Perspectives

Face/Off: Value Premium and Interest Rates

By Wes Crill, PhD, Senior Client Solutions Director and Vice President

Mar 02, 2023

1 Minute Read

Topic

Value Premium

For some investors, the tea leaf-reading exercise of Fed-watching may spill over into speculation about the impact of future interest rate changes on the value premium, which is commonly believed to be sensitive to interest rate activity. Recent relative performance of value stocks did nothing to dispel this belief. Over the period 2018–2020, the 10-year US Treasury yield fell by 1.47% while the average annual US value premium was -22.21%. The script flipped in 2021–2022, when a rise in rates of 2.95% was accompanied by an average annual value premium of 25.71%.

Drawing conclusions about the relation between value and interest rates using a few select data points is no more advisable than inferring the high correlation between Nicolas Cage movie releases and fatal pool accidents is causal.¹ A more comprehensive view of the value premium shows little sensitivity to interest rate changes. The exhibit below indicates rising rate years have existed all over the distribution of value premium observations. There is no tendency for these periods to cluster among good (or bad) outcomes for value stocks. Trying to guess how value stocks will perform in response to future interest rate changes may be even less productive than sitting through a Cage movie.

Past performance is not a guarantee of future results. Returns are not representative of actual portfolios and do not reflect costs and fees associated with an actual investment. US Value Premium defined as the return of the Fama/French US HML Research Factor, available from the Data Library of Ken French. Each year is categorized by rising (falling) rates if the 10-Year US Treasury yield at the end of the year is higher (lower) than the yield at the end of the previous year. Treasury data available from the Federal Reserve Bank of St. Louis. The Fama/French factors represent academic concepts that may be used in portfolio construction and are not available for direct investment or for use as a benchmark. Eugene Fama and Ken French are members of the Board of Directors of the general partner of, and provide consulting services to, Dimensional Fund Advisors LP.

Footnotes

¹“Spurious Correlations,” tylervigen.com.

GLOSSARY

Fama/French US HML Research Factor: Constructed from four size/book-to-market research portfolios. HML for July of year t to June t + 1 includes all NYSE, AMEX, and NASDAQ stocks for which we have market equity for December t − 1 and June of t, and (positive) book-to-market equity data for fiscal year ending in t − 1. HML (High minus Low) is the average return on two value research portfolios minus the average return on two growth research portfolios: 1/2 (Small Value + Big Value) − 1/2