-50% hit rate achieved by all large-cap active managers. “Quant stock selection has been terrible,” Cliff Asness, chief investment officer at AQR Capital Management, told Barron’s.
As value investing is based on a simple strategy of picking undervalued stocks relative to their fundamentals, such a strategy may work in relatively normal times. But super-low interest rates since the global financial crisis are at least one sign that equity markets are not operating under normal conditions, and in recent months, the uptick in volatility appears to be an effect of stocks being governed more by the most recent headline rather than fundamentals. What value investors need, is a return to normalcy, whatever that is.