We know from a vast array of academic research that value stocks outperform growth stocks over long measurement periods. While recent market performance has caused many to question this conclusion as growth has outperformed value. Academic research looking back over many decades corroborates these conclusions.
Fama and French identified many other characteristics that lead to meaningful outperformance. In this piece, I want to focus on the U.S. Value category and how investors may best capture the long-term premia that come from large cap value stocks.
The value factor contends that value stocks produce superior returns over time relative to growth stocks. While this can vary wildly and growth stocks can outperform for even long stretches of time, over the very long run, data leads to the conclusion that value stocks will outperform growth stocks. The evidence for the value premium is robust, and diverse across geographical regions as demonstrated by (Fama/French, 1997).
"Value stocks have higher returns than growth stocks in markets around the world. For 1975-95, the difference between the average returns on global portfolios of high and low book-to-market stocks is 7.60% per year, and value stocks outperform growth stocks in 12 of 13 major markets. An international CAPM cannot explain the value premium, but a two-factor model that includes a risk factor for relative distress captures the value premium in international returns." (Fama, French "Value Versus Growth: The International Evidence", 1997)
Data on The U.S. Value Premium
The first thing investors need to understand when selecting a U.S. value fund is how the fund is constructed and what their strategy is going to be. When we examine the data on U.S. value funds, we see that not all funds are created equally.
Average Annual Returns | 1999-2022 |
Vanguard Value Index (VIVAX) | 7.06% |
DFA US Large Cap Value III (DFUVX) | 8.19% |
DFA US Large Cap Value III (DFUVX) outpaces the Vanguard Value Index (VIVAX or ETF: VTV) creating 113Bps. of alpha during the period. When we look into the construction of these two funds, we see that the Vanguard Value Index follows the CRSP Large Cap Value Index, whereas the DFA fund holds more stocks in the mid cap value category, catching more of the value, and size premium. In addition, DFA tilts to profitability, holding more of the companies that exhibit characteristics of high levels of profitability and underweighting those companies that show low levels of profitability. Investors following this approach were rewarded over the long run.
This demonstrates the clear advantage that investors have by ignoring the sirens call of speculators promising large returns and delivering subpar performance at high fees. Following the evidence and allocating capital towards the sources of outperformance is the only way to get your fair share of investment returns.
In terms of active managers, the evidence is clear that the majority of large cap value managers have failed to outpace the index. An even smaller portion have beaten the DFA U.S. Value Fund III. While some have been able to achieve high levels of performance over long periods of time, investors must deal with the fact that many of these funds, produce additional alpha through style drift, shifting to what is popular in an attempt to capture alpha.
While it is clear that value outperforms growth over long measurement periods traditional index funds fail to fully capture that premium. The DFA U.S. Value III fund is a far better solution for investors looking to beat the market by utilizing investment science rather than a strategy which seeks to outpace peers through pure speculation.
Investors who want to take a chance on a large cap value active manager, must be sure that this manager is going to provide them with a long term, consistent approach to large cap value stocks. Very few managers are able to do this, and thus funds are subject to style drift to attempt to produce returns that outpace the index.
Conclusion
Looking at the factors across time, and geographies, what we see is that the factor premiums tend to be robust and yet consistent as the graphic above from Dimensional Fund Advisors shows. It is important for investors to ensure they are holding these factors in their portfolios to be able to take advantage of the premiums when they present themselves. This shows the importance of holding a diversified portfolio across asset classes, geographies and even factors. DFA's unique process, and daily implementation strategy allows investors to take advantage of their expertise to do just that.