“The world as we have created it is a process of our thinking. It cannot be changed without changing our thinking.”
- Albert Einstein
“I’ve always been warned that when people say ‘it’s different this time’ it really isn’t very different. Yet if I look back over the last decade and I see so much underperformance by value investors (both traditional and the more modern-approach), I think to myself, ‘is it really different this time? Does value investing not work anymore’”?
- Sally Jenkins
In my past few articles, I’ve discussed the distinction between growth and value investing, value’s difficulties since the 2007 - 2009 market crash, and how that has been part of a greater discussion about the viability of value investing in today’s markets. In this article, I thought I’d tie together the two themes and - at a very high level - summarize what the last decade has told us in terms of investment learnings and how we might come to terms with the over decade-long short circuiting in value investing performance.
At Nintai, we divide the market returns since the height of the technology bubble into four phases. Phase one was the run up into the technology bubble running roughly from 1998 - 2000. Traditional value investors - in general - did poorly as they continued to invest along more classic value investing guidelines. Many value investor shareholders began to get nervous as they opened their returns and saw underperformance being led by such staid companies as industrial parts supplier Fastenal (FAST) or spectrometry provider to biopharma Waters (WAT).[1] Some truly great investors closed their doors at the height of the bubble commenting on the fact they simply didn’t understand the market anymore. Phase two was the period of 2001 - 2006 when value investing roared back and more traditional companies like Proctor & Gamble (PG) or Coca Cola (KO) saw great returns while technology stars of the bubble sustained losses of up to 90% or even bankruptcy. It was rare to see such a clear vindication of value investment theory and practice. Phase three was the market crash of 2007 - 2009 led by the financial and credit markets starting with Bear Stearns and Lehman Brothers all the way to the government interventions of Fannie and Freddie Mac. There was a huge distinction though between the bursting of the technology bubble and the bursting of the credit/real estate market bubble. In the latter, many traditional value investors lost as heavily (and sometimes even more) as the general markets and even growth investors. Famous value investors who had been hailed as geniuses just half a decade before were chalking up 30, 40, and even 50% losses as their traditional value methods of using low price-to-book or price-to-revenue models imploded. Phase four added to the agony as the general markets powered through a nearly decade long recovery. While this was happening, traditional value returned paltry returns in what traditionally would have been a golden era for that investment style. Rather, you saw an entire generation of value investment leaders struggle for the entire decade. It was reflected in returns and even more importantly in their assets under management. The list is long and well-respected. Marty Whitman ($4.6B AUM in 2011 to $1.19B AUM in 2019), John Hussmann ($5.4B AUM in 2011 to $350M AUM in 2019), and David Dreman ($5.3B AUM in 2011 to $220M AUM in 2019). Wally Weitz can be considered a success by seeing a rather slim increase in AUM (going from $2.3B in 2012 to $2.52B in 2019). Perhaps the harshest lessons were learned by David Winters, going from value investing rock star and CIO of Wintergreen Fund with $1.5B in AUM in 2012 to shuttering his doors in 2019 with less than $90M in assets. This humbled writer/investment manager had a dismal record with my own corporate internal fund (and eventual Charitable Trust) which was outperformed 4 out 5 years from 2011 - 2015 before I left the fund for greener pastures.
Is Value Investing Dead or Has It Simply Genetically Evolved?
In a recent Westwood Insights (“Value Stocks are Screaming for a Reversion to the Mean. Is Anyone Listening?”. It can be found here.) there is a segment describing the end of Julian Robertson’s career in March, 2000. It reads:
“It was an unseasonably warm 58 degrees in New York City on March 30, 2000. Winter white was just a faint memory on that Thursday, and the thoughts of bustling commuters had turned to spring. All was not balmy in the canyons of Wall Street, however, as the shock heard around the investing world had been announced that morning. Before the New York Stock Exchange opened, value investing legend Julian Robertson, age 67, announced that he was calling it quits, and would return the $13 billion that he managed to his 700 shareholders. He planned to shut down his fund and walk away.
At his fund’s peak in 1998, Robertson managed $22 billion, but he had seen withdrawals of $8 billion over the previous two years, including $1 billion in the first quarter of 2000. His fund had lost 19 percent in 1999, badly trailing the 21 percent gain in the S&P 500 index. He had lost another 14 percent in the first quarter of 2000. The New York Times summed up his predicament the day after his announcement, saying that Robertson ‘had essentially decided to stop driving the wrong way down the one-way technology thoroughfare that Wall Street has become.’
