A new study casts doubt on how the two investment philosophies have been understood
Traditionally, traders on financial markets were divided into growth “speculators” who buy and sell based on price and value “investors” who look at fundamentals. But a new study suggests that the two strategies don’t make money the way people have always thought.
The study, published in the latest issue of the Journal of Portfolio Management, was authored by Goldman Sachs Asset Management associate Joseph Kushner. According to the Wall Street Journal, Kushner looked at 30 years’ worth of returns data from value and momentum portfolios, analysing it in terms of valuation changes and business improvement.
“Mr. Kushner found that the approach of buying companies that are cheap as measured by price-to-book value made all its gains from a rise in valuations—before rebalancing back into cheap companies once a year,” the Journal article said. “That is, the companies didn’t actually get any better; other people were just willing to pay more for them.
“By contrast the short-termist approach of momentum, holding stocks for just a month at a time, made money despite falling valuations over the month because, on average, improving fundamentals offset the lower multiple,” it said.
The new conclusions from the study might be just academic to traders, as both strategies have suffered over the past ten years. Looking at data back to 1926, value strategies reportedly performed worst from 2006 to 2016, bouncing briefly after the presidential election in the US.
“Value underperformed mainly because it missed out on the recent sharp rise in valuations of the large growth companies, exemplified by the technology sector,” the Journal piece said. “Momentum held better companies than usual, but after being crushed by the speed of the recovery in 2009 it was repeatedly hit by sharp market reversals.”
However, the piece noted that value and momentum strategies depend on irrational investment behaviour. Value assumes that people will overestimate the impact of bad news, creating windows when stocks are underpriced from which they’ll eventually recover. Meanwhile, momentum assumes that people will flock toward rising stocks, which will go up further due to the increased interest.
“If we truly live in the winner-takes-all world exemplified by the biggest tech stocks, a value strategy that ends up buying the losers won’t work,” the Journal said. “But there is little reason to think market psychology has truly changed … Eventually reality will dawn and value start to perform again.”
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The study, published in the latest issue of the Journal of Portfolio Management, was authored by Goldman Sachs Asset Management associate Joseph Kushner. According to the Wall Street Journal, Kushner looked at 30 years’ worth of returns data from value and momentum portfolios, analysing it in terms of valuation changes and business improvement.
“Mr. Kushner found that the approach of buying companies that are cheap as measured by price-to-book value made all its gains from a rise in valuations—before rebalancing back into cheap companies once a year,” the Journal article said. “That is, the companies didn’t actually get any better; other people were just willing to pay more for them.
“By contrast the short-termist approach of momentum, holding stocks for just a month at a time, made money despite falling valuations over the month because, on average, improving fundamentals offset the lower multiple,” it said.
The new conclusions from the study might be just academic to traders, as both strategies have suffered over the past ten years. Looking at data back to 1926, value strategies reportedly performed worst from 2006 to 2016, bouncing briefly after the presidential election in the US.
“Value underperformed mainly because it missed out on the recent sharp rise in valuations of the large growth companies, exemplified by the technology sector,” the Journal piece said. “Momentum held better companies than usual, but after being crushed by the speed of the recovery in 2009 it was repeatedly hit by sharp market reversals.”
However, the piece noted that value and momentum strategies depend on irrational investment behaviour. Value assumes that people will overestimate the impact of bad news, creating windows when stocks are underpriced from which they’ll eventually recover. Meanwhile, momentum assumes that people will flock toward rising stocks, which will go up further due to the increased interest.
“If we truly live in the winner-takes-all world exemplified by the biggest tech stocks, a value strategy that ends up buying the losers won’t work,” the Journal said. “But there is little reason to think market psychology has truly changed … Eventually reality will dawn and value start to perform again.”
For more of Wealth Professional's latest industry news, click here.
Related stories:
Benchmarks outperform ‘overwhelming majority’ of equity managers
‘Global disinflation’ to limit rise in yields
