Value investing – for and against

20 Jan 2020

In finance there are many investment styles. The ones best known are from quantitative studies by Fama & French in the 90’ies. They initially focused on the factors: Capital size and Value, to which were later added Volatility, Momentum and Quality.

The value style proposition is that a smart investment manager by rigorous analysis of a company’s accounting data are able to find overlooked value which then inevitably lead to financial overperformance – the idea often marketed as, “buy a 100$ note for just 50$”.

Mr. Warren Buffet, the enigmatic CEO of the investment company Berkshire Hathaway (the oracle of Omaha) is often promoted as the champion of value investors. Mr. Buffet studied under Benjamin Graham who coined the phrase value investment as he(and David Dodd) wrote Security Analysis published in 1934. The book emphasises the quantifiable aspects of security analysis (such as the evaluations of earnings and book value) while minimizing the importance of more qualitative factors such as the quality of a company’s management.

Mr. Buffet has over time  strayed quite significantly from the pure value style of listed public equity to increasingly focus on private equity investments. This segment has quite a few very different features.

So far, so good.

However, looking into the cold hard facts (arguably a good starting point) – value style has not performed for 13 years. To be clear, the value style factor has underperformed a passive benchmark in every one of the past 13 years.

Loss of informational advantage with the invention of the computer.

With the still broader application of computers since the late 80’ies the claim of informational advantage from rigorous studies of corporate accounting ratios, free operating cashflow analysis etc. all publicly available online to everyone on the planet has rapidly faded.

The argument probably made sense in 1934, but nearly a century later in the age of information technology, that story has become let’s just call it “a hard sell”. Today, machines evaluate hexabytes of data covering thousands of companies before any value investment manager will reach the printer to examine just a single corporate filing.

Investment product producers are adapting following a prolonged period of trying to convince investors that “the market is wrong”. Any investment styles based on sets of static factors – such as value style – are at risk of being commoditised. Value products are offered to investors in the form of passive ETF funds. As a consequence, investment managers fees have tumbled from some 2% pa. before 2018 to now closer to 0.10% pa. That is good news for the investors and less so for the traditional active value investment managers.

Absent a change by value managers for a more dynamic systematic to determine value excess performance the current underperformance could easily continue another decade, and beyond. Maybe even worse should be the revelation that when at some point value investment style should begin to outperform, it will likely not be due to any value added by the investment manager. Rather it will be due to some as of yet unknown constellation of exogenous factors to which the managers is oblivious and unable to control.

So, going forward? At the risk of being burned at the stake as value heretics, we propose that value is due for an upgrade.

A few basic suggestions:

  • Adding a quantitative tactical allocation overlay. Determine when value style is likely to perform – and when not. Adapting to the simple fact that there is no single factor that works constantly.
  • Application of machine learning focused on optimising the value style excess performance. Some investors actually expects the investment manager to work on this objective.
  • Follow the footsteps of Warren Buffet into private equity. Information are here not as easily available, why informational advantage enjoy benefit of the doubt.
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