Robertson, a giant of the hedge fund and value investing worlds for more than 30 years, was a casualty of the technology stock euphoria that the prior five years had wrought on traditional value investors. ‘I’m not going to quit investing. I don’t mind people calling me an old-economy investor, but it doesn’t go over well with the clients,’ Robertson noted in his farewell.”
With the nearly decade-long underperformance (nearly twice as long as Robertson’s), that last paragraph wrings eerily true for many value investors as they gaze back at their record. It certainly hasn’t gone over well with their clients as well. But is it enough to simply say these days that value investors are just “old-economy” or is there something far more fundamentally wrong here? Is the very structure and model of value investing broken?
Looking back over the last decade, I would argue value investing was already evolving before this last decade. Thinking and strategy had started to bifurcate as two distinct approaches began to appear. The first was based in the more traditional lower price-to-book and lower price-to-earnings (such as looking for companies with less than a 12-15 P/E ratio). These types of investors are generally descended more from the Ben Graham risk-focused, cigar-butt DNA. The second approach - sometimes referred to as value investing 2.0 - is more in the what was referred to as GARP (growth-at-a-reasonable-price) investing. As an example, this is where a value investor is willing to place value on less-traditional assets such as technology or informatics platforms than a physical manufacturing plant or equipment (I confess I fall clearly in the latter category). What makes this dichotomy interesting is that value investors (2.0) have generated better returns over the last decade than the more traditional value investors. Part of that seems to be based on investment strategy (where growth stocks have been outperforming value) and part of it on individual stock selection (higher quality stocks have done equally well - if not better in some cases - than less quality picks).
Putting aside the debate about more traditional value investing and value investing 2.0, the great question is whether value investing - in general - has gone the way of the dodo or great auk. One side of the argument argues that value investing (defined as low price/book ratio) has actually performed as you would think it would (meaning neither out or underperformed). It has been growth investing that has significantly outperformed its benchmarks over the past decade. In a recent report from Dimensional Investing (“Value Judgments: Viewing the Premium’s Performance Through History’s Lens” which can be found here), the authors discuss the fact that value stocks actually have underperformed growth stocks 11.4% to 14.7% for the period 2010 – 2019. But the way we look at this underperformance is likely skewing the debate about the longer term viability of value investing. The authors contend the issue is less about value stocks underperforming but more about growth stocks outperforming. They go on to demonstrate that value stocks over the past decade have traded similar to what you would expect over a longer-term duration that include several market cycles. Value stock decade-long (2010 - 2019) returns of 11.4% track closely to their 11.9% return since 1979. The interesting data show up in the growth stocks. This segment’s previous decade (2010 - 2019) returns of 14.7% have far outperformed their 11.3% return from the period 1979 - 2019. Dimensional can’t isolate any particular reason why growth stocks have achieved such abnormally higher returns over the past decade. The authors say the data do not support any of the theories proposed by market analysts including low interest rates, quantitative easing programs by central banks, and the outsize influence of the so-called FAANG stocks, a group of stocks that include Amazon (AMZN), Apple (AAPL), and Facebook (FB). In this thesis, the bottom line is that value stocks (as defined by Dimensional) have produced similar returns over both decade-long and three decade-long time frames. The simply have not been able to keep up with a decade-long outperformance (for which we can’t account) in growth stocks.
Others Say Not So Fast
Another school of thought has developed counter to the thinking of Dimensional’s theory. An example of this is a recent paper by Baruch Lev and Anup Srivastava entitled “Explaining the Recent Failure of Value Investing” (it can be here). In the abstract of their work, they summarize their view that value investing’s best days are behind it:
“It is widely believed that the long-standing and highly popular value investing strategy—investing in low-valued stocks and selling short high-valued equities—lost its edge in the past 10 - 12 years. The reasons for this putative failure of value investing elude investors and academics, making it a challenge to assess the likelihood of the return of value investing to its days of glory. Based on extensive data analysis we show that value investing has generally been unprofitable for almost 30 years, barring a brief resurrection following the dotcom bust. We identify two major reasons for the failure of value investing: (1) accounting deficiencies causing systematic misidentification of value, and particularly of glamour (growth) stocks, and (2) fundamental economic developments which slowed down significantly the reshuffling of value and glamour stocks (mean reversion) which drove the erstwhile gains from the value strategy.”
