That value stocks (in particular, small value stocks) have provided higher returns for investors over time is both well-documented and well-known. So it’s no great surprise that—as director of research for The BAM Alliance, a community of more than 140 independent RIA firms—I’ve been getting a lot of questions about the recent disappearance of the value premium.
Figure 1 shows the returns of five value funds and five blend funds from the same major asset classes: small U.S. stocks, large U.S. stocks, small developed-markets equities, large developed-market equities and emerging markets. The funds are managed by Dimensional Fund Advisors (DFA) and the data covers the 10-year period from 2005 through 2014. (Full disclosure: My firm, Buckingham, recommends DFA funds in constructing client portfolios.)
Using these funds allows us to view live returns, which include costs, as opposed to looking at index returns.
Figure 1: Blend Vs. Value Funds
|DFA Small Cap (DFSTX)||8.8||DFA Small Cap Value (DFSVX)||7.9|
|DFA Large Cap (DFUSX)||7.7||DFA Large Value (DFLVX)||8.1|
|DFA International Small (DFISX)||6.7||DFA International Small Value (DISVX)||7.1|
|DFA International Large (DFALX)||4.6||DFA International Large Value (DFVIX)||4.6|
|DFA Emerging Markets (DFEMX)||8.6||DFA Emerging Markets Value (DFEVX)||8.8|
|Average Return||7.3||Average Return||7.3|
As you can see, in terms of annualized returns, there has been, on average, no realized value premium over the last 10 calendar years. While this certainly has been a disappointment to investors who expected higher returns from value stocks, there was also no harm done to those who “tilted” their portfolios toward value. There was no annualized premium, but there wasn’t any underperformance either.
Small Value Vs. Other Equity Classes
Figure 2 provides annualized returns for various equity classes over the 88-year period from 1927 through 2014. It shows why the lack of a value premium over the last 10 years might surprise many investors and cause them to question their asset allocation decision. Data is based on the Fama-French Indices (ex-utilities).
Figure 2: Returns Of Various Equity Classes, 1927-2014
The outperformance of value stocks, and in particular, small value stocks, relative to other asset classes, has led many investors to consider including more exposure to them than the market has overall. For small value, that share is only about 2 percent of the total market. In addition to the above-market return, the persistent outperformance of small value stocks also has been very high. Consider the following:
- The data set can be broken down into 17 consecutive (nonoverlapping) five-year periods from 1927 through 2011.
- Small value stocks outperformed large growth stocks in 11, or 64 percent, of those periods.
- Small value stocks outperformed the S&P 500 Index in 10, or 59 percent, of those periods.
- Small value stocks outperformed small growth stocks in 10, or 59 percent, of those periods.
While the data shows persistence of outperformance overall, about 40 percent 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, adhering to their plan.
Note also that large value stocks outperformed large growth stocks and the S&P 500 Index in 10, or 59 percent, of the 17 consecutive (nonoverlapping) five-year periods. Observe that whenever large value stocks outperformed large growth stocks, they also outperformed the S&P 500 Index. And the reverse was also true.
Considering A Longer Time Frame
The same set of data provides us with eight nonoverlapping, 10-year periods to evaluate.
- Small value stocks outperformed large growth stocks in seven of the eight periods. The only exception was for the period from 1987 through 1996, when small value underperformed by 0.31 percentage points per year.
- Small value stocks outperformed the S&P 500 Index in all eight periods.
- Small value stocks outperformed small growth stocks in all eight periods.
- Large value stocks outperformed large growth stocks in six of the eight periods, or 75 percent of the time.
- Large value stocks outperformed the S&P 500 Index in six of the eight periods, or 75 percent of the time. Large value underperformed once, and there was one tie (from 1987 through 1996, they both returned 15.29 percent per year).
Even these high rates of persistence demonstrate it’s still possible an investor could wait out a 10-year investment horizon and still face a situation where small value and large value stocks underperform other asset classes.
If there were no chance of that occurring, then there wouldn’t be any risk in allocating to value over growth. As a result, knowledgeable investors shouldn’t be surprised that we have just experienced a 10-year period when value stocks didn’t outperform growth stocks.
My almost 20 years of experience as a financial advisor has taught me that even the most disciplined investors can have their patience sorely tested by as little as even a few years of underperformance, let alone a full 10-year period without higher returns to value stocks. A dramatic example of the potential for underperformance, or what’s referred to as negative tracking error, is the five-year period ending in 1999.