The underperformance of value funds has been a hotly debated topic over the last decade. But a statistic may have distorted that narrative, according to an interview in Institutional Investor with Andrew Wellington and Jeffrey Keswin, founders and CIO and CEO respectively of Lyrical Asset Management. As Wellington points out, the majority of companies in both the S&P 500 value index and the Russell 1000 Value Index are also in the S&P 500.
About 200 of the cheapest stocks saw annual returns of 19% between 2009 and 2017, a time when much of Wall Street was deriding the value investing strategy, even while the S&P 500 Value index returned 13.7% during the same period. The major indices don’t reflect the strategy at all, Keswin said. “If you [called] your average financial advisor and said ‘Hey, what do you think is going on in a value index?’ they probably wouldn’t think [that they’re getting] 85 percent of the total S&P, or that 40 percent of the holdings have a one-year forward PE of more than 20. No, you think you’re getting low PE.” Looking past those major indices shows that the story hasn’t changed since 2008. Those benchmarks have often incorrectly influenced investor perception of value investing. At Lyrical, they avoid businesses and sectors they deem to be too big and not transparent, and generated solid returns for 9 years. But in 2018, they saw their value stocks battered by the market with a 28.4% decline over the next 21 months.
In 2020, Lyrical’s strategy began to outperform again, even as the major indices continued to underperform. Because of the methodologies used by those indices, they now include generally all but the priciest stocks. But Hamish Preston, the director of U.S. Equities Indices at S&P Dow Jones Indices, told Institutional Investor that “every member of the S&P 500 has a growth or value application” and that the other S&P 500-style indexes show the same general value and growth shifts that are seen by S&P Dow Jones, which also now provides highly selective, pure style indices.
For their part, seeing that the indices were driving investors away from value investing, Wellington and Keswin created an alternative index and an ETF to track it. They continue to invest in about 30 stocks using an active strategy. “We saw a problem with the indices, and…said let’s do something about it,” Keswin told Institutional Investor. “All of this will be as biased as that sounds, but I think it was based on this objective observation about the frailties in the system that we can rightly opine about.”