The author’s argument in many inverts the thinking behind the team at Dimensional. They believe the overperformance of value investing post-technology bubble was not the mean but rather an anomaly in a longer history of underperformance since the late 1980’s. They state (somewhat in agreement with Dimensional) that there is no specific market-driven item that can be identified as eliminating value’s edge. Rather, they believe it was changes in how we value companies – rather than process of picking low P/E stocks – that eliminated value investing’s edge. From their paper they write:
“The expensing of intangibles, leading to their absence from book values, started to have a major effect on financial data (book values, earnings) from the late 1980s, due to the growth of corporate investment in intangibles. This book value mismeasurement was a major contributor to the demise of value investing which started in the late 1980s.”
The failure of value investing during the credit/real estate crash of 2007 – 2009 layered on another shift in economic changes (not market changes). They state that more traditional value companies (particularly those with debt loaded balance sheets ranging from manufacturing firms to larger financial institutions) lost their access to capital. Meanwhile, the more glamorous asset-light companies (technology and biopharma) became Wall Street and credit provider darlings leading to a distinct economic advantage for the latter.
Since there has been little change in this newer economic model, Lev and Srivastava don’t see value investing making any big comeback soon.
What This All Means
All of this data brings us back to the core questions surrounding the prognosis for value investing. Is it really different this time? Are the prognosticators of doom finally correct?
The simple - and most honest - answer is we simply have no idea what the future holds for those investors who follow a value investment strategy[2]. For those who suffered tremendous losses in the 2007 - 2009 crash (where value methods should have prevented such results) followed by multi-year underperformance in a record setting bull market (again, where there should be some outperformance in value in the years following a bear market), the question is almost moot. If your investment strategy fails you in both bull and bear markets, then it’s not irrational to call into question the fundamentals of such an approach.
At Nintai, the entire debate is more academic than practical in our view. As investors in assets trading at a discount to our estimated intrinsic value, we think this puts us clearly in the value investment approach. Whether that is based on hard assets on the balance sheets or value derived from the future cash flow of an asset-light business model is irrelevant. We think the focus on value makes you a value investor – nothing more and nothing less.
Having said that (and there’s always a “but” in any good argument!), we do believe that value investing 2.0 has had a leg up on more traditional value investing over the last decade. I have no data to support such a claim nor do I have any specific reason (like Dimensional) why that would be the case. My only idea is that over the long term (here I mean a time frame greater than a decade), buying quality companies at fair prices will generate better returns than purchasing medium/poor quality companies at great prices. Again, I want to point out I have no data to support such a claim. Most of it likely lies in the fact I’m simply more comfortable investing with those caveats in mind[3].
The larger debate about whether value investing (regardless of more traditional or 2.0) is dead really isn’t all that clear. If you argue like Lev and Srivastava the edge has been gone for over 4 decades, then there isn’t much to debate. If you take the more nuanced view such as the Dimensional team then there is still room for debate about value investing’s future.
In the final analysis, it’s up to each individual investor to develop their own investment style that meets a couple of needs: it lets them sleep well night and it produces returns adequate to meet their financial requirements. Whether that’s achieved through a more traditional value approach, value 2.0 approach, or growth investing approach is up to them. But as a portfolio manager myself, I wouldn’t rule out value investing yet. There are still people outperforming the market who all share the same genetic roots from Graham and Doddsville. Whether the causation and pool of candidates are as large as when Warren Buffett first brought the concept to the investing world’s attention, it can’t be denied it’s still there. It may be different this time, but it doesn’t mean value investing is dead yet.
[1] These were two companies I owed at the time I was personally managing the Nintai Partner private investment fund. They certainly weren’t the WorldCom’s or the Cisco’s of the investment world.
[2] It should be said this applies to any investment approach or for the markets in general.
[3] As I’ve discussed previously, over the time frame of 2002 – 2015 the portfolios I personally managed were able to outperform the markets by a considerable margin (past results are no guarantees of future returns!). From my limited perspective, my hybrid value approach has worked well meeting my investment needs.
