Can Value Investing Still Trump Growth?
The last time I ran a comparison of value vs. growth strategies in the U.S. equity market, I found a significant value premium. But that was a couple of years ago, when the equity markets’ recovery still felt fresh.
So afer six years of a surging bull market, I wanted to revisit that analysis to discover: Does value-oriented investing still win out? My goal was to find out whether the value premium has persisted among U.S. large-, mid- and small-cap equity indexes — and, if so, to quantify its impact.
The “Quarter-Century Analysis” chart below shows the performance of U.S. equities, U.S. cash and U.S. bonds — as well as the value and growth indexes across three market capitalizations (large, mid- and small caps) — over the 25-year period from Jan. 1, 1990, to Dec. 31, 2014.
A $10,000 initial investment on Jan. 1, 1990, is tracked for all categories (not adjusted for taxes or inflation, and assuming no additional deposits or withdrawals).
Over that 25-year period, the annualized return of the S&P 500 was 9.62%, with a standard deviation of annual returns of 18.25%. An initial investment of $10,000 in 1990 grew to $99,350 by the end of 2014.
The annualized return of three-month Treasury bills was 3.01%, with an annualized standard deviation of return of 2.27%, and the $10,000 grew to $20,989. And the Barclays Capital Aggregate Bond Index had a 6.49% annualized return, a 4.89% standard deviation and a final account value of $48,209.
As it turns out, the value premium persists across all levels of equities.
Over the 25-year period, growth-oriented large-cap U.S. equities (the average of the Russell 1000 Growth Index and the Lipper U.S. Index of Large-Cap Growth funds) had an annualized return of 8.72%. By contrast, value-oriented large-cap U.S. equity (the average of the Russell 1000 Value Index and the Lipper U.S. Index of Large-Cap Value funds) had an annualized return of 9.58%.
So, in the aggregate, large-cap value generated a premium of 86 basis points over large-cap growth over the period. This value premium amounted to a differential in the final account value of $17,499 in favor of large-cap value.
The average 25-year return of two mid-cap value indexes (average of the Russell Mid-Cap Value Index and Lipper U.S. Index of Mid-Cap Value funds) was 11.15%, considerably better than the 10.16% average return of the combined mid-cap growth indexes (average of Russell Mid-Cap Growth Index and Lipper U.S. Index of Mid-Cap Growth funds). This 99 bps difference in performance amounted to a mid-cap value premium of $28,304 over the past 25 years.
Among small-cap U.S. equities, the value premium over the 25-year period was an astonishing 224 bps.
With a 25-year annualized return of 10.96%, small-cap value (the average of the Russell 2000 Value Index and the Lipper U.S. Index of Small-Cap Value funds) turned $10,000 into $134,508 — $53,607 more than the ending balance in small-cap growth.
By contrast, small-cap growth (the average of the Russell 2000 Growth Index and the Lipper U.S. Index of Small-Cap Growth funds) had an annualized return of 8.72% over the 25-year period.
Clearly, many clients won’t invest for that specific length of time, so I also examined performance in smaller time frames.
Over five-year periods, for example, I found that among large and mid-cap U.S. equity indexes and funds, the competition between growth and value is basically a push, with value having the slight edge over the past 25 years.
Across all 21 five-year rolling periods, large-cap value demonstrated a performance premium 52% of the time, and the average five-year value premium was 462 bps. Large-cap growth outperformed large-cap value 48% of the time and by an average of 280 bps.
For instance, over the five-year period from 1992 to 1996, large-cap value U.S. equity demonstrated a 240 bps premium over large-cap growth U.S. equity. Among mid-caps during the same period, there was a value premium of 203 bps, and among small-caps the value premium was 363 bps.
More broadly, among small-cap U.S. equity indexes, value has outperformed growth 76% of the time by an average of 487 bps (over five-year periods).
Yet when small-cap growth wins, the margin can be large. For example, during the five-year period of 1995 to 1999, small-cap growth beat small-cap value by 860 bps.
Overall, when small growth has outperformed small-cap value, the average margin of victory has been 336 bps.
These findings do not argue for eliminating growth-oriented assets from a portfolio. However, the analysis does suggest that a value “overweight” is justified in the long run — particularly among small-cap U.S. stock mutual funds.
WHAT’S THE PREMIUM?
The value premium over various rolling time frames is illustrated in the “Value Premium” chart below. As the length of the investing period increases (from one-year rolling periods up to 10-year periods), the frequency of a value premium tends to increase.
In small-caps, for example, value outperformed growth 52% of the time over the 23 three-year rolling periods between 1990 and 2015, 76% of the time over the five-year rolling periods and 88% of the time over 10-year rolling periods.
Among large-caps, value has outperformed growth 69% of the time over the rolling 10-year periods in the past quarter-century. Among U.S. mid-cap equities, value has outperformed growth in 81% of the rolling 10-year periods.
As noted above, the most compelling value story is seen among small-cap U.S. equity, with value beating growth 88% of the time over rolling 10-year periods.
There will certainly be periods in which growth outperforms, as witnessed in U.S. large-cap growth indexes and funds during the last six rolling five-year periods (2005-2009 through 2010-2014).
But for the patient investor, value has historically proven to be the long-term winner, particularly among U.S. small-cap stocks.
Craig L. Israelsen, a Financial Planning contributing writer in Springville, Utah, is an executive in residence in the personal financial planning program at the Woodbury School of Business at Utah Valley University. He is also the developer of the 7Twelve portfolio.