Expensive Junk Stocks are Killing High-Quality Value Stocks, YTD

Expensive Junk Stocks are Killing High-Quality Value Stocks, YTD

August 4, 2015 Value Investing Research, $vlue, $iwd, $qual
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(Last Updated On: March 8, 2016)

In general, investors focused on affordable stocks with strong fundamentals have been taken to the cleaners year-to-date.

Meanwhile, expensive stocks with poor fundamentals have been rocking!

Some Basic Statistics:

Below we  document some core performance figures using Ken French’s data on value/growth portfolios (proxy for cheap/expensive) and high profitability/low profitability portfolios (proxy for high quality/low quality).

We look at the value-weight returns for the top and bottom decile portfolios. The monthly returns runs from 1/1/2015 to 6/30/2015. Results are gross of fees. All returns are total returns and include the reinvestment of distributions (e.g., dividends).

Specifically, here are the four portfolios:

  1. Expensive = Value-weight returns to the bottom decile formed on B/M.
  2. Cheap = Value-weight returns to the top decile formed on B/M.
  3. Low Quality = Value-weight returns to the bottom decile formed on profitability.
  4. High Quality = Value-weight returns to the top decile formed on profitability.

Here are the month-by-month results–a nasty year for cheap value stocks (as proxied by B/M) and high quality stocks (as proxied by profitability):

 Month Expensive Cheap  Outcome Low Quality High Quality  Outcome
201501 0.04% -6.87% Lose -1.68% -2.17% Lose
201502 6.71% 3.56% Lose 9.64% 6.55% Lose
201503 -0.69% -1.59% Lose -0.31% -0.66% Lose
201504 0.19% 1.81% Win -0.53% 0.80% Win
201505 2.17% 0.58% Lose 5.18% 0.78% Lose
201506 0.61% -0.71% Lose -1.38% -1.24% Win

The results are hypothetical results and are NOT an indicator of future results and do NOT represent returns that any investor actually attained. Indexes are unmanaged, do not reflect management or trading fees, and one cannot invest directly in an index. Additional information regarding the construction of these results is available upon request.

How have Expensive Low-Quality Stocks Performed Relative to Cheap High-Quality Stocks?

In this section we look at the YTD performance of expensive low-quality stocks versus cheap high-quality stocks.

We examine value-weight returns for cheap high-quality quintile and the expensive low-quality quintile. The daily returns run from 1/1/2015 to 6/30/2015. Results are gross of fees. All returns are total returns and include the reinvestment of distributions (e.g., dividends).

Specifically, here are the two portfolios:

  1. Cheap, High Quality = Value-weight returns to the cheap high-quality quintile.
  2. Expensive, Low Quality = Value-weight returns to the expensive low-quality quintile.
cheap hiqh quality versus expensive low quality stocks
The results are hypothetical results and are NOT an indicator of future results and do NOT represent returns that any investor actually attained. Indexes are unmanaged, do not reflect management or trading fees, and one cannot invest directly in an index. Additional information regarding the construction of these results is available upon request.

Year-to-date, a portfolio of cheap high-quality socks is down around 6%, before fees and expenses (probably more like -7% if those were included).

In contrast, a portfolio of the most expensive, lowest-quality firms is up around 12%, before fees and expenses (probably around 11% after fees).

On net, the spread is almost 18% YTD.

Incredible, but not surprising.

When we look to the marketplace for live strategies focused on market neutral strategies anchored on cheapness and quality, the Gotham Funds Gotham Neutral fund is probably the most prominent example. The fund isn’t completely market neutral, but at a 25% net long exposure, that is about as close as we’re gonna get.

YTD the Gotham Neutral Fund is down 10.39%. That is pretty terrible, and it would have been worse if they were truly market neutral, but in the context of the results above, where one goes long generic value/quality and short generic expensive/junk, -10%+ isn’t half bad. One could argue on a factor-basis that they added value (I know, that sounds odd).

gotham funds market neutral performance

As we’ve said time and time again, active value investing has been digging manager graveyards since 1900…but that is the nature of the active value investing game…long horizons are required and volatility relative to the standard benchmarks can be expected.


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About the Author

Wesley R. Gray, Ph.D.

After serving as a Captain in the United States Marine Corps, Dr. Gray received a PhD, and was a finance professor at Drexel University. Dr. Gray’s interest in entrepreneurship and behavioral finance led him to found Alpha Architect. Dr. Gray has published three books: EMBEDDED: A Marine Corps Adviser Inside the Iraqi Army, QUANTITATIVE VALUE: A Practitioner’s Guide to Automating Intelligent Investment and Eliminating Behavioral Errors, and DIY FINANCIAL ADVISOR: A Simple Solution to Build and Protect Your Wealth. His numerous published works has been highlighted on CBNC, CNN, NPR, Motley Fool, WSJ Market Watch, CFA Institute, Institutional Investor, and CBS News. Dr. Gray earned an MBA and a PhD in finance from the University of Chicago and graduated magna cum laude with a BS from The Wharton School of the University of Pennsylvania.


  • dph

    Do you think Gotham funds will outperform over the next 5+ years after factoring in their fees/cost?

  • not sure, but they face large headwinds with their fees and taxes. The strategy is interesting, but you can get better systematic value strategies at lower costs and with lower taxes in the marketplace.

  • Adam Kearny

    That’s an interesting point about the -18% on factor-based model. I have no doubt that they’re set up to perform extremely well over the next 5 yrs. Long-term 5-7 yr cycles of “growth”/momentum vs. “value” indicate that “value” is clearly due. Only question is whether it gets worse over the next 12 months before the big snap-back (is this the summer of 1999 or the summer of 2000?).
    A similar, analyst-driven fund, BPLSX, which has been around for 20 yrs and is also negative this year, was -12.8% in 1999 and followed that up with +85% (that’s not a typo) over the next five quarters while the broad market entered a tech-led bear. I’d call that a tad bit of outperformance, wouldn’t you? The current set-up is similar albeit perhaps less extreme. Curiously, the macro backdrop is also very similar to 1999–strong dollar environment with oil/gold/EM having crashed, and US tech/healthcare/momentum hot and bubbly, M&A/IPO boom, etc. History seems to rhyme.
    “Better strategies at lower costs”–I don’t suppose you have a horse in this race, do you? (Wink-wink!). Anyway, if they’ve added 8% in value over the past eight months, they’re certainly earning their 2% fee.
    Wes: You should analyze Cliff Asness’ market neutral QMNIX–an interesting fund that potentially illustrates the value of combining momentum and value/quality to smooth the ride. They’re up almost 10% this year, most of it in the past two months.

  • Adam Kearny

    Wes, in last year’s post, weren’t you suggesting that Gotham Neutral would have been -70% in 1999? -10% isn’t fun, but not exactly “face-ripping” unless you expect it to get worse. Curious, with your factors, how does this year compare to 1999, assuming you use sector caps? Comparable, milder, or worse?

  • Yes, that is what the data say, not what I’m saying…the spread in returns between cheap quality and expensive junk was incredible in the internet bubble.

    This is still not even in the same league as the late ’90s bull run in expensive junk…but I’m not sure we’ll ever see something like that in our lifetime again (maybe in my kid’s lifetime).

  • james

    a

  • james

    Excluding your products, are you referring to any other mfunds or etfs out there? FYI..I like the QVAL etf and am waiting for you guys to roll out QVAR Aggressive as a retail product.