Has the Value Investing Pain Train Ended?

Has the Value Investing Pain Train Ended?

March 8, 2016 Value Investing
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Last year we highlighted what we deemed the “value investing pain train.”

In 2015, cheap high-quality stocks started getting crushed by expensive junk stocks. Here is a recap of the carnage.

In many respects, value investing is a lot like Terry Tate — the huge “office” linebacker that would crush employees who made mistakes. His nickname: the “pain train.”

SAT answer: Terry Tate is to office employees, as value investing is to investors.

The value investing pain train: a visualization

Let’s look at the progression of the value investing pain train.

Here is a link to the source data: Price/Quality portfolio data. We examine value-weight returns for the cheap high-quality quintile and the expensive low-quality quintile. The daily returns run from 1/1/2015 to 1/31/2016. Results are gross of fees. All returns are total returns and include the reinvestment of distributions (e.g., dividends).


value pain train
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.
  1. Beginning of summer…value is getting cheap.
  2. End of summer…value is super cheap.
  3. End of the year…value is a stupid strategy.

Fast forward to 2016. Below are the results for January from 1/1 to 1/31. Value started off on the wrong foot, possibly due to redemptions from 2015?

pain train in jan
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.

Is value ready for a rally? Or is this a head fake?

The value investing propaganda starting coming out hot and heavy in February. Rob Arnott led the charge at Research Affiliates, with a piece with an amazing title, “How Can Smart Beta go Horribly Wrong.” A simple summary is that value investing has gotten destroyed and seems like a great opportunity. Buy RAFI products. Now. The public relations effort on behalf of value investing seems to have worked: February was an epic month for all things that buy cheap out-of-favor firms.

Great news for all of us who traffic in the stock market’s trash can.

A logical conclusion from the analysis and commentary above might be to buy value. After all, value has sucked wind for a long time and a lot of folks have given up on the strategy. However, we should be careful with “logical” conclusions. As we’ve said time and time again, active value investing has been digging manager graveyards since 1900 and this form of investing is simple, but not easy. The chart in 2015 highlights that relative performance can get a lot worse before they get better. And trust us, the chart from 2015 is not the exception, but the rule. Value investing is a long-term strategy that cannot be timed. You buy the exposure over time, sock it away in a lock box, and don’t touch it–no matter what.

The winners in the value trade are those who can hold the strategy when many other market participants have given up. The pain train seems to have subsided–and we hope that is the case–but the reality is that all value investors must be mentally prepared to do what others cannot. Or in the words of Cliff Asness, be prepared to see the grim reaper at your door!


Please remember that past performance is not an indicator of future results. Please read our full disclaimer. The views and opinions expressed herein are those of the author and do not necessarily reflect the views of Alpha Architect, its affiliates or its employees. This material has been provided to you solely for information and educational purposes and does not constitute an offer or solicitation of an offer or any advice or recommendation to purchase any securities or other financial instruments and may not be construed as such. The factual information set forth herein has been obtained or derived from sources believed by the author and Alpha Architect to be reliable but it is not necessarily all-inclusive and is not guaranteed as to its accuracy and is not to be regarded as a representation or warranty, express or implied, as to the information’s accuracy or completeness, nor should the attached information serve as the basis of any investment decision. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission from Alpha Architect.


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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.

  • As “Generic” small cap value has merit as a proven and accessible value stock universe for the average investor ( returned -10.1% Jan 2015 – Feb 2016 as per Vanguard Small Cap value VBR ). A further application of quantitative tactical allocation with the addition of “Sell in May” component ( “Sell in May” added value in a significant way the case of this model ) applied to small cap value, has produced risk managed alpha over a 90 year sample .. https://docs.google.com/presentation/d/1C37CJypoxHWHB09e3g25ewOGjP83wDZhj5j6tlrLJoA/edit?usp=sharing

  • Steve Marcum

    I guess your definition of value investing is different than mine. I think of value investing as buying a security that is trading below its intrinsic value. I don’t think “cheap, high quality” is the same thing. Even a low quality business is worth something. And if the market is offering a price for that low quality business that is clearly below its intrinsic value, a value investor (as per my definition) would consider buying it.

  • Steve, sorry for the confusion.

    “Value investing,” as documented in empirical research, is the spread in returns between “cheap” and “expensive” based on some price-to-fundamental metric. Think Ben Graham value investing. This is what we typically mean when we talk about value investing on this blog.

