Never Has a Venial Sin Been Punished This Quickly and Violently!
There have been proclamations about how value investing, at least value investing as we know it, is dead – such as this one which tries to argue that value of companies with innovative capabilities (say Tesla) that can have far reaching impact over a long period of time is simply hard to assess. Well this is not the first time we have heard that line of argument. Expectedly so, some of the gurus of value investing such as Seth Klarman and Joel Greenblatt whose funds have continued to underperform have come back strongly in defence of value investing (see here and here). They are joined by their quant cousins in support of why the value factor will bounce back – Rob Arnott of Research Affiliates and Cliff Asness of AQR have been the most vocal of the lot. This piece by Cliff as he himself acknowledges as a piece of ‘quantitative whining’ laments about how the first two months of 2020 have been the most destructive start to the year for the value factor (whilst Tesla shares have more than doubled in the same period). He begins his rant by acknowledging that the value factor tends to be riskier in the short run and almost impossible to time.
“We certainly know that contrarian valuation-based factor timing tilts are low Sharpe ratio strategies (very low short-term, somewhat better medium- to long-term) that are rarely immediately rewarded (few have such timing luck).”
But just how bad is value’s underperformance this year compared to history?
“Take the Russell 1000 Growth and Value series starting in 1991. We consider this a pretty simplistic form of value investing, but it captures the core concept and is widely followed. From January 1st until February 13th of 2020 the cumulative daily return difference between the two is -6.4% (take a guess which one of the two was worse). Comparing this period to all rolling periods of the same number of days going back to 1991, this difference falls below the 3rd percentile. Of course, that includes such famous events as the technology bubble of 1998-2000 and the GFC of 2008-2009. If you only look at 2010 to today, this is the zeroth percentile event. That is, in a decade quite bad for value investing, the start of 2020 is the absolute worst 6-week period.
Doing the same comparison among small stocks (Russell 2000 value vs. growth) from 1993 onward yields nearly identical results. Now, if we use Fama and French’s HML (using AQR data as Ken doesn’t update fast enough for this!), it’s a bit more extreme. This 6-week period falls below the first percentile since 1963 and, of course, is the worst such period since the value drawdown began a decade ago.”
Whilst he doesn’t quite believe that value pain is as exacerbated as during the tech bubble, he does see signs and recommends loads of patience as no one knows WHEN the mean reversion would come:
“I have been a pooh-pooher (if that’s not a word, it should be) of some who compare this current value pain to the tech bubble. We have found value spreads are quite wide today, but not tech-bubble wide. Though I have to admit, while you don’t come to me for my feelings about markets.., I will say comparisons to the tech bubble, in terms of seeing more radical events (no more slow steady losses for value, now it’s very quick big ones!), and the widespread embracing by many of all the reasons (which they usually have never mentioned before) as to why value is never going to work again, are converting me. It’s getting very bubbly out there…
Again, our plan is to do very little. That doesn’t mean we don’t question everything constantly (“doing very little” does not apply to research into what’s going on or trying, as we always are, to improve strategies). But, if that questioning doesn’t result in damning evidence (again, the paper by my colleagues is forthcoming!), it means sticking with the process.
We’ve seen this movie before a few times and we know how, but definitely not when, it ends. We believe that sticking with the process is the only way to achieve the long-term gains we seek (and which won’t always be provided by a long-only market that continues to levitate). We also know that sticking with something that’s good through its occasional very bad times, and even acting as a contrarian when others are finding newly created (and creative) reasons to throw in the towel, is very difficult.
But this very difficulty is a large part of why we believe it’s long-term rewarded, and much harder to arbitrage away than some seem to think. As they say, if something were easy, everyone would do it.”
And amidst all this, the world’s greatest quant fund has been raking it on its Tesla position (see here)