Investors who took the “Vaccine Monday” surge in battered stocks as a signal to give their portfolios a value tilt have misunderstood this strategy, according to Dr Wes Crill of Dimensional Fund Advisors, who says you risk missing out on most of its advantages if you wait until after such performance bursts before committing.
Value investing has underperformed its growth counterpart for much of the past decade. Until about six months ago, some commentators warned it may be a remnant of a past and slow-moving world.
However, on 9 November when news broke that the Pfizer-BioNTech vaccine demonstrated more than a 90 per cent efficacy against Covid-19, it led to a long-awaited rotation in the stock market from growth towards value.
Performance of value vs growth since vaccine Monday
Source: FE Analytics
Crill, head of investment strategists at Dimensional, said he wasn’t surprised to see value performing so strongly over such a short period of time.
“If we look back using almost 100 years of data within the US to assess the longer-term trends for value versus growth,” he noted, “we see that in about one in 20 months, the return difference between small value and large growth has been 7.5 percentage points.
“That’s just in one month. You get that about one out of every 20 months – that's an important reminder about how these premiums can show up in bunches.”
Crill believes this has important implications for investors and managers who want to capture the value premium – which is the spread in returns between value and growth stocks.
He said: “We need to be laser-like in our focus on the value premium. We want to make sure we have continuous exposure day in and day out.
“We don't know when the value premium is going to be positive. We expect it every day. But realised returns can differ from expected returns based on whatever the news of the day is.
“So if we don't know when it's going to be negative, we want to make sure that we don't miss out on it when it does show up.”
Crill also added that there is no evidence that investors can consistently time the value premium.
“I need to just be positioned to capture the value premium whenever it does appear,” he said. “The data tells us that if we deviate from that course – if we try to predict when it's going to be negative, then we miss out on some of the outsized returns that we've seen historically.”
“The value effect is really just rooted in the fact that there's differences in discount rates across different stocks,” Crill continued.
“Just like different investors when they go to the bank might receive different rates on their loans. It's the same idea with some stocks. Future cash flows are discounted more heavily even than others.
“And value investing is in a nutshell about paying less for a stream of future cash flows – that's a very evergreen principle.”
While owning value stocks to capture the value premium may seem straightforward, Crill argued that not all managers can do this equally well.
“I always like to point out that value in and of itself is an asset class, it's not an investment strategy,” he added.
He highlighted the performance of US large cap value funds in the months when value has outperformed growth over the last 10 years, and their price-to-book (P/B) ratios. Each dot below represents one large-cap value portfolio.
Source: Dimensional Fund Advisors
Crill pointed out how important starting P/B ratios – which go from just over 1 to 4.5 – are to returns during the months when value outperforms.
He said: “We see a pretty linear relationship here where the more exposure you have to deeper value – which is quantified by lower P/B ratios – the returns have generally been increasing.”
In his view, the data suggests that not every manager is able to deliver the outperformance when the value premium is positive.
The head strategist said: “We like to keep a daily focus within our process where every single day we look for where the portfolio is positioned, how prices have changed from one day to the next, and we can make small changes within the portfolio to keep that focus towards deeper value exposure.”
“Not all stocks in the value category delivered the value premium in any given year. It's really a subset of value stocks that migrate from value to growth – and they deliver the value premium on their way out.”
Given only a subset of value stocks delivers the value premium, he said a traditional asset manager could easily end up missing out on the associated performance boost, even if they regard themselves as a value investor.
On the passive side, he said: “If I have a very regimented rebalance schedule to which I'm adherent that's dictated by the index sponsor, not by index fund manager – they're just trying to maintain low tracking error.
“Well, then they might not be keeping the portfolio continuously positioned as prices are changing between rebalance points.
“So we want to use the characteristics of the stocks to determine what we want to hold, and we want to evaluate that every single day.”
Since 9 November 2020, the £422m Dimensional International Value fund has delivered a total return of 19.82 per cent, versus 16.01 per cent from the MSCI World Value index and 8.16 per cent from the IA Global sector average.
Performance of Dimensional International Value vs MSCI Value/Growth since “Vaccine Monday”
Source: FE Analytics
The fund currently yields 1.72 per cent and has an ongoing charges figure of 0.36 per cent.