When the British people declare, "The King is dead! Long live the King!" they mean that the person who held the title of King is dead, but the institution of "King" will endure with the ascension to the throne of a new King.
For the past year (at least), many newspapers, magazines and television shows that cover the investment management industry have been writing obituaries for value investing. Here are a few examples:
- Is value investing dead? It might be, and here's what killed it
- Value investing is long on virtue but has been short on reward
- Value investors are running out of dumb humans
Industry practitioners and researchers agree with the trade press. One recent paper, by Baruch Lev and Anup Srivastava, concludes that value investing isn't working and hasn't worked for most of the past 30 years. The authors "doubt" that value investing will work in the future.
I think it's time to declare, "Value Investing is dead!" That is, the most widely-used, systematic approach to constructing value portfolios (the Fama-French High-Minus-Low "Value" Factor) is dead.
As Lev and Srivastava point out, using book value to classify stocks as "growth" or "value" is flawed because many companies are asset-light, and GAAP standards force many investments to be expensed rather than placed on the balance sheet. This results in a lot of value miscalculations (the authors show how making various adjustments to the standard Fama-French approach results in much higher returns for "value"). Many other systematic approaches for finding "value" stocks are also flawed, for related reasons.
I think the fundamental approach to value investing, first presented by Graham and Dodd in 1934, is, in many respects, also dead. It needs to be updated and extended to deal effectively with modern business models competing in an interconnected, rapidly changing, global economy. I think this lack of innovation has contributed to the underperformance (from 2010-2019) of fundamental value-focused hedge funds.
Despite the "death" of widely-practiced, traditional approaches to value investing, it is also time to declare, "Long live Value Investing!" because the institution of value investing will endure. It has to. It represents the essence of investing.
Using your judgment to assess the value of something, comparing it to the asking price, and determining whether to buy (or sell), is what investors do. Not just value investors, all investors. Whether in venture capital, private equity, turnarounds, or any other area of specialization, investors look at a prospective investment to determine, based on their analysis and expertise, whether the company will be worth more in the future than it is today. If they think the prospective upside is worth the risk, they invest.
The institution of value investing will remain intact, but value investors will have to adapt their tools and techniques to improve their returns. This is true for both systematic and fundamental approaches. What is required for a successful transition is the entire focus of our firm, and will be the subject of many future posts.