- Albert Einstein
“I’ve always been warned that when people say ‘it’s different this time’ it really isn’t very different. Yet if I look back over the last decade and I see so much underperformance by value investors (both traditional and the more modern-approach), I think to myself, ‘is it really different this time? Does value investing not work anymore’”?
- Sally Jenkins
In my past few articles, I’ve discussed the distinction between growth and value investing, value’s difficulties since the 2007 - 2009 market crash, and how that has been part of a greater discussion about the viability of value investing in today’s markets. In this article, I thought I’d tie together the two themes and - at a very high level - summarize what the last decade has told us in terms of investment learnings and how we might come to terms with the over decade-long short circuiting in value investing performance.
At Nintai, we divide the market returns since the height of the technology bubble into four phases. Phase one was the run up into the technology bubble running roughly from 1998 - 2000. Traditional value investors - in general - did poorly as they continued to invest along more classic value investing guidelines. Many value investor shareholders began to get nervous as they opened their returns and saw underperformance being led by such staid companies as industrial parts supplier Fastenal (FAST) or spectrometry provider to biopharma Waters (WAT).[1] Some truly great investors closed their doors at the height of the bubble commenting on the fact they simply didn’t understand the market anymore. Phase two was the period of 2001 - 2006 when value investing roared back and more traditional companies like Proctor & Gamble (PG) or Coca Cola (KO) saw great returns while technology stars of the bubble sustained losses of up to 90% or even bankruptcy. It was rare to see such a clear vindication of value investment theory and practice. Phase three was the market crash of 2007 - 2009 led by the financial and credit markets starting with Bear Stearns and Lehman Brothers all the way to the government interventions of Fannie and Freddie Mac. There was a huge distinction though between the bursting of the technology bubble and the bursting of the credit/real estate market bubble. In the latter, many traditional value investors lost as heavily (and sometimes even more) as the general markets and even growth investors. Famous value investors who had been hailed as geniuses just half a decade before were chalking up 30, 40, and even 50% losses as their traditional value methods of using low price-to-book or price-to-revenue models imploded. Phase four added to the agony as the general markets powered through a nearly decade long recovery. While this was happening, traditional value returned paltry returns in what traditionally would have been a golden era for that investment style. Rather, you saw an entire generation of value investment leaders struggle for the entire decade. It was reflected in returns and even more importantly in their assets under management. The list is long and well-respected. Marty Whitman ($4.6B AUM in 2011 to $1.19B AUM in 2019), John Hussmann ($5.4B AUM in 2011 to $350M AUM in 2019), and David Dreman ($5.3B AUM in 2011 to $220M AUM in 2019). Wally Weitz can be considered a success by seeing a rather slim increase in AUM (going from $2.3B in 2012 to $2.52B in 2019). Perhaps the harshest lessons were learned by David Winters, going from value investing rock star and CIO of Wintergreen Fund with $1.5B in AUM in 2012 to shuttering his doors in 2019 with less than $90M in assets. This humbled writer/investment manager had a dismal record with my own corporate internal fund (and eventual Charitable Trust) which was outperformed 4 out 5 years from 2011 - 2015 before I left the fund for greener pastures.
Is Value Investing Dead or Has It Simply Genetically Evolved?
In a recent Westwood Insights (“Value Stocks are Screaming for a Reversion to the Mean. Is Anyone Listening?”. It can be found here.) there is a segment describing the end of Julian Robertson’s career in March, 2000. It reads:
“It was an unseasonably warm 58 degrees in New York City on March 30, 2000. Winter white was just a faint memory on that Thursday, and the thoughts of bustling commuters had turned to spring. All was not balmy in the canyons of Wall Street, however, as the shock heard around the investing world had been announced that morning. Before the New York Stock Exchange opened, value investing legend Julian Robertson, age 67, announced that he was calling it quits, and would return the $13 billion that he managed to his 700 shareholders. He planned to shut down his fund and walk away.
At his fund’s peak in 1998, Robertson managed $22 billion, but he had seen withdrawals of $8 billion over the previous two years, including $1 billion in the first quarter of 2000. His fund had lost 19 percent in 1999, badly trailing the 21 percent gain in the S&P 500 index. He had lost another 14 percent in the first quarter of 2000. The New York Times summed up his predicament the day after his announcement, saying that Robertson ‘had essentially decided to stop driving the wrong way down the one-way technology thoroughfare that Wall Street has become.’
