Covid condemns value investing to worst run in two centuries


Value investing is suffering its worst run in at least two centuries after the pandemic compounded a decade of struggles for a popular strategy that consists of buying cheap stocks in often unfashionable industries.

The approach of favouring bargains — typically judged by comparing a company’s share price to the value of its assets — over faster-expanding but expensive growth stocks has a long history. Economists Eugene Fama and Kenneth French have shown that modestly priced stocks have in the long run returned significantly more than the broader equity market.

But value stocks have performed dismally since the 2008-09 financial crisis and this year the drought has worsened dramatically, making the degree of underperformance relative to racier growth stocks even more extreme than at the peak of the dotcom bubble. 

“The dispersion between growth and value is around the highest we’ve ever seen,” said Kasper Elmgreen, head of equities at asset manager Amundi. “At the one end you have tech stocks, which have been easy to fall in love with when we are all working from home, and at the other you have financials and banks.”

Bank stocks have struggled to shake off their low valuations, relative to earnings and assets, for a host of reasons — ranging from stricter post-crisis regulation to low or even negative interest rates, which curtail their profitability. As a result, their prospects are much dimmer than the fast-growing “Big Tech” stocks that have come to dominate many equity markets. Many oil companies are also struggling, as investors fret that the industry will be hurt by a global shift towards renewable energy.

Research by Mikhail Samonov, the head of Two Centuries Investments, a quantitative fund manager, suggests the performance of value is now the worst since at least 1826 — the year former presidents Thomas Jefferson and John Adams both died. US stock market data only goes back to 1927, but Mr Samonov has gone back a century further using older, rougher data compiled by Yale finance professor William Goetzmann.

Line chart of Cumulative loss of value factor since most recent peak (%) showing Two centuries of value drawdowns

The value factor’s performance is usually calculated from a model that buys the cheapest shares and bets against the most expensive ones. For 1826 to 1926, when many companies did not routinely report their balance sheet and stock price data were sparser, Mr Samonov used dividend yields to create a proxy for what constituted a value stock. 

According to Mr Samonov, the value factor is now down 64 per cent from its peak in 2007, going beyond the previous record — a 59 per cent tumble suffered from the late 19th century until a nadir in 1904.

Line chart of Cumulative long-short excess returns (%) showing Value investing has done well over time, despite big drawdowns

Prominent value investors include Berkshire Hathaway’s Warren Buffett, the hedge fund manager Seth Klarman, GMO’s Jeremy Grantham, and Benjamin Graham, the doyen of financial analysis. Many quantitative, computer-powered investment groups such as AQR have systematised value investing into a “factor” that they can mine over time. 

Many value investors had hoped for a comeback for value stocks this year after a long, frustrating period since 2008 culminated in a slump in 2019. However, the Covid-19 pandemic has exacerbated many of the trends that made some companies and sectors cheap or expensive, sharpening the pain.

“We came into this year after the big capitulation last year thinking that value is going to come good . . . We didn’t foresee a global pandemic,” said Michael Barakos, co-chief investment officer for JPMorgan Asset Management’s international equity group. “That’s a pretty extreme curveball that’s been very detrimental for value and very positive for growth.”

This year, MSCI’s index of global value stocks has fallen about 12 per cent, lagging far behind its growth counterpart, which has soared nearly 22 per cent.

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