As the director of research for Buckingham Strategic Wealth and The BAM Alliance, one of the most asked questions I get about factor-based investing relates to investment horizon.
It goes something like: “The value premium has been negative for the last 10 years, and I don’t have 10 years to wait for a value or size—or any other factor—premium to show up.”
Before addressing this question, note data from Ken French’s website show that, while the value premium in U.S. stocks was down 0.8% per year over the period 2008 through 2017 (and down 8.8% in the first 10 months of 2018), it was actually positive in international stocks—making it hard to claim that the value premium is dead.
The following table, which uses data from Ken French’s website, shows that, no matter which metric was used, there was a value premium in developed international markets from 2008 through 2017.
Note that, using the B/M metric, the developed-market international value premium was down 3.4% in the first 10 months of 2018.
Returning to the question about investment horizon, one of the most important lessons history teaches us is that all factor premiums, including market beta (the return on stocks minus the return on one-month Treasury bills), have experienced long periods of negative returns. My guess is the following data, showing the annualized return to the market beta factor, will come as a big surprise to most investors. Data is from Ken French’s website.
- 14 Years (1929-1943) U.S. Market Beta: down 0.7%
- 15 Years (1969-1983) U.S. Market Beta: down 0.1%
- 13 Years (2000-2012) U.S. Market Beta: down 0.2%
As you can see, we had three long periods where the U.S. market beta premium was negative—investors took all the risks of equities while earning lower returns than they could have earned on riskless one-month Treasury bills.
And that’s without even considering the costs of implementing an equity strategy. Thus, live results would have been even worse. Note also that the three periods make up a total of 42 of the 90 years from 1929 through 2018—that’s 47% of the total period. Equities are risky, and investors require a large premium for taking that risk.
Size & Value
Now, again using Ken French’s data, let’s look at how the size and value premiums performed during those same three periods.
- 14 Years (1929-1943) U.S. Market Beta: down 0.7%; Size: up 5.8%; Value: up 3.2%
- 15 Years (1969-1983) U.S. Market Beta: down 0.1%; Size: up 3.6%; Value: up 6.0%
- 13 Years (2000-2012) U.S. Market Beta: down 0.2%; Size: up 4.4%; Value: up 5.0%
As you can see, in each case, the size and value factors provided large premiums during the long periods when market beta was negative. Of course, that isn’t a guarantee this will always be the case.
However, it does demonstrate the historical and potential benefits of diversifying across unique sources of risk.