Since 1928, value stocks have outperformed growth stocks by 3+% per year on average. Legendary investor Warren Buffett is maybe the best-known example of a dedicated value investor, who throughout his career has captured an impressive outperformance of his own – Berkshire Hathaway has outperformed the S&P 500 from 1965 – 2019 by 10.3% per year.

So what is value investing? It is the bargain-shopping of the investment world. Introduced in the 1920s by Benjamin Graham and David Dodd, it’s an investment strategy based on finding stocks that appear to be trading for less than what they are actually worth (through analysis of the company’s balance sheet). In the 1990s, Nobel Laureate Eugene Fama and Kenneth French added fuel to the value fire by arguing that the value premium – the positive return investors get from investing in cheap stocks – largely explained equity outperformance in both the US and International markets. 

Recently, value has not been having its day in the sun. Over the past 10 years, growth stocks have outperformed value by 3.3% per year*. So what happened to value premium? 

Cliff Asness and his colleagues at AQR recently wrote a white paper titled Is (Systematic) Value Investing Dead?  Their argument? Long-term value premiums are alive and well. 

Said differently, even a sound investment strategy with a high expected return, like value investing, can underperform, even for extended periods. After all, without this inherent risk, we wouldn’t expect to see a positive return in the first place. That’s not to say the recent underperformance can’t continue, but if you are looking for the best odds of success, it would be hard to ignore the evidence over the long-term.

Our take: value investing is not dead. Far from it. Instead, true value investors earn their return in periods like these…by sitting still. Warren Buffett is quoted as saying “The stock market is designed to transfer money from the impatient to the patient”. Well said.

*comparing the S&P 500 (with more growth-oriented stocks) with the Russell 1000 Value Index

We like to share updates from our Investment Policy Committee, which makes key decisions involving the specific evidence-based tools and funds we use to execute our approach. The following is a note they wanted to share for our readers:

The year has been off to a rocky start – with global equity markets roiling from the coronavirus pandemic, and volatility remaining elevated above historic levels. When rough markets come, our clients are ready. How? Uncorrelated asset classes. One of the ways we help combat the inevitable ups-and-downs are by including certain asset classes in clients’ portfolios that move differently from equity markets.

The most familiar of these is fixed income. Most people know intuitively that investing in fixed income reduces risk exposure, as we saw most recently during the 2008 financial crisis. We are a firm believer that while equities help you “eat well,” fixed income helps you “sleep well.” In other words, equities are the source of your return, and fixed income is your stability. That’s why we believe in holding high quality bonds with short to intermediate maturities – solid and sturdy.

Fixed income is the way most of us are  familiar with capturing this benefit. At HIG we go a couple of steps further – capturing other uncorrelated asset classes through market neutral funds. Market neutral funds do basically what their name says – they seek to access return no matter what is happening in the market. They do this by targeting sources of return unrelated (and therefore uncorrelated) to the traditional equity and fixed income markets.

We believe incorporating the right market neutral fund can help smooth the ride, while maximizing your odds of success – making it easier for you to stick with your allocation when things get rough. An added benefit? Market neutral funds can allow you to capture a higher expected return than fixed income – a win-win in our book.

Just like with all things, not all market neutral funds are created equal. The market neutral fund we recommend is the Style Premia Alternative fund (QSPIX), created by AQR.  With this fund, AQR takes a disciplined and systematic approach that aligns itself with our evidence-based investment philosophy. The fund invests across five different asset types and four investment styles, that over the long-term have shown very low correlation to the equity markets.

Here’s some hard data to illustrate the point: since the markets peaked on February 19^th this year, the S&P 500 has dropped by 23.3% while AQR’s Style Premia Alternative fund has shown a decline of only 7.5% through the end of March. Although diversification is not meant to eliminate risk completely (which would mean no reward on the other side) it can reduce the extreme highs and lows, offering a smoother ride to help our clients take the long view.

Behavioral and emotional aspects of our planning are important to us. When we better understand ourselves, we get closer to breaking our old patterns. For more inspiration, we point you to a recent WSJ article “For the New Year, Say No to Negativity”.

What we love about the article is that it acknowledges the truth found in the research – bad stuff impacts us more than good stuff – but the article and corresponding book offer practical ways to turn the corner towards a clear focus on health and wealth in 2020. And you know we are suckers for anyone who uses our motto “take the long view” to help readers/investors shift their outlook to a prosperous lens.

“By rationally looking at long-term trends instead of viscerally reacting to the horror story of the day, you’ll see that there’s much more to celebrate than to mourn.”