Want to Invest in a True 'Value' Fund? Good Luck Finding One -- Journal Report
February 03 2019 - 10:40PM
Dow Jones News
By Mark Hulbert
It's a lot harder than you might think to invest in a portfolio
of pure value stocks.
I'm referring to stocks that trade for the lowest ratios of
price to book value. Groundbreaking research by University of
Chicago finance professor (and Nobel laureate) Eugene Fama and
Dartmouth professor Ken French found that such stocks over the long
term have significantly outperformed so-called growth stocks --
those with the highest such ratios. They report that, from 1926
through 2018, the 20% of stocks at the value end of the spectrum
have beaten the quintile at the growth end by 3.6 annualized
percentage points.
To be sure, value stocks are coming off a decade in which they
have significantly lagged behind growth, leading some to speculate
that the so-called value effect no longer exists. Those in that
camp, needless to say, aren't going to care that it may be
difficult to invest in pure value stocks. But it is of concern if
you are among those who believe that value stocks are poised to
make a comeback.
According to a new study circulated a few weeks ago by the
National Bureau of Economic Research, there are hardly any mutual
funds or ETFs that consistently invest in the quintile of stocks
with the greatest value. Titled "The Characteristics of Mutual Fund
Portfolios: Where are the Value Funds?," the study was written by
Martin Lettau, a finance professor at the University of California,
Berkeley; Sydney Ludvigson, an economics professor at New York
University; and Paulo Manoel, a Ph.D. candidate at UC Berkeley.
In fact, upon analyzing a comprehensive database of thousands of
funds and ETFs between 1980 and 2016, they found just two that
consistently have invested in this top quintile of value stocks.
Even more incredibly: The average fund that self-describes its
investment focus as "value" invests in stocks that are two
quintiles away from the most value-oriented 20% -- closer to the
"growth" end of the spectrum, in fact. (See chart.)
Prof. Lettau emphasized in an interview that this surprising
finding isn't a function of so-called style drift, which
occasionally occurs after a sustained period in which value lags
behind growth. At such times, of course, managers of value funds
will be tempted to increasingly invest in growth stocks. But that
isn't what is going on here, he stresses. On the contrary, the
pattern has been persistent at least since the early 1980s.
Nor is the researchers' finding a function of managers shying
away from using the price-to-book ratio as a proxy for value. They
reached a nearly identical conclusion when using a number of
alternative criteria of value, such as price-to-earnings ratios,
price-to-cash-flow ratios and dividend yield.
Behavioral cause?
The inability of both style drift and alternative definitions of
value to explain the researchers' finding suggests that there may
be a behavioral cause: Investors and advisers alike may find it
distasteful to purchase stocks that most satisfy the criteria of
value, no matter how strong value's historical performance over
growth. Kent Daniel, a finance professor at Columbia University,
says that he finds support for this hunch in his research showing
that by the time a stock has a low price-to-book ratio, it often
has suffered many years of poor price performance. And if a stock
has lagged behind the market for many years, it may take a rare
degree of courage to invest in it, he says.
You might wonder, therefore, why there are so few extreme value
ETFs, since they typically are benchmarked to a particular index
and manager discretion plays no role. But behavioral factors can
influence an ETF's composition in other ways, such as in the choice
of the index to which it is benchmarked in the first place. And
sure enough, according to Prof. Lettau, almost all of the
supposedly value-oriented ETFs are benchmarked to indexes that
don't define value using the price-to-book ratio or similar
metric.
How, then, can you gain exposure to extreme value stocks? One
option is to invest in the very few funds that truly invest in such
stocks, though this approach has its drawbacks. The fund that most
consistently invests in value stocks, according to the researchers,
is the Aegis Value Fund (AVFAX). But Aegis invests in microcap
companies and therefore is inappropriate if you want to invest in
midcap or large-cap companies in the extreme value quintile. The
fund second to Aegis in terms of investing in extreme value is the
JNL/Mellon Capital S&P Smid 60 Fund, which is offered only
through a variable annuity.
Other than those two funds, the best you can do when investing
in a mutual fund or ETF is to gain exposure to the top two
quintiles of value. The largest funds available to individual
investors that provide that exposure, according to the researchers,
are the Franklin Balance Sheet Investment Fund (FRBSX), with a
0.92% expense ratio, and SA US Value Investor Fund (SABTX), with a
0.95% expense ratio.
Do-it-yourself model
An alternative is to construct a portfolio yourself of extreme
value stocks. However, if you take this route, you need to build a
big enough portfolio to be adequately diversified -- at least 25
stocks, Prof. Lettau says. To give you an idea of the kind of
stocks you will be investing in, here is a list of stocks in the
S&P 1500 that have the lowest price-to-book ratios and that are
currently recommended for purchase by at least one of the
top-performing investment newsletters I monitor:
-- Bank OZK (OZK)
-- Brighthouse Financial (BHF)
-- Capital One Financial (COF)
-- Citigroup (C)
-- Goldman Sachs (GS)
-- Gulfport Energy (GPOR)
-- Mallinckrodt PLC (MNK)
-- New York Community Bancorp (NYCB)
-- PennyMac Mortgage Investment Trust (PMT)
Mr. Hulbert is the founder of the Hulbert Financial Digest and a
senior columnist for MarketWatch. He can be reached at
reports@wsj.com.
(END) Dow Jones Newswires
February 03, 2019 22:25 ET (03:25 GMT)
Copyright (c) 2019 Dow Jones & Company, Inc.
Gulfport Energy (NASDAQ:GPOR)
Historical Stock Chart
From Aug 2024 to Sep 2024
Gulfport Energy (NASDAQ:GPOR)
Historical Stock Chart
From Sep 2023 to Sep 2024