Value investing in the US has been under pressure recently, having underperformed growth and momentum over the last decade. The most popular explanations given for this are:
- Price-to-book, the most popular metric of value investors, stopped being a good measure of value.
- Value, as a strategy, got crowded after putting in a strong performance the prior decade.
- The value effect is the strongest in small- and micro-caps but scale prevents investment managers from being able to access it. Making large-cap value an over-fished pond.
- All anomalies, including value and momentum, have their ups and downs. Investors chase performance, thus preserving the anomaly.
- This time is different.
From a quantitative point of view, “value” is a way of ranking the universe of stocks and applying a cut-off on them. The cut-off is based on historical averages. But the problem with historical averages is that history is still being made. This point is driven home in newer markets, like India’s, where we cannot lean on 100-year back-tests but have to depend on data-sets that are, at best, 10- or 15-years old. And here’s how that last 10-year price-to-book of different indices looks like:
The averages are being made as we speak. This presents a moving target for value investors because value is all about mean-reversion. And something similar could be happening in the US – maybe a few decades from now, a test looking back at today will reveal that the high PB stocks were unusually cheap.
Related: Index Valuations