The Incredible Shrinking Value Premium?

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backpacker
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The Incredible Shrinking Value Premium?

Post by backpacker »

Image

This chart is for trailing 20 year annualized outperformance of value stocks. As you can see, the 20 year return of value recently hit a new low. Is this the death of the value premium? Or are we watching the slow inflation of a growth bubble? I have no idea myself.

Data is the usual Ken French HML series. 2015 returns are through August.
Last edited by backpacker on Mon Oct 12, 2015 7:25 am, edited 2 times in total.
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alec
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Re: The Incredible Shrinking Value Premium?

Post by alec »

what was it right before the beginning of the charts? seems like it's due for a comeback. no?
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Re: The Incredible Shrinking Value Premium?

Post by backpacker »

Here's the full chart.

Image

Just looking at the chart, it's hard to resist the idea that the value premium started a general decline after the 1993 publication of the Fama and French common returns paper. That general decline was interrupted by the inflating and deflating of a growth bubble, but has now become clearer after more than twenty years of live returns.

On the other hand, a big comeback could be in the cards. No one knows! :beer
Last edited by backpacker on Mon Oct 12, 2015 7:35 am, edited 1 time in total.
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Re: The Incredible Shrinking Value Premium?

Post by nedsaid »

Backpacker, what we are seeing is a normal market cycle. We seem to be in a growth stock decade as we experienced in the 1990's. I started noticing that my value funds started to trail the averages about 2010. It seems to be happening Internationally too. I will have to consult Morningstar to confirm this with International stocks. But clearly we are in a growth cycle.
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Re: The Incredible Shrinking Value Premium?

Post by larryswedroe »

First, should not be a surprise that we see some deterioration as more people chase the premium after publication. But if risk based shouldn't disappear.
Also for same reasons that are very logical explanations for the BETA premium to have fallen over time (note IMO those using CAPE 10 to state market overvalue are way off base), the value and other premiums should have shrunk, logically (think small cap premium falls as trading costs fall).

Then add that value stocks typically benefit from inflation that is higher than expected as they are more financially leveraged, and we have had inflation now being lower than expected for long time---and no big surprise then that the value premium is slightly negative, like 1%, for last 10 years.

Claude Erb did series of studies on the various premiums and he concluded that ONLY premium that had not deteriorated significantly was small value (note the premium is largest there IMO due to variety of things including small growth stocks with low profitability are the black hole of finance)

Hope that helps
Larry
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Re: The Incredible Shrinking Value Premium?

Post by grok87 »

i agree with Larry's point about small-value being better and that a key driver of the small-value premium is unexpected inflation. i'm not much good at posting charts but here is the data (for small-hi minus big-lo). if you look at the years starting in 1974 you will see what Larry is talking about. also small-value value is bad in deflation- see the 1927-1931 numbers are all big negatives.

for this very reason, a few years ago i moved away from tilting to small-value. i'm putting a lot of money into long term tips already to hedge unexpected inflation (for my retirement liabilities). so with inflation hedged, the next big risk to hedge is deflation. i started off by eliminating things that are expected to do poorly in deflation. so i said goodbye to small-value stocks.

these days i get my "factor-junkie" fix from two funds: Vanguard Market Neutral (VMNFX) and Vanguard Global Minimum Volatility (VMNVX). Part of the rational for VMNVX is that the stocks it owns are less leveraged and will hopefully do better in a deflation scenario. For the same (leverage) reason, i don't like REITs but prefer the TIAA Real Estate Annuity.

