The search for under-appraised stocks may have become futile thanks to trends not captured by the value model
It’s not hard to see why value investing has legions of adherents. The fundamental idea behind it — that some assets have an underlying value that’s grossly underestimated by the market — makes perfect sense. Theoretically, it has support from the widely recognized research on factors done by Eugene Fama and Kenneth French; empirically, it’s bolstered by the legendary results achieved by Warren Buffett.
But the approach may very well be past its heydays. A new commentary from AP Bernstein suggests that the approach is no longer fit for today’s financial markets— and there are two culprits responsible.
The first factor is the long period of low interest rates. The Federal Reserve’s quantitative easing program was launched to resuscitate the US economy following the 2008 recession. But an easier monetary policy also lifted valuations across the board; the premium on cheap stocks shrank, the commentary said, which contributed to the long stretch of underperformance of value names.
“Duration has been bid up as rates are so low,” wrote Inigo Fraser-Jenkins, Bernstein’s head of European quantitative strategy, in a note released last Wednesday. “Thus, the outperformance of value might require higher interest rates, which could be structurally difficult to achieve in the foreseeable future.
“In this sense one could say that QE could have stopped the mean-reversion process that usually occurs over the economic cycle,” he added.
The other variable to short-circuit the value-investing paradigm, he argued, was the expanding influence of tech companies. While many companies have traditionally managed to gain and retain value due to moats of competitive advantage, technology has managed to overcome or eradicated moats across many industries.
“If Amazon is going to continue to destroy other parts of the retail sector, say, then why should we expect mean-reversion to still hold?” Fraser-Jenkins said. “We agree that this dynamic is likely behind part of the underperformance of value. Technology has disrupted industries in a way that may permanently destroy ‘moats’ that used to exist around certain industries”
The surging appetite for rapidly growing companies like tech has also burned value investors badly. As CNBC noted, the trend favouring growth over value has remained in recent years, to such an extent that even managers of self-described value funds have appeared to inch closer to the “growth” end of the style spectrum.
Technology is also a difficult-to-quantify element for value investors whose decisions rely on price-earnings ratios. “Most important growth assets are intangible which in many cases are not captured in book value and retained earnings, making the usefulness of book value and earnings questionable,” Fraser-Jenkins said.