Value investing has had a tough decade of underperformance. This seems to have led many investors to ignore the extensive research showing how value investing outperforms the market over longer time horizons, and today many are under-allocated to value stocks. However, history suggests that periods of value underperformance always end – and often they end abruptly - as we saw last year. The question is whether the factor rotation seen in the second half of 2016 was a one off event, or the beginning of a more sustainable comeback.
In recent years, investors have generally preferred the perceived safety of stable dividends and growth rather than hunting for potential bargains among value stocks – which we might broadly define as stocks that are statistically cheap according to some ratio of price-to-fundamentals, like price-to-earnings or price-to-book. Moreover, in the ultra-low interest rate environment, investors hunting for yield substituted bond investments with so-called ‘bond proxy’ stocks, which offered low volatility and steady yield. While valuations for such stocks became stretched, a decade of underperformance for value means that value stocks are now at depressed valuation levels relative to the overall market.
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