The average value investor underperforms an S&P 500 index fund, even before fees, by almost a percentage point — even though the average value fund outperforms the S&P 500.
This, and other shortcomings of value investors, is the subject of Research Affiliates’ latest newsletter.
Readers may already be scratching their heads on two counts. First, how does the S&P 500 beat value and value beat the S&P 500? They can’t both be right!
And secondly, could that really be Research Affiliates — whose smart-beta indexes are essentially rules-based systems for buying undervalued stocks and selling overvalued stocks — that makes this apparently anti-value claim?
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Careful readers will understand that at issue here is investor underperformance rather than investment underperformance; and further, that the Newport Beach, Calif.-based value shop’s seeming trashing of value is but a prelude for a deeper understanding of the value of value — that is, the “tremendous opportunities” it holds for disciplined contrarian investors.
Firm co-founder Jason Hsu and senior researcher Vivek Viswanathan do yeomen’s work in unpeeling this investing paradox by first airing what they call “an inconvenient truth.”
The data show that value investors underperform the buy-and-hold S&P 500 index return by 0.92%.
This is not to say that they concede the argument of cap-weighted index champions like Vanguard’s Jack Bogle that picking stocks, even value stocks, is risky and undesirable.
On the contrary, Hsu and Viswanathan unequivocally affirm the value is king of all investment anomalies, having “consistently delivered a premium over the capitalization-weighted market portfolio for the last 90 years.”
One poignant proof of this is that value investors underperform value funds by an even greater amount than S&P 500 funds, losing out on an annual 1.31% (given investment returns of 9.36% and dollar-weighted investor returns of 8.05% between 1991 and 2013).
So the inconvenient truth is that value investors’ 23-year losing streak indicates they are neither extracting a value premium nor exploiting the mistakes of their counterparties taking the other side of the trade.
By comparing actual fund investor purchases and redemptions with reported fund returns, the Research Affiliates duo conclude that investors in value funds are trend chasers, who sell after their funds underperform and buy after they outperform.