year sh-bl 20 year avg
1927 -9.1
1928 -5.0
1929 -18.2
1930 -18.7
1931 -16.4
1932 14.7
1933 88.5
1934 1.4
1935 10.6
1936 57.8
1937 -15.8
1938 -8.9
1939 -14.4
1940 -0.1
1941 10.8
1942 22.5
1943 79.8 10.6
1944 32.3 11.8
1945 36.8 13.1
1946 1.4 12.5
1947 2.7 13.1
1948 -5.8 13.0
1949 -1.9 13.9
1950 28.0 16.2
1951 -8.2 16.6
1952 -4.6 15.6
1953 -9.1 10.8
1954 16.1 11.5
1955 -3.4 10.8
1956 0.2 7.9
1957 -7.0 8.4
1958 29.3 10.3
1959 5.0 11.2
1960 -3.7 11.1
1961 5.7 10.8
1962 1.6 9.8
1963 6.7 6.1
1964 9.6 5.0
1965 27.6 4.5
1966 3.3 4.6
1967 39.3 6.4
1968 42.4 8.8
1969 -27.8 7.5
1970 13.0 6.8
1971 -10.4 6.7
1972 -14.2 6.2
1973 -5.1 6.4
1974 10.7 6.1
1975 24.1 7.5
1976 43.3 9.7
1977 32.3 11.6
1978 15.0 10.9
1979 24.0 11.9
1980 -13.8 11.4
1981 25.5 12.4
1982 19.2 13.2
1983 33.6 14.6
1984 8.7 14.5
1985 0.2 13.2
1986 -0.4 13.0
1987 -14.4 10.3
1988 18.3 9.1
1989 -19.7 9.5
1990 -24.8 7.6
1991 -2.3 8.0
1992 28.9 10.2
1993 26.1 11.7
1994 -2.6 11.1
1995 -4.5 9.6
1996 1.1 7.5
1997 7.7 6.3
1998 -39.9 3.5
1999 -19.8 1.4
2000 35.8 3.8
2001 37.4 4.4
2002 13.9 4.2
2003 37.0 4.3
2004 15.1 4.7
2005 6.0 5.0
2006 13.6 5.6
2007 -22.6 5.2
2008 1.5 4.4
2009 2.1 5.5
2010 12.1 7.3
2011 -11.2 6.9
2012 5.9 5.7
2013 7.8 4.8
2014 -11.2 4.4
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Re: The Incredible Shrinking Value Premium?

Post by small_index »

grok87 wrote:year sh-bl 20 year avg
I don't follow what "sh-bl" represents, although the context of your post suggests small value minus inflation.

Here's William Bernstein's article on the value premium v.s. inflation:
http://www.efficientfrontier.com/ef/701/value.htm

My varying thoughts on holding small cap value or small cap blend:
1) "unexpected inflation" can't be predicted, so hold small cap value since you can't time the value premium. The performance near 2000-2002 supports this argument.
2) "low inflation" has been the situation for past and likely persists for a time. Hold Small cap blend until inflation changes. All the points where changes are gradual support this approach.
3) "similar performance" of blend and value for small caps. Looking at the recent performance on Google Finance, they don't differ enough to be interesting.
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Re: The Incredible Shrinking Value Premium?

Post by gwrvmd »

I have been a value investor for 35 years. I don't do a lot of statistical analysis but my feeling is that my experience is the same as the figures posted by Backpacker.......Gordon
Added: The 70s, 80s and the 90s were good times to be a value investor
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Re: The Incredible Shrinking Value Premium?

Post by larryswedroe »

grok
The way to address both is to own SV and buy bit longer term bonds to hedge the deflation risk while also earning the term premium at same time. So you get all the premiums, beta, size, value and term (don't want default/credit as doesn't mix well).
And generally when have CDs as options TIPS won't look as good as you will be paying a higher risk premium for the protection than if compare to Treasuries.
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Re: The Incredible Shrinking Value Premium?

Post by jadd806 »

backpacker wrote:Here's the full chart.

Image

Just looking at the chart, it's hard to resist the idea that the value premium started a general decline after the 1993 publication of the Fama and French common returns paper. That general decline was interrupted by the inflating and deflating of a growth bubble, but has now become clearer after more than twenty years of live returns.

On the other hand, a big comeback could be in the cards. No one knows! :beer
I think it's important to note that we've seen a general downtrend since the advent of automated computerized trading in the early 1990's. This caused the death of many simple technical systems which were purported to work up until that point, such as Richard Dennis' "Turtle Trading" system.
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Re: The Incredible Shrinking Value Premium?

Post by grok87 »

larryswedroe wrote:grok
The way to address both is to own SV and buy bit longer term bonds to hedge the deflation risk while also earning the term premium at same time. So you get all the premiums, beta, size, value and term (don't want default/credit as doesn't mix well).
And generally when have CDs as options TIPS won't look as good as you will be paying a higher risk premium for the protection than if compare to Treasuries.
Larry
Thanks Larry, that's an interesting idea. I think there are different ways to come at this...

The reason i like my approach is that i have a high confidence that, if i hold to maturity, long term tips will hedge my inflation risk. Small-value stocks may or may not hedge inflation risk, i think it is a bit more uncertain.
Last edited by grok87 on Mon Oct 12, 2015 9:56 am, edited 1 time in total.
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Re: The Incredible Shrinking Value Premium?

