Why does value investing work? Because, ultimately, it is a common-sense philosophy rooted in human behaviour – in effect, looking to buy pound coins when they are temporarily on sale for 50p.
While the current level of valuation dispersion in global equity markets is a perfectly valid reason to think now might be a good time to consider building value exposure, we believe it is more important to focus on value as a long-term strategy for stock market success. Indeed, at Schroders, we see value as an area to which investors should always be exposed so they can reap the long-term compounding benefits.
To illustrate why, in effect, value should be for life and not just for a few quarters, let’s take a look at some very long-term data. Imagine that, back in the middle of the ‘Roaring 20s’, your great-grandparents came into some money and decided to invest $10,000 in stocks. If they had invested that in a Fama-French ‘growth factor’ portfolio of US equities in 1926, it would be worth over $80m today.
Staggering difference
Kudos, then, to dear old ‘Grandma and Grandpa Growth’ for their portfolio management skills? To an extent, perhaps. Still, not to be ungrateful, if they had invested the same $10,000 in the counterpart Fama-French ‘value factor’ strategy, as the following chart illustrates, it would have grown to be worth a staggering $780m-odd. The difference is so stark, we have to use a logarithmic scale to plot the two lines on the same graph.
When people talk about the perennial stock market war between value and growth then, it has not really – at least from a long-term perspective – been a contest. Undeniably, the last 10 years have been more difficult on a relative basis for value – yet, just as undeniably, the long-term track record of value’s compounding outperformance is incredibly strong.
That said, we appreciate showing very long-term charts of value outperformance is not a wholly convincing argument. For one thing, the last decade or so has hardly resembled that long-term history. And for another, while that chart does a good job of illustrating what value has done historically, it conveys little about why it has done so – or indeed about why you should believe in value investing as a strategy for the future.
Crucial question
For us, that is the crucial question. And to understand why value works, you have to go right back to basics – to Benjamin Graham. When Graham was writing about investing in the 1930s, there was no such thing as a value factor. His faith in the approach was not based on a historical back-test. He did not have the luxury of computers to crunch the data and generate reassuring charts.
No – Graham’s belief in value was based on common sense, intuition and, above all, astute observation of human behaviour. If you want to make money in the stock market consistently, Graham stressed, you must not fall into the trap of playing the same game as everyone else and speculating on future growth. Instead, seek out the companies the market has knocked down to an irrationally low price.
Ultimately, this boils down to swimming against short-term sentiment to identify the best deals and avoid the rip-offs. It is the same common-sense approach we all take when we are out shopping for groceries or clothes or anything else. Value investing is just contrarian bargain-hunting applied to the stock market – in effect, looking to buy pound coins when they are temporarily on sale for 50p.
Enduring appeal
Why is this contrarian approach so enduring? Because it exploits the one thing that never really changes in stock markets – human beings. When the outlook is dark and cloudy, people grow fearful and despondent and some companies just grow too cheap. Whereas, when all we can see on the horizon is sunshine, lollipops and rainbows, people grow euphoric and greedy and then lots of companies grow too expensive.
Value investing is designed to exploit those persistent patterns of human behaviour. Time and time again, the frailties of human psychology, combined with the irrationality of crowd behaviour, create these pricing inefficiencies that patient investors are able to exploit – and, here at Schroders, we do not think that dynamic will ever really change.
Graham actually put it very neatly himself when, towards the end of his career, he was asked in an interview to sum up what he had learned from his decades of investing in the stock market. Given the current environment, his response strikes us as very prescient – he simply replied: “The more it changes, the more it is the same thing.”
Truer than ever
That feels truer than ever today, when we are constantly being told we are living in an age of unprecedented disruption when technology, society, the climate, everything is changing. There are plenty of people out there, too, who will say the stock market has fundamentally changed since Graham’s day – whether that be as a result of ultra-low interest rates, technological disruption or whatever.
We continue to believe Graham’s words will hold true and that, in the end, the one constant in stock markets is the human behaviour that drives it. The more people say ‘This time it’s different’, the more their behaviour starts to resemble every other market bubble in history – in other words, the more people think it changes, the more it is the same thing.
As investors, we can wheel out statistical back-tests of the value factor all we like but what really gives us confidence to stick with the strategy for the long run, through thick and thin, is our belief in this ‘why’ factor. Why does value work? Because, ultimately, it is a common-sense philosophy rooted in human behaviour. That does not stop it falling out of favour at times – as we have seen in recent years – but it should mean value continues to be a powerful long-term strategy for those with the patience and fortitude to stick with it.
To read our latest value insights, click here or visit our website to find out how Schroders can support you.
By Liam Nunn – Fund Manager, Schroder Global Value Team
Liam is co-manager of the Schroder Global Income and Schroder Global Sustainable strategies and deputy fund manager of the Schroder Global Recovery strategies. He has managed value portfolios at Schroders since 2020.
Liam’s investment career commenced in 2011 at Schroders as a Pan European sector analyst. He subsequently moved to Merian Global Investors (formerly Old Mutual Global Investors) in 2015 as an equity analyst/fund manager, before re-joining Schroders in January 2019 as an analyst for the Global Value team. Liam is a Chartered Financial Analyst and has a degree in Politics, Philosophy and Economics from Durham University.
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