Research Review | 20 December 2019 | Value Investing

Value Bubbles
Messaoud Chibane and Samuel Ouzan (Neoma Business School)
February 27, 2019
According to several extended behavioral theories, value profits should mirror momentum profits, and vary over time. We test these theories in the cross section of returns. Value returns depend on market states. From 1926 to 2018, following negative market return, the average so-called value premium is about three time its unconditional counterpart, whereas it appears to vanish following positive market return. Moreover, several short episodes of extreme losses in momentum strategy (momentum crashes) are contemporaneous with extreme value profits (value bubbles). Our results are robust to various time varying risk- based explanations.

Does the Value Premium Decline with Investor Interest in Value?
Gunter Löffler (Ulm University)
October 24, 2019
I approximate the interest that value investing attracts through the frequency with which terms such as “book to market ratio” appear in the corpus of books scanned by Google. Following the years in which investor interest in value is relatively high, the realized value premium is found to be below average. On the other hand, there is no evidence that secular trends in interest have an impact on the value premium. The results therefore do not support the hypothesis that the value effect disappears once investors have become aware of it.

Reports of Value’s Death May Be Greatly Exaggerated
Robert D. Arnott (Research Affiliates), et al.
December 19, 2019
Value investing has underperformed growth investing for over 12 years with a -39.1% drawdown from peak to trough using the classic Fama-French definition of the value factor. The second-longest duration of underperformance occurred during the tech bubble, and while deeper than the recent drawdown, lasted less than 4 years. As a result, many now argue, relying on a variety of narratives, that the value investing style is no longer viable. We examine some of these narratives and find them wanting. We use a bootstrap analysis to show that the likelihood (given the historical data) of observing such a large drawdown is about 1 in 20—unusual but not enough to support structural impairment. We then decompose the value–growth performance into three components: the migration of securities, a profit differential, and the change in a valuation spread. Our analysis of pre- and post-2007 data reveal no significant difference between the migration of stocks (from value to neutral or growth or from growth to neutral or value) in the two periods nor do we observe a difference in profitability. The drawdown is explained by the third component: value has become unusually cheap relative to growth with the valuation now in the 97th percentile of the historical distribution. Even given the noisy nature of returns, expected returns are always elevated when in the extreme tail of a distribution.

Multi-Asset Value Payoff: Is Recent Underperformance Cyclical?
Yesim Tokat-Acikel (QMA), et al.
November 25, 2019
Value is one of the most studied risk premia strategies across asset classes. Value factors, however, have struggled lately. To uncover the drivers of recent value factor underperformance, it is important to understand how value returns are affected by macroeconomic conditions. We build on the existing literature by directly measuring the macroeconomic characteristics of value factor portfolios, namely real economic growth and inflation exposures. By pairing methodologies commonly used to derive fundamental characteristics of equity portfolios, we are able to identify macro linkages that have not been previously made evident. Our holdings-based and factor-mimicking portfolio analyses provide insights into the behavior of value strategies across various asset classes, looking at both cyclical and idiosyncratic drivers.

The Value-Momentum Correlation: An Investment Explanation
Elisa Pazaj (Cass Business School)
October 28, 2019
This paper shows that both value and momentum premia arise in a q-theoretic framework that considers optimal corporate policies under uncertain financing conditions. Book-to-market and past performance predict future returns because they serve as indicators of firm financing position. The book-to-market ratio increases with financing constraints, with high book-to-market firms investing less and demanding higher risk premia compared to unconstrained, low book-to-market firms. The value premium increases in bad times because value firms become even more constrained, while ample cash reserves allow growth firms to fare much better. Momentum effects appear among the most financially constrained firms. For these firms, financing constraints imply large price swings following cash-flow shocks and valuable equity market timing options imply positive autocorrelation in returns. Absent equity market timing during bad times, momentum disappears. The model is able to explain many empirical features of value and momentum premia, such as: (i) the procyclicality of the momentum premium, (ii) the countercyclicality of the value premium (iii) the negative correlation between the two, and (iv) severe losses to momentums strategies during market rebounds. Several new testable hypotheses arise regarding the fundamentals of value and momentum stocks. The empirical evidence is largely supportive.

Why Value Investing Works: A Theoretical Framework
Eben Otuteye (U. of New Brunswick) and M. Siddiquee (Mount Saint Vincent U.)
February 27, 2019
We hear a lot about value investing, an investing approach introduced by Benjamin Graham in the 1930s and championed by Warren Buffett, but we know very little about why it works so consistently. Academia has considered the consistent performance of value investors as a statistical anomaly, but given that it has persisted for more than eighty years, it warrants further investigation. In this paper, we tried to explain why value investing works. This paper presents a basic exposition of the core tenets of value investing. We make a clear distinction between value investing according to the Graham-Buffett paradigm and what is typically referred to in the academic literature as value investing. We then provide some reasons behind the recent underperformance of value portfolios and why value investing is likely to bounce back. Finally, we provide some behavioral explanations as to why investors find it so difficult to practice value investing consistently for long periods of time.


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