Post by grok87 »

small_index wrote:
grok87 wrote:year sh-bl 20 year avg
I don't follow what "sh-bl" represents, although the context of your post suggests small value minus inflation.

Here's William Bernstein's article on the value premium v.s. inflation:
http://www.efficientfrontier.com/ef/701/value.htm

My varying thoughts on holding small cap value or small cap blend:
1) "unexpected inflation" can't be predicted, so hold small cap value since you can't time the value premium. The performance near 2000-2002 supports this argument.
2) "low inflation" has been the situation for past and likely persists for a time. Hold Small cap blend until inflation changes. All the points where changes are gradual support this approach.
3) "similar performance" of blend and value for small caps. Looking at the recent performance on Google Finance, they don't differ enough to be interesting.
Sorry i was using the fama french notation
Sh = small hi = small value
Bl = big lo = large growth

So I'm showing the returns of small cap value stocks minus the returns of large cap growth stocks
1st column is year
2nd column are the annual data
3rd column is the 20 year moving average idea that backpacker started us out looking at
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Re: The Incredible Shrinking Value Premium?

Post by SimpleGift »

grok87 wrote:So I'm showing the returns of small cap value stocks minus the returns of large cap growth stocks
1st column is year
2nd column are the annual data
3rd column is the 20 year moving average idea that backpacker started us out looking at
  • Image
Just posting this chart of the data from upthread — I'll defer to grok87 and others for commentary on the history of the small value premium.
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Re: The Incredible Shrinking Value Premium?

Post by larryswedroe »

Grok
Obviously TIPS are the best hedge of inflation risk
And note that small value tends to do well in rising inflation, until it gets "too high" and then Fed steps in and drives real rates way up to reduce that risk, and they get crushed---but of course that is when longer term high quality bonds do best

So value relationship to inflation isn't linear--it's like a big frown

Larry
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Re: The Incredible Shrinking Value Premium?

Post by grok87 »

larryswedroe wrote:Grok
Obviously TIPS are the best hedge of inflation risk
And note that small value tends to do well in rising inflation, until it gets "too high" and then Fed steps in and drives real rates way up to reduce that risk, and they get crushed---but of course that is when longer term high quality bonds do best

So value relationship to inflation isn't linear--it's like a big frown

Larry
Thanks Larry, makes sense
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Re: The Incredible Shrinking Value Premium?

Post by SimpleGift »

larryswedroe wrote:And note that small value tends to do well in rising inflation, until it gets "too high" and then Fed steps in and drives real rates way up to reduce that risk, and they get crushed...
Comparing grok87's small-value premium data to inflation since 1923, there appears to be a fairly strong positive correlation (chart below) — as Larry points out. This suggests that the declining value and small-value premiums in recent decades may have more to do with declining inflation than either market crowding or a growth stock bubble.
  • Image
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Re: The Incredible Shrinking Value Premium?

Post by Maynard F. Speer »

^^
Could it be low inflation encourages looser monetary policy, which brings everything up together?

Image
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Re: The Incredible Shrinking Value Premium?

Post by Epsilon Delta »

grok87 wrote:i agree with Larry's point about small-value being better and that a key driver of the small-value premium is unexpected inflation.
If a premium is risk based it's not better, it simply is.

The question is do you want to take that risk, and what the heck is the risk anyway?
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Re: The Incredible Shrinking Value Premium?

Post by larryswedroe »

Epislon
I disagree for two reasons

First, if the premium results not from risk, just is an anomaly explained by bad investor behavior, then it's better. And SV premium is partly result of investor mispricing of lottery ticket stocks, mostly SG. That is partly why the SV premium is much larger than the LV premium.

Second, even if all risk, due to diversification benefits and how correlations work in flights to quality, IF add SV tilt and lower beta exposure at same time the historical evidence, and the logic, as presented in the Incredible Shrinking Alpha, show that you have more efficient portfolios with less downside risk (assuming you use high quality bonds)

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Re: The Incredible Shrinking Value Premium?

Post by backpacker »

nedsaid wrote:Backpacker, what we are seeing is a normal market cycle. We seem to be in a growth stock decade as we experienced in the 1990's.
You may well be right nedsaid. Looking at the chart, though, there seems to be a general decline over and above the recent growth cycle. The growth cycles seem to be getting better for growth and the value cycles not as good for value.
larryswedroe wrote: Claude Erb did series of studies on the various premiums and he concluded that ONLY premium that had not deteriorated significantly was small value.
Well, the HML portfolio is already tilted to small stocks. This because it equally weights the performance of large value stocks (with a greater than median market cap) and small value stocks (with less than median market cap). Since the combined market cap of large value stocks is much higher than the combined value of small value stocks, the HML portfolio is already tilted to small stocks.

