Best Of 2016: Swedroe On The Mystery Of Vanishing Premiums

February 16, 2016

[Editor's Note: We are rerunning some of our best stories of the year.]

Given that it’s been both well-documented and well-known that value stocks—in particular small value stocks—have provided higher returns for investors over time, it’s no surprise that as director of research for The BAM Alliance, I’ve been getting a lot of questions about the disappearance of the value premium.

The following table shows the returns of five value and five blend funds from the same major asset classes (large and small stocks from the U.S., developed and emerging markets). The funds are managed by Dimensional Fund Advisors (DFA) and the data covers the 10-year period ending Feb. 11, 2016. Using these funds allows us to view the returns of live funds, which include costs, as opposed to looking at index returns. (Full disclosure: My firm, Buckingham, recommends DFA funds in constructing client portfolios.)

As you can see, in terms of annualized returns, an equal-weighted portfolio of the five value funds underperformed an equal-weighted portfolio of the five blend funds by 0.9 percentage points per year for the last 10 years. And as further evidence, for the 10 years, from 2006 through 2015, the annual average global value premium was -1.4%, while the annual average U.S. value premium was -1.5%. This type of underperformance comes as a surprise to many investors given the longer-term evidence.

A Long-Term View

The following table provides annualized returns for various equity classes over the 89-year period of 1927 through 2015 It shows why the lack of a value premium over the recent 10-year period might catch many investors off guard and cause them to question their asset allocation decision. The data is based on the Fama-French Indexes.

 

Despite disappointing recent results, investors who know their financial history understand that the underperformance of value stocks for the last 10-year period, while perhaps not “expected” (meaning it wasn’t the most likely outcome), shouldn’t have been “unexpected” either (meaning there was a reasonable chance this outcome was going to happen).

Consider the following evidence when we break down the full 89-year period into 17-consecutive (nonoverlapping) five-year periods from 1927 through 2011:

  • Small value stocks outperformed large growth stocks in 11, or 64%, of those periods.
  • Small value stocks outperformed the S&P 500 Index in 10, or 59%, of those periods.
  • Small value stocks outperformed small growth stocks in 10, or 59%, of those periods.

While there was persistence in outperformance, overall, approximately 40% of the five-year periods saw underperformance for small value stocks. Unfortunately, too few investors are willing and able to stay disciplined over such periods and adhere to their long-term financial plan.

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