Following value’s worst quarter of performance in a century, leading quants are “butting heads” in a hot debate over whether the strategy can survive. This according to a recent article in Bloomberg.
“After kicking off the factor boom in the early 90s,” the article reports, “value is punishing the faithful three decades on. Billions are getting wiped out, quant shops are shrinking, and even its architects Eugene Fama and Kenneth French can’t quite figure out of the strategy’s alive or dead.”
Critics reportedly argue that the current recession—the worst since the Great Depression—is the final nail in value’s coffin. But staunch supporters of the strategy lean on extreme valuation gaps as evidence of a potential comeback.
Drawing on research from both sides of the camp, the article offers the following insights:
- Over the long term, stocks that appear cheap relative to earnings do outperform, but some argue that this has primarily occurred among small-cap stock, not large-caps. In a paper last month, Rob Croce of Mellon Investments wrote that while value might look good in academic studies, it has been “misappropriated by practitioners to sell ‘smart beta’ value products.”
- Changes in the economic landscape may threaten the value strategy—“technological advances have made a slew of stocks structural winners and losers in an age of rising market concentration”—but value’s defenders “advise against extrapolating from a few years of data.” AQR’s Cliff Asness, for example, says that regardless of the leaps in tech, wide valuation spreads tell us that investors may be too optimistic about growth and too pessimistic on value.
- While the value factor may be “stuffed with broken businesses,” AQR data suggests that the gap in profitability and return on assets between value and growth stocks hasn’t widened much. The article says this “suggests fundamentals are far from driving value’s losing streak. Investors are simply paying less attention to them.”
- The rise of intangible assets may be part of the problem, says NYU professor Baruch Lev, who notes that outdated accounting rules treat spending on intangibles like expenses instead of investments—making growth stocks seem more expensive than they are. “In a way,” the article says, “this is a pro-value argument. It implies the premium still exists—quants were just capturing it wrongly.” However, data gathered by Dimensional Fund Advisors starting from 1963 reportedly shows that capitalizing intangibles made little difference to return spreads.
- Low interest rates play a role, since cheap stocks are more tethered to the business cycle and tend to do poorly when rates are low, and the economic outlook is weak. Also, the article explains, “a lower discount rate makes short-term cash flows—something value tends to offer—less valuable versus long-term ones,” making growth companies more attractive. But a recent AQR paper challenges the relationship between rates and value stocks, arguing that it depends on the period, markets and measurements analyzed.
- The article notes that while many make a case for a rotation back to value, the difficulty is in knowing when it will happen. Dimensional Fund Advisors says that “while wide valuation spreads tend to augur stronger returns, timing a value strategy based on that doesn’t beat a simple buy-and-hold strategy.”
The upshot, the article concludes, it that for diehard value investors, “all the hate, skepticism and outflows mean the factor won’t be arbitraged away anytime soon. So, no pain, no gain. As long as you survive long enough.”