Robertson, a giant of the hedge fund and value investing worlds for more than 30 years, was a casualty of the technology stock euphoria that the prior five years had wrought on traditional value investors. ‘I’m not going to quit investing. I don’t mind people calling me an old-economy investor, but it doesn’t go over well with the clients,’ Robertson noted in his farewell.”
With the nearly decade-long underperformance (nearly twice as long as Robertson’s), that last paragraph wrings eerily true for many value investors as they gaze back at their record. It certainly hasn’t gone over well with their clients as well. But is it enough to simply say these days that value investors are just “old-economy” or is there something far more fundamentally wrong here? Is the very structure and model of value investing broken?
Looking back over the last decade, I would argue value investing was already evolving before this last decade. Thinking and strategy had started to bifurcate as two distinct approaches began to appear. The first was based in the more traditional lower price-to-book and lower price-to-earnings (such as looking for companies with less than a 12-15 P/E ratio). These types of investors are generally descended more from the Ben Graham risk-focused, cigar-butt DNA. The second approach - sometimes referred to as value investing 2.0 - is more in the what was referred to as GARP (growth-at-a-reasonable-price) investing. As an example, this is where a value investor is willing to place value on less-traditional assets such as technology or informatics platforms than a physical manufacturing plant or equipment (I confess I fall clearly in the latter category). What makes this dichotomy interesting is that value investors (2.0) have generated better returns over the last decade than the more traditional value investors. Part of that seems to be based on investment strategy (where growth stocks have been outperforming value) and part of it on individual stock selection (higher quality stocks have done equally well - if not better in some cases - than less quality picks).
Putting aside the debate about more traditional value investing and value investing 2.0, the great question is whether value investing - in general - has gone the way of the dodo or great auk. One side of the argument argues that value investing (defined as low price/book ratio) has actually performed as you would think it would (meaning neither out or underperformed). It has been growth investing that has significantly outperformed its benchmarks over the past decade. In a recent report from Dimensional Investing (“Value Judgments: Viewing the Premium’s Performance Through History’s Lens” which can be found here), the authors discuss the fact that value stocks actually have underperformed growth stocks 11.4% to 14.7% for the period 2010 – 2019. But the way we look at this underperformance is likely skewing the debate about the longer term viability of value investing. The authors contend the issue is less about value stocks underperforming but more about growth stocks outperforming. They go on to demonstrate that value stocks over the past decade have traded similar to what you would expect over a longer-term duration that include several market cycles. Value stock decade-long (2010 - 2019) returns of 11.4% track closely to their 11.9% return since 1979. The interesting data show up in the growth stocks. This segment’s previous decade (2010 - 2019) returns of 14.7% have far outperformed their 11.3% return from the period 1979 - 2019. Dimensional can’t isolate any particular reason why growth stocks have achieved such abnormally higher returns over the past decade. The authors say the data do not support any of the theories proposed by market analysts including low interest rates, quantitative easing programs by central banks, and the outsize influence of the so-called FAANG stocks, a group of stocks that include Amazon (AMZN), Apple (AAPL), and Facebook (FB). In this thesis, the bottom line is that value stocks (as defined by Dimensional) have produced similar returns over both decade-long and three decade-long time frames. The simply have not been able to keep up with a decade-long outperformance (for which we can’t account) in growth stocks.
Others Say Not So Fast
Another school of thought has developed counter to the thinking of Dimensional’s theory. An example of this is a recent paper by Baruch Lev and Anup Srivastava entitled “Explaining the Recent Failure of Value Investing” (it can be here). In the abstract of their work, they summarize their view that value investing’s best days are behind it:
“It is widely believed that the long-standing and highly popular value investing strategy—investing in low-valued stocks and selling short high-valued equities—lost its edge in the past 10 - 12 years. The reasons for this putative failure of value investing elude investors and academics, making it a challenge to assess the likelihood of the return of value investing to its days of glory. Based on extensive data analysis we show that value investing has generally been unprofitable for almost 30 years, barring a brief resurrection following the dotcom bust. We identify two major reasons for the failure of value investing: (1) accounting deficiencies causing systematic misidentification of value, and particularly of glamour (growth) stocks, and (2) fundamental economic developments which slowed down significantly the reshuffling of value and glamour stocks (mean reversion) which drove the erstwhile gains from the value strategy.”
