Value’s Rebound Rewarded Investors Who Stayed in Their Seats
Value’s recent turnaround has rewarded investors who remained disciplined following its prolonged slump. In addition to reminding us how quickly premiums can show up, the past few years reinforce an important factor in determining how much one should tilt toward higher expected returns: The upside is beneficial only if you can stay invested through the down times.
The Pendulum Swings
The three-year period ending in June 2020 was one of the worst ever for the value premium, with the MSCI World IMI Value Index underperforming the MSCI World IMI Growth Index by 14.8 percentage points annualised. Since then, value has been mounting a comeback, beating growth by 9.9 percentage points annualised through June 2022.1
Investors’ experience during these times depended, in part, on their degree of value emphasis. The more one deviates from the market along drivers of expected returns, the greater the tracking error relative to the market—but the greater the expected outperformance when targeted premiums are positive.
Three of Dimensional’s strategies convey the range of outcomes for various levels of tilt (see Exhibit 1). During the value swoon from 2018 through 2020, the World All Cap Core Equity, which targets a balanced exposure to the size, value and profitability premiums, underperformed the MSCI World IMI Index by 3.1 percentage points per year. At the other end of the spectrum, the World SMID Cap Value strategy, which takes a targeted exposure towards the value and size premiums, trailed the index by 16.7 percentage points.
The script has since flipped. Value’s rebound helped push the Core strategy to a 2.6 percentage points advantage over the market in the two-year period ending in June 2022. On the other hand, the World SMID Cap Value strategy’s heavier tilt led to outperformance by more than 11 percentage points per year.
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Annualised return difference (in percentage points) vs. MSCI World IMI Index
Past performance does not predict future returns.
Finding Balance with Your Tilts
It’s important for investors to balance their enthusiasm for higher expected returns with their tolerance for underperformance. Reining in one’s tilts toward the premiums following a period of underperformance—and consequently forfeiting a portion of the eventual rebound—could lead to an unfortunate scenario. Land on a tradeoff you can stick with and you may find April showers are followed by May flowers.
Glossary
Value Premium: The return difference between stocks with low relative prices (value) and stocks with high relative prices (growth).
Tracking error: A measure used to quantify how closely a portfolio follows an index or benchmark, often defined as the standard deviation of the difference between the portfolio and index returns.
Past performance does not predict future returns.
Footnotes
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1MSCI data © MSCI 2022, all rights reserved. Indices are not available for direct investment, therefore their performance does not reflect the expenses associated with the management of an actual portfolio.
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