Is Value Investing Dead? A "Cliff Note" on Cliff's Note

Cliff Asness and AQR's Approach

I always appreciate Cliff Asness’s self-deprecating approach to investment management. Cliff is the Managing and Founding Principal of AQR, a quantitative, global investment management firm managing about $250 B in assets. As one of the largest firms, they certainly have the right to pridefully fight back against critics. Yet, when their investment strategies are criticized, they tend not to get defensive and instead step back, listen to the criticisms, introduce more of their own, undergo thorough testing and analysis and then lay it out on the table for all to see.

Is Systematic Value Investing Dead?

As we are experiencing historical levels of spread between value stocks and growth stocks, Cliff’s latest commentary, “Is (Systematic) Value Investing Dead?” on  May 8, 2020, does exactly this as he summarizes the more detailed research of his colleagues: “Is (Systematic) Value Investing Dead? by Israel, Laursen, and Richardson April 9, 2020.

Cliff’s summary is a candid, honest, and understandable read for most investors. The team’s research respectfully and exhaustively responds to the increasing drumbeat that “value investing” is dead. (By the way, we have heard this drum before.)  After all, value has had a historically poor 10-year run versus growth, so it must be dead, right? Before you draw that conclusion, you should review their research.

AQR relies on various investment quantitative factors across their systematic investment strategies, and value plays a key role in many of these. As a result, AQR has had some challenges lately, but once again their research gives investors comfort and hope. In fact, one could argue that now might be the restart of great things in the world of value investing.

Review of Terminology

What do you mean by “value”? There are many definitions. Academics thrive on using book to price, but practitioners typically use multiple variations of value metrics, such as price to earnings (trailing and forecasted), price to sales, and price to cash flow. These are used to rank stocks with the cheapest being “value” and the most expensive being “growth.”

What is the “value spread?” In this paper, AQR uses the gap between the P/B of the most expensive one-third (“growth stocks”) and the least expense one-third (“value stocks”) to define “value spread.” (They test other measures like P/E and P/Se and get the same conclusions, so they stick with P/B for simplicity). The theory is that the bigger the spread, the higher the expected return of value stocks versus growth stocks.

How do you invest in value systematically? There are many ways to implement this. Again, academics have their way and practitioners have theirs. A simple and non-recommended method is to rank stocks annually based on the value metric, then “buy” the cheapest one-third and “sell” the most expensive one-third. Then repeat this every year. (Of course, it is more complicated than this but frankly, if you did only this, you are probably better off than most investors!)

Our "Cliff Note" on Cliff's Note

AQR shows we are in a time of historically large “value spread.” Given the 10-year run in growth, the gap between the cheapest stocks and the most expensive stocks is extremely wide (over 4 standard deviations!). This means we may have an incredible opportunity to be value investors. Or not, as objections and naysayers come forth. And that is the essence of this paper: a critical review of the most relevant arguments that value is broken or dead to see if they have validity. They test each objection with over 50 years of global stock data. In the end, the data and analysis methodically knock each one down.

Objection #1: Price to book is just a poor, antiquated methodology for measuring value gap.

Nope. The team tested multiple definitions of value (P/E, P/S, P/CF) and the historical gap exists across all common measures.

Objection #2: Certain stocks or industries are creating the spread and creating all of the noise.

Nope. They repeat their analyses excluding high-growth tech stocks and even excluded entire industries such as technology, media and telecom and still get historically large spreads.

Objection #3: The largest mega-cap companies with more monopolistic powers are creating distortion.

Nope. They exclude the largest 5% of the companies over time and still get the same conclusion.

Objection #4: The most expensive stocks are expensive for a reason (whatever that may be) and create a misleading spread.

Nope. They exclude the 10% most expensive stocks each year and still get the same magnitude to spread.

OK. So the spread is great, is it time to buy value now? Not too fast! They examine some more objections:

Objection #5: Cheap isn’t really cheap. The gap is because “expensive” is so expensive not that “cheap” is cheap.

Nope. Looking at average “cheap” and average “middle” over time you see that “cheap” is, in fact, “cheap.”

Objection #6: OK, they look cheap because those cheap companies are bad or risky companies.

Nope. The team looked at profitability ratios and leverage ratios over time. There is no indication that today’s cheap companies are any different than those historically. They are just cheap.

Conclusion

Again, we appreciate the willingness of AQR to listen and analyze objectively. As a firm that utilizes value, this type of research gives us more confidence to the long-term evidence and more conviction in our investment selections.[1]

I conclude with a direct quote from Cliff’s piece. I chose this quote because of the refreshing honesty (but also because I have four kids, just like Cliff):

“If value investing was like driving my four kids on a long car ride, we’d be very deep into the “are we there yet?” stage of the ride, and value investors are justifiably in a world of pain. Could we hit new highs in the value spread (and incur more losses for value) from here? Sure, we could (we do think this gets increasingly unlikely as spreads widen more and more but sadly there’s certainly no provable limit). Regarding timing, could systematic value come back very quickly over say a few months, or slowly over a few years? We don’t know. Good investing isn’t about sure things and certainly rarely about precise timing. Sure, things are usually about cheating, and if it’s not cheating it almost always gets arbitraged away really fast. Good investing is about being on the right side of the odds and sticking with good strategies, if (a big “if” we have hopefully taken great strides to dispelling here), after careful examination, you are convinced they are not broken.”

[1] Disclosure: our firm utilizes strategies from AQR, DFA, Vanguard, Goldman Sachs and First Trust that seek to capture the value premium.