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The Value of Staying The Course Thumbnail

The Value of Staying The Course

Where's the Value?

Purchasing relatively inexpensive securities has been an outperforming investment strategy over the long term.

As you can see in the charts below, across all long time periods, value (relatively inexpensive stocks) have outperformed growth (relatively expensive stocks) as a group.

Canadian Value Performance:

US Value Performance:

International Value Performance:

Emerging Markets Value Performance:

If Value is so pervasive, why would it be difficult to own value stocks in your portfolio?  The reason is that there can be long periods where value doesn't work.  The past decade, in particular, has been a difficult time for Value stocks.  The underperformance of value has been especially acute in the United States, where value has trailed growth by a significant margin in the period between 2010 and 2020:

The recent underperformance of value may have caused investors to "bail" on value in the spring or summer of 2020.  While the total US US market (measured by the CRSP 1-10 index) in the United States dropped 20.45% year to date as at March 30, 2020, US value stocks dropped even further.  The Fama French Value Index, YTD 2020 Ending on April 1, 2020 was down  38.43% Year to Date.

History has shown that a disappointing period for a premium like value can be followed by a quick turnaround, and that’s what happened beginning in October 2020. 

Through March 2021, the small value index saw its own noteworthy outperformance: 63% over that span, among the best stretches since the 1920's.

History hasn’t presented a reliable way to predict when small value stocks will outperform. Swings can be swift and sharp—staying invested is the best way to capture expected gains over the long term.

Thinking of Diversification Differently

I can convince an investor that diversifying away from a single stock makes sense.  I can probably convince them that owning stocks outside of Canada makes sense (getting away from home country bias).  I can probably convince them to own fixed income if they don't need or want a lot of volatility in their portfolio.  Why, then, is it so hard to pursue other diversifying factors in a portfolio for the long run?

This article from Larry Swedroe talks about how investors often misunderstand their lack of diversification by ignoring factors like small cap and value.  Investors who are "all in" on TSM (total stock market) equity index funds or large cap index funds, are all on on "Beta".  Beta is a factor, but it is only one of the several risk factors that drive returns in a portfolio.   The others include size, value, profitability, and momentum.

I can understand the allure of beta.  When large cap growth stocks outperform the way that they have recently, the large, broad indices have outperformed with them.  This may lead investors to think that this is the way it will always be, and that a diversified portfolio can be constructed using only large cap-heavy growth stocks.

But people forget that large cap indices, or beta, can go through long periods of underperformance.  It is during these periods where you want to be diversified across factors, the same way that you are diversified across geographies and asset classes.

In the article Larry looks at the performance of small cap value stocks during periods of underperformance of the S&P 500.

"...the S&P 500 Index has experienced longer and more extended periods of negative premiums than has small value. Consider that the S&P 500 Index has experienced three periods of at least 13 years when it underperformed riskless one-month Treasury bills: 

  • 1929-1943: The S&P 500 Index returned just 0.3 percent per annum versus the 0.7 percent return to one-month Treasury bills. During this period small value stocks, as measured by the Dimensional U.S. Small Cap Value Index, provided basically the same return, 0.1 percent.
  • 1966-1982: The S&P 500 Index returned 6.8 percent per annum versus the 7.0 percent return of one-month Treasury bills. During this period the Dimensional U.S. Small Cap Value Index returned 16.0 percent a year, an outperformance of 9.2 percentage points a year for 17 years. 
  • 2000-12: The S&P 500 Index returned 1.7 percent per annum versus the 2.1 percent return of one-month Treasury bills and the 12.5 percent return of the Dimensional U.S. Small Cap Value Index, an outperformance of 10.8 percentage points per year for 13 years."

Now that value has once again shown that it can show up and outperform in strong bursts, I hope that investors will be more open to adopting a multi-factor approach, and sticking with it, for the long term.

The evidence tells us that there is a lot of value to be had in staying the course.


Chart Source: Dimensional Fund Advisors and DFA Returns Web

Photo by Duane Mendes on Unsplash