Looking for Value in the Wrong Places

In a recent blog post, Adam Butler of ReSolve Asset Management wrote an excellent research article on “evidence-based investing.”  As with everything Adam and his colleagues write, the article is very informative, but one observation in particular resonated with me:

“[W]hile the popular ‘value’ factor exhibits a large and significant effect when applied to mid- and small-cap U.S. companies, it renders a statistically insignificant result when applied to a large-cap investment universe.  Thus there appears to be little value in exposing investors to value tilts in large-cap portfolios.”

If data from MSCI are to be believed, this appears to be true not just in the U.S., but also in Europe, and other regions around the world.  For example, large growth portfolios worldwide have outperformed large value portfolios over the last one, three, five, and ten-year periods in just about every instance.  While it is tempting for some to blame this “lost decade” for value investing to the financial crisis of 2007-2009, it does not appear to be the main culprit, as there is little difference in the returns of the portfolios going back to when data begin in May of 1994:


Despite a similarly disappointing decade for small value investors versus growth investors, the strategy has paid off longer-term, as Adam noted.  However, where small value investors have enjoyed the most success is not the U.S. equity markets, but those overseas, particularly in emerging markets, where the strategy has outperformed small growth over every time period observed:


Some caveats do apply here, of course.  MSCI uses three metrics to build their “value” portfolios:  price-to-book, forward price-to-earnings, and dividend yield.  It is entirely possible that different metrics would yield substantially different results.  In any event, the lesson here may be that in order for value to realize its fullest potential, it should be sought not only in smaller companies, but also perhaps in less studied and less efficient markets such as those in the emerging universe.