By Baruch Lev and Anup Srivastava
In our widely debated paper (“Explaining the Recent Failure of Value Investing”), we have established empirically the following:
- The failure of value investing isn’t a recent phenomenon. In fact, this highly touted and widely used investment technology stopped performing in the late 1980s.
- Value investing had a five-to six-year resurgence in the early 2000s, mainly due to Nasdaq’s collapse, and then returned to its long-term underperformance.
- An important reason for the failure of value investing is the use of highly deficient accounting data ? book values and earnings, in particular ? in selecting “value” and “growth” stocks.
- Beyond such mismeasurements, the main reasons for the failure of value investing are long-term, structural economic changes, causing a significant slowdown of the mean reversion of both value and growth stocks.
For the unfamiliar: Value investing is a popular investment scheme of buying low-valued stocks (e.g., low market-to-book or price-to-earnings stocks), and selling short highly valued stocks. The natural rebound of the former (“value” stocks) and the price drop of the latter (“growth” stocks) — namely, mean reversion ? generated the gains from value investing in the 1970s and 1980s.
But despite the clear and damning empirical evidence and the protracted underperformance of most value funds, there are still die-hards claiming that value investing will return to its former glory. In particular, some assert now that value investing is a safeguard in time of crisis. We decided to examine this claim on two recent crises: the financial crisis (December 2007 through June 2009, both inclusive), and the COVID crisis (2020 year, until July 27, 2020). Our data, presented below, will continue to disappoint value believers.
We used two publicly available data in computing the yield of value investing: (1) selling short Nasdaq (populated by growth stocks) and buying the S&P 500 Value Index, and (2) relying on the widely used (and publicly available from Ken French website) Fama-French HML factor for value and growth stocks. Here are our findings:
Source: the author
The data in the table above show that a value investor who shorted Nasdaq and bought the S&P 500 Value Index during the financial crisis (December 2007 through June 2009, both inclusive) lost 13.39%, and doing the same thing during COVID (January through June 2020) would have led to a loss of 17.43%. Measuring the yield on such value investing by the Fama-French HML factor indicates a financial crisis loss of 11.6% and a COVID-period loss of a whopping 30%. A long-only value investing strategy would also have led to substantial losses (except for a zero gain during COVID from the S&P Value Index).
Our sincere apologies to value-investing die-hards. The facts, even in times of crisis, continue to disappoint. Value investing is far from a safeguard both in good and bad times. But, we guess, hope springs eternal.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.