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Saturday, February 7, 2015

Value vs Growth Why Value Stocks Outperform

The data are overwhelming: value stocks beat growth stocks. And since it is well proven that active managers underperform passive/asset class investors, the superior choice seems clearly to be passive funds targeted towards value stocks.

This strategy has now been categorized as part of the "smart beta" trend but in fact it has been practiced by Dimensional Funds Advisors (DFA) in funds available only through advisors for more than two decades. There are also several ETFs with varying methodologies. Vanguards' carry the lowest expense ratios
VTV large cap
VOE mid cap
VBR small cap

Two etfs with a methodology developed by Research affiliates uses a different methodology but is value weighed
PRF large cap
PRFZ small/mid cap

A nice summary of the data on value vs growth is here with a table with data.

The explanation for small value vs growth performance is stated nicely:

  1. Small Cap Value stocks are generally very boring companies that no one has heard of. These are unglamorous companies, unlikely to garner much oohs and aahs around the dinner table
  2. Investors over react to growth prospects and bid up the shares high. That is why growth stocks are expensive and provide smaller returns. On the flip side, investors over react and force the smaller value stocks down at the slightest whiff of bad news or general discomfort.
  3. There is insufficient coverage of these stocks on the Wall Street due to smaller size and lack of liquidity. As a result, they escape the attention of most institutional and retail investors who depend on brokers or sell side analyst’s recommendations
  4. Most institutions and funds are not allowed to own small cap and micro cap stocks and if they do come into possession of any such stock, perhaps due to a spin off, they are forced to sell off their position
Due to these reasons, there is little investor interest in small cap stocks. But enterprising value investors know that small caps offer the best places to find true value stocks that will on average comfortably beat the market over the long term.

The article includes lomg term data but the last ten years shows the same patter small value total return of 127% VTI total stock market (which includes some small value stocks) 1118.9 %and the S+P 500 (all large cap with a higher weighting to growth than value 107.7%.
This also demonstrates that the S+P 500 is not a good representative of the entire market it is totally a large cap index weighted towards large cap growth.
So why not own only small value stocks ?: this group of stocks is significantly more volatile than the overall market and the outperformance is over the long term small value stocks can underperform for long periods. Not only is patience required it is also important to note that a period of significant underperformance if it is at a period close to when the investor is approaching retirement when hopefully the portfolio has grown significantly and can have a big impact without time to recover porfolio value when there is "reversion to the mean" and small value again outperforms.
Another good summary of the data is here...with some important advice

Profiting From Small Caps Comes From Patient Management

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