Why we still like value

25 Jun 2021

Dear investors,

Value stocks (+15.7%) have made quite a comeback with respect to their more glamourous counterparts (+6.2%) in 2021. Yet, while there may be some hick ups along the road, we believe that - in the long run - the value premium still has a lot of catching up to do.  In this newsletter we will discuss one of the reasons why we believe that value stocks have a good chance to outperform in the years to come.

Value Spread

The value spread is the difference between a value signal, like Price-to-Book or Price-to-Earnings, in value versus growth stocks over time. The spread for the Price-to-Book ratio is plotted in the graph below, which is taken from an article  written by AQR.

As you can see, growth stocks tend to be 4 to 5 times more expensive than value stocks on average. The difference in valuation tends to be larger during periods of crises, but normalizes quickly after these events. Obviously, the spread is currently anchored well above its long term-average. Last year it reached an all time high as it toppled even the levels of dispersion that we  have seen during the dotcom bubble and the financial crisis. Why is this good news for quantitative investors? Well, several authors argue that this spread contains useful information about the future returns of the value premium. For instance, a  paper published recently in the Review of Finance finds that when the value spread is one standard deviation away from its mean a Value minus Growth portfolio’s return tends to be 17% higher during the subsequent 24 months than it would be when the premium is at its long-term average. 

Near its peak growth stocks were about 12 times more expensive than value stocks, which is extremely rare as it is a 4.5 standard deviation event. So, even though value may have played a little catch-up during the last year the spread is still at an exceptionally high level. Obviously, this should be good news for everyone who has a horse in the race when it comes to value investing. As value remains an important tool in a quant’s kit, this should be a tailwind for Vector in the years to come.

Both Vector Navigator (+0.11%) and Vector Flexible (+0.27%) ended the month slightly outperforming their benchmarks. While the funds performed remarkably well during the first half of the month, we suffered during the second half as the rotation from growth into value reversed for a little while.

 Kind regards,

Werner, Thierry & Nils