But you may be right. Maybe the key to finding a robust value premium is tilting harder to small stocks. The decline of traditional HML is still interesting, though, because lots of value strategies from RAFI and DFA and AQR are primarily large value strategies. Investors considering those strategies should use expected HML returns less than half the historic average.
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Re: The Incredible Shrinking Value Premium?

Post by backpacker »

Simplegift wrote:
grok87 wrote:So I'm showing the returns of small cap value stocks minus the returns of large cap growth stocks
1st column is year
2nd column are the annual data
3rd column is the 20 year moving average idea that backpacker started us out looking at
  • Image
Thanks grok87 and Simplegift.
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Re: The Incredible Shrinking Value Premium?

Post by afan »

The premium is simply another way of taking risk, beyond variance. If you account for higher moments, the premium goes away. In many studies it goes away as soon as you account for the negative skewness of the resulting portfolios.

This means you cannot evaluate whether the premium has changed without looking at the higher moments. Just as you cannot know whether you are getting a better risk adjusted return from market exposure without considering risk, you cannot know whether value is better, worse or the same as it was in the past until you look over the other elements of risk.

It is possible that the supposed premium became widely followed around the same time that information about small and distressed stocks became readily available, fixed commissions went away and overall trading costs declined. Each of these changes made these stocks less risky, and hence reduced the demand for higher returns for holding them. To a large extent the small premium was an illusion based on the limited information available to researchers when they first articulated it. Prices for these stocks were hard to come by. Often they were dealing with weekly or monthly prices, not the microsecond by microsecond prices we have now.

Once these problems were recognized investigators went back and dug through the data to find better prices. When they did this the premiums were seen to reflect risk, nothing more.

But if you like your risk in the form of skewness and if you are more willing to accept negative skewness than are investors on average, then you can benefit from having a different utility curve. Whether this still works depends not only on the returns, but also on the skewness of these small value portfolios. If it has been becoming less negative than in the past, then a lower return may still be a good deal for a skewness indifferent investor.
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Re: The Incredible Shrinking Value Premium?

Post by Epsilon Delta »

larryswedroe wrote: Second, even if all risk, due to diversification benefits and how correlations work in flights to quality, IF add SV tilt and lower beta exposure at same time the historical evidence, and the logic, as presented in the Incredible Shrinking Alpha, show that you have more efficient portfolios with less downside risk (assuming you use high quality bonds)

Larry
No. If the premium is due to risk it is not a risk being measured by the model. Ignore things you don't measure at peril of picking up nickels in front of invisible steam rollers.
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Re: The Incredible Shrinking Value Premium?

Post by backpacker »

jadd806 wrote:I think it's important to note that we've seen a general downtrend since the advent of automated computerized trading in the early 1990's. This caused the death of many simple technical systems which were purported to work up until that point, such as Richard Dennis' "Turtle Trading" system.
This make sense. I've often thought that backtesting simple quant strategies can be silly for exactly this reason. They are, in essence, telling us what returns we could have gotten if we data and computing power in the past that no one at the time actually had. It's like pointing out that beating Alexander the Great would have been easy, assuming that we had tanks and he had horses.
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Re: The Incredible Shrinking Value Premium?

Post by backpacker »

afan wrote:This means you cannot evaluate whether the premium has changed without looking at the higher moments. Just as you cannot know whether you are getting a better risk adjusted return from market exposure without considering risk, you cannot know whether value is better, worse or the same as it was in the past until you look over the other elements of risk.
A nice point. We barely have enough data IMO to say anything interesting about the skew of value returns in general. We certainly don't have enough to know how the skew has changed over time.
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Re: The Incredible Shrinking Value Premium?

Post by backpacker »

grok87 wrote:i agree with Larry's point about small-value being better and that a key driver of the small-value premium is unexpected inflation. i'm not much good at posting charts but here is the data (for small-hi minus big-lo). if you look at the years starting in 1974 you will see what Larry is talking about. also small-value value is bad in deflation- see the 1927-1931 numbers are all big negatives.
The idea that the value premium has anything to do with inflation is IMO a financial urban legend. Just look at the returns for various value strategies in Japan over two decades of essentially zero inflation. If the value premium somehow depended on inflation, these returns would make no sense.

Image

(Chart from http://greenbackd.com.)
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Re: The Incredible Shrinking Value Premium?

Post by Maynard F. Speer »

backpacker wrote:
grok87 wrote:i agree with Larry's point about small-value being better and that a key driver of the small-value premium is unexpected inflation. i'm not much good at posting charts but here is the data (for small-hi minus big-lo). if you look at the years starting in 1974 you will see what Larry is talking about. also small-value value is bad in deflation- see the 1927-1931 numbers are all big negatives.
The idea that the value premium has anything to do with inflation is IMO a financial urban legend. Just look at the returns for various value strategies in Japan over two decades of essentially zero inflation. If the value premium somehow depended on inflation, these returns would make no sense.

(Chart from http://greenbackd.com.)
Value based active funds in the UK (of which there aren't many - but then I'm not sure of any passive options either) have outperformed significantly since the financial crisis .. Also in a low inflation environment

Which is why I'd wonder if it's not inflation but rather expansive monetary policy accompanying low inflation that impacts the value premium .. In the case of Japan, value would've kept you out of an enormous bubble .. I'd wonder how Japanese value stocks compare today, since Abenomics
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Re: The Incredible Shrinking Value Premium?

Post by larryswedroe »

basically all the assets with high returns tend to have high negative skew, exactly what you should expect when you have risk averse investors
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Re: The Incredible Shrinking Value Premium?

Post by Robert T »

.
Here are the 20 yr annualized returns of small cap HML, large cap HML, and the combined HML (as presented in the OP). The main driver of the declined in HML was the declined in the large cap component - driven by the late 1990s superior large growth performance ("bubble"). The recent 20 yr annualized returns for small cap HML is not dramatically below the long-term average.

Image

Just to see how the late 1990s large growth outperformance ("bubble") impacted the above 20 yr results, here are the 15 year annualized return results.

Image

Results are somewhat time period dependent. Obviously no guarantees.

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Re: The Incredible Shrinking Value Premium?

Post by backpacker »

Robert T wrote:Here are the 20 yr annualized returns of small cap HML, large cap HML, and the combined HML (as presented in the OP).
Thanks Robert. Good to see the SV premium holding up even if LV premium looks a bit precarious.

One of the problems with using 15 year returns at the present moment is that the apparent recent uptick is really just the result of cutting the last major growth/value cycle in half. The most recent 15-year period catches the deflating of the tech bubble without the inflating of the tech bubble. But without the inflating, there would have been no deflating. So the outperformance of value in the early 2000s would have been lower. I picked 20 year returns in part to avoid this problem. The most recent 20 year return includes both the inflating and the deflating so, I think, gives a better feel for the expected value premium going forward.

One of the reasons I'm interested in this is that I'm trying to figure out how much return I should really be expecting from large value funds (like PXF and PXH). I'm happy owning Vanguard Small Value, partly because I'm happier owning Vanguard funds and partly because I'm more confident in the SV premium than the general value premium.
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Re: The Incredible Shrinking Value Premium?

Post by JoMoney »

Looking at rolling returns of the Small and Large "Value Premiums", the "premiums" from 15 years ago during the dot-com boom had never been so large for the "small value", and you have to go back to the 1929 market boom to find them that large for the "large value" premium.

FF Large Value Premium
Image
FF Small Value Premium
Image
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Re: The Incredible Shrinking Value Premium?

Post by Robert T »

backpacker wrote:One of the problems with using 15 year returns at the present moment is that the apparent recent uptick is really just the result of cutting the last major growth/value cycle in half. The most recent 15-year period catches the deflating of the tech bubble without the inflating of the tech bubble. But without the inflating, there would have been no deflating. So the outperformance of value in the early 2000s would have been lower. I picked 20 year returns in part to avoid this problem. The most recent 20 year return includes both the inflating and the deflating so, I think, gives a better feel for the expected value premium going forward.
While the last 15 years seems to capture more 'deflating' of growth relative to value, it does not capture a "full deflation" of the valuation spread between large cap growth and large cap value (as per the charts below). Will these fully revert to the long-term average spread? No one knows.

Image

Image

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Re: The Incredible Shrinking Value Premium?

Post by gtwhitegold »

Well, even if valuation levels remain the same, LCV still should outperform LCG over time due to more favorable ROIC. It does look like a growth bubble right now.
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