Value investing is well used by investors, and has been the subject of extensive academic research. Yet recent years have shown that value factor has not behaved as expected.
The core investment factors - size, Value, momentum, minimum volatility, quality and high dividends - and their relationship with different macroeconomic environments are well understood. But in recent years these factors have not behaved as expected. For instance, the recent outperformance of Value factor points to a more fundamental shift in macroeconomic conditions.
After five years of lacklustre performance, Value factor has sprung back to life. Over the last two quarters of 2016, Value indices have outperformed standard indices by 7% in Europe and by 3% in the US(1).
Buying cheap stocks in the expectation of their prices improving over the long term is a well-established strategy. Investors select Value stocks by looking for those companies with specific financial metrics, such as low price-to-book ratios or price-to-earnings ratios. These discounted stocks tend to be higher-risk companies, often with high levels of debt. Over time, however, investors expect to be rewarded for investing in these higher risk companies with greater potential returns than would be achieved by investing in the overall market.
This stock characteristic has been heavily researched by academics and consistently generates outperformance. But despite its well-established credentials, this strategy will sometimes experience long periods of underperformance.
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