A recent paper by RAFI Indices argues that now is the time to increase allocations to value strategies –specifically, to the RAFI strategy, a value-tilted approach that focuses on disciplined rebalancing out of trendy, popular, and most expensive securities, and into securities whose prices have fallen and become undervalued.
The paper, co-authored by Research Affiliate’s Rob Arnott, offers an in-depth look at the origins of value investing and its historical performance data. Here are some highlights:
Historical data shows that the “current underperformance of value stocks relative to growth stocks has exceeded most, and in emerging markets all, previous drawdowns,” the paper states. It adds that history shows value stocks across the globe winning more than losing, “beating growth over 5-year rolling intervals approximately 55% of the time for the full period of our analysis, rising to 70% over rolling 10-year intervals.”
A disciplined and systematic rebalancing strategy should add value in the long run for the following reasons:
- Security prices are “inherently noisy” which means they will “mean revert toward zero over time, with near-continuous new shocks in either direction.”
- “True bargains cannot exist in the absence of fear, reflecting a generally accepted narrative that conditions will get worse before they get better.”
- Behavioral science says that human nature creates anomalies in the capital markets “that the patient investor can systematically exploit.”
Outperformance of today’s most dominant companies is “unlikely to be sustainable in the long run.” A disciplined rebalancing strategy can take advantage of a “performance snapback when the cycle turns once again in favor of value investing.”
The authors conclude: “We can’t promise that tough times are behind us,” adding that it’s difficult to predict what will trigger a value rebound. That said, they assert, “We can state with confidence that the evidence and intuition underlying a contrarian value investing discipline has proven merit in cycle after cycle across history. When value becomes cheap, it almost always and almost everywhere comes back as an outperforming investment strategy.”