The author’s argument in many inverts the thinking behind the team at Dimensional. They believe the overperformance of value investing post-technology bubble was not the mean but rather an anomaly in a longer history of underperformance since the late 1980’s. They state (somewhat in agreement with Dimensional) that there is no specific market-driven item that can be identified as eliminating value’s edge. Rather, they believe it was changes in how we value companies – rather than process of picking low P/E stocks – that eliminated value investing’s edge. From their paper they write:
“The expensing of intangibles, leading to their absence from book values, started to have a major effect on financial data (book values, earnings) from the late 1980s, due to the growth of corporate investment in intangibles. This book value mismeasurement was a major contributor to the demise of value investing which started in the late 1980s.”
The failure of value investing during the credit/real estate crash of 2007 – 2009 layered on another shift in economic changes (not market changes). They state that more traditional value companies (particularly those with debt loaded balance sheets ranging from manufacturing firms to larger financial institutions) lost their access to capital. Meanwhile, the more glamorous asset-light companies (technology and biopharma) became Wall Street and credit provider darlings leading to a distinct economic advantage for the latter.
Since there has been little change in this newer economic model, Lev and Srivastava don’t see value investing making any big comeback soon.
What This All Means
All of this data brings us back to the core questions surrounding the prognosis for value investing. Is it really different this time? Are the prognosticators of doom finally correct?
The simple - and most honest - answer is we simply have no idea what the future holds for those investors who follow a value investment strategy[2]. For those who suffered tremendous losses in the 2007 - 2009 crash (where value methods should have prevented such results) followed by multi-year underperformance in a record setting bull market (again, where there should be some outperformance in value in the years following a bear market), the question is almost moot. If your investment strategy fails you in both bull and bear markets, then it’s not irrational to call into question the fundamentals of such an approach.
At Nintai, the entire debate is more academic than practical in our view. As investors in assets trading at a discount to our estimated intrinsic value, we think this puts us clearly in the value investment approach. Whether that is based on hard assets on the balance sheets or value derived from the future cash flow of an asset-light business model is irrelevant. We think the focus on value makes you a value investor – nothing more and nothing less.
Having said that (and there’s always a “but” in any good argument!), we do believe that value investing 2.0 has had a leg up on more traditional value investing over the last decade. I have no data to support such a claim nor do I have any specific reason (like Dimensional) why that would be the case. My only idea is that over the long term (here I mean a time frame greater than a decade), buying quality companies at fair prices will generate better returns than purchasing medium/poor quality companies at great prices. Again, I want to point out I have no data to support such a claim. Most of it likely lies in the fact I’m simply more comfortable investing with those caveats in mind[3].
The larger debate about whether value investing (regardless of more traditional or 2.0) is dead really isn’t all that clear. If you argue like Lev and Srivastava the edge has been gone for over 4 decades, then there isn’t much to debate. If you take the more nuanced view such as the Dimensional team then there is still room for debate about value investing’s future.
In the final analysis, it’s up to each individual investor to develop their own investment style that meets a couple of needs: it lets them sleep well night and it produces returns adequate to meet their financial requirements. Whether that’s achieved through a more traditional value approach, value 2.0 approach, or growth investing approach is up to them. But as a portfolio manager myself, I wouldn’t rule out value investing yet. There are still people outperforming the market who all share the same genetic roots from Graham and Doddsville. Whether the causation and pool of candidates are as large as when Warren Buffett first brought the concept to the investing world’s attention, it can’t be denied it’s still there. It may be different this time, but it doesn’t mean value investing is dead yet.
[1] These were two companies I owed at the time I was personally managing the Nintai Partner private investment fund. They certainly weren’t the WorldCom’s or the Cisco’s of the investment world.
[2] It should be said this applies to any investment approach or for the markets in general.
[3] As I’ve discussed previously, over the time frame of 2002 – 2015 the portfolios I personally managed were able to outperform the markets by a considerable margin (past results are no guarantees of future returns!). From my limited perspective, my hybrid value approach has worked well meeting my investment needs.
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