    However, as a former fundamental stock-picker (http://blog.alphaarchitect.com/2013/07/23/please-admit-me-to-stock-pickers-anonymous/), I understand there is another version of “value investing,” which is more in line with the Warren Buffett style of value investing you’ve mentioned. (although, the empirical evidence suggests Buffett is more Graham than the story he tells). See http://www.econ.yale.edu/~af227/pdf/Buffett's%20Alpha%20-%20Frazzini,%20Kabiller%20and%20Pedersen.pdf

  • Adam Kearny

    Hi Wes,
    Checking in on the Gotham Funds (GONIX) discussion from last year. In a mere first six weeks of 2016, GONIX spreads quickly made back half of the entire 2015 year’s losses. What I found interesting was your observation that the underperformance of “value” strategies intensified in summer/fall of 2015. Yet, GONIX spreads stopped going negative after the end of June and actually rebounded. Sort of evidence that they’re doing something more analogous to Steve’s definition below, rather than the “naïve value factors” (Rich Pzena’s term) that you’re basing your analysis on. That reality (together with various risk-management trading factors as an adjunct to valuation-based security selection–note Greenblatt tipping his hand on this in a late 2009 interview on Morningstar when the question of L/S quant strategies came up) explain why your earlier analysis about hypothetical 50-70% draw-downs in 1999 was completely off-base.
    Your analysis was nonetheless well-taken in the context of simplistic, non-risk managed, L/S factor-based strategies. A bit of a stretch though in extrapolating this analysis to real-life funds.

  • Hi Adam,

    Strategies that mix value and quality as equal ingredients do a poor job capturing the value premium — they are a mix of good (value premium) with a mix of bad (quality) so you are left with mediocre. GONIX isn’t a bad concept and/or exposure per se. But good ideas can be destroyed by high fees and poor tax efficiency. GONIX is a great example of this scenario. One can capture the same concept by buying a closet-index value/quality ETF and shorting a future and/or a growth index. To charge 2%+ for a strategy that is long 600 names and short 600 names is odd, to say the least. See attached. Not to mention a 1% redemption fee? God bless Joel — huge fan both personally and professionally — but from the perspective of being “investor-friendly,” especially in a world of ETFs with amazing tax-efficiency, I’m not seeing a compelling value proposition — at all.

    Anyway, for more details on the subject of the value premium and what it is and what it isn’t, you can read an entire book to this subject: Quantitative Value. Moreover, the original LSV 94 paper highlights that “Cheap” drives the anomaly because of behavioral bias:
    Quality is only useful in the context of the cheapest stocks. In isolation, quality is a priced.

    And we stand by our analysis that long/short value strategies can get destroyed at times. If you don’t believe the evidence, there are anecdotes of L/S value guys getting their faces ripped off in the internet bubble: Julian Robertson is a great example. Are those events rare? Sure. Would it be smart to assume they are impossible? Not really, unless you were promoting a specific viewpoint. Trust me, we love to tell people that long/short value strategies represented a fairly stable investment opportunity with controlled drawdowns. But that’d be against our culture and mission of empowering investors through education.

    Maybe there is some secret sauce with GONIX, but a 2.62% cumulative performance since inception figure –with a decent size drawdown already baked in the cake, surely doesn’t prove that this is the case. Can others do it? Sure, we run across them every so often in our role as a consultant for a bunch of HNW and family offices. But they are rare.

  • Adam Kearny

    Julian Robertson didn’t get his face ripped off in the internet bubble–he had a low-teens drawdown (not 50-70%), and his investors gave up–he followed that up in his private portfolio with massive gains (e.g. 80%) over the next couple of years. Ditto with mutual fund BPLSX which is similar to GONIX. What is your opinion of BPLSX (20-yr track record)? They seem to have pulled it off quite well, and with tolerable draw-downs.

    Also, note that GONIX on a full-year basis (extrapolate from GARIX alpha) was +18% in 2013. The 120/120 L/S spread (i.e. after hedging out the 25% net long with an index ETF short) is on track for mid-20s so far this year.
    I also disagree with your notion that value/growth ETFs could consistently replicate this. Long IWN and short IWO, for example, would have worked this year, but not for most of the past 8 years (while Gotham funds were working just fine). In fact, you would have a huge cumulative draw-down over the past several years doing just that (although it’s probably set for a snap-back over the next several years).

  • Adam Kearny

    On your other comments: (i) most of the fund is concentrated in the top 60-80 positions on each side (review the SEC filings)–most of those 600+ are tiny residual positions–this is definitely not a closet-index fund; (ii) the 1.00% redemption fee is irrelevant to anyone holding the fund for any reasonable time period; (iii) whether the 2% management fee is reasonable depends on the annualized after-fees alpha that may be achieved over a long time frame (say, 5 yrs minimum). BPLSX has charged that same fee for 20 years and has clearly earned it.
    One other point you are overlooking in the value proposition–with these funds, an individual investor can get 180-240% gross exposure per dollar invested. If one were, say, long GENIX and short an index, that would be 340% gross exposure. Using (non-leveraged) ETFs, an investor can only get 200% gross exposure. This has its own risks, of course, but with low-vol, highly diversified/hedged strategies in a low-return world, some zero-cost leverage is arguably a good thing.