A Vanishing Value Premium?


The value premium, a long-time driver of fund returns, keeps chugging along. In the past nearly 90 years through 2017, a new report by Dimensional Fund Advisors shows that investing in value-styled stocks -- as represented by the Fama/French U.S. Value Research Index -- generated a 3.5% greater annualized return versus a sister domestic growth benchmark. 

The latest in-depth DFA research piece, however, notes that in seven out of the last 10 full calendar years tilting to value has produced a negative "premium." (See chart below.)

Yearly Observations of Premium

Still, as depicted in the above graph, returns from investing in value stocks have varied greatly over shorter timeframes. Researchers point out that "there are only a handful of years that were within a 2% range" of the longer-term average. "This data helps illustrate that there is a significant amount of variability around how long it may take a positive value premium to materialize," DFA's analysts observe.

This latest research generally falls in-line with past studies. Analysts tracked by IFA, both academic and finance industry professionals, have placed a premium for maintaining exposure to value stocks (versus growth) roughly in a range of 2.3% to 3.5% a year over extended periods.

In its simplest form, value stocks can be defined as having discounted prices based on some financial fundamental such as sales, net income, dividends and "book" values. In particular, we've found book value ratios to be particularly effective -- and efficient -- in constructing globally diversified portfolios which give index investors the best chance to capture higher returns over time, net of fees. (For an in-depth analysis of why such a book value-to-market ratio works so well, you can read "Capturing the Value Premium: Is More Necessarily Better?" by Tom Allen and Mark Hebner.)

"While the current stretch of extended underperformance for the value premium may be disappointing," DFA's study notes, "it is not unprecedented."

Histrocial Observations of 10-Year Premiums

From 1930 through 1939, the premium for value stocks went through an extended nadir, DFA's latest research on the topic shows. By comparison, the study found the best 10-year period for such an investment benefit came in 1941 through 1950. (See chart above.)

But for patient and strategic long-term investors, here's what really might resonate the most: The value premium proved positive in a vast majority of 10-year periods. Against such an extensive backdrop of market data, the recent stretch of negative results appears as a distinct outlier.

In fact, it's just one of 13 such periods since 1937 that produced a negative annualized value premium, DFA's analysts report. "Of these, the most recent period of underperformance has been fairly middle-of-the-road in magnitude," they add. 

Histrocial Performance of Premiums over Rolling Periods

So what does history show about how long outperformance by value stocks has lasted as market risks ebb and flow?

The above graphic breaks down positive value premiums by one-, five- and 10-year rolling periods. As might be expected, investors able to take a big picture view and not pull their trigger fingers too soon stand to gain the most.

A case in point: When moving from five- to 10- year rolling periods, the frequency of positive average premiums increased from 75% to 84%. "Even with long-term positive results, though, periods of extended underperformance can happen from time-to-time," DFA concludes.

We've presented research before about the risks of trying to "time" investments to take advantage of the so-called size premium. In a similar vein, our advisors caution against listening to short-term alarms about any potential waning appeal of tilting to value stocks.

This new DFA research provides us with even more evidence that a disciplined investment plan emphasizing consistent exposure to value stocks -- through good times and bad -- is the most reliable way for investors to maximize longer-term benefits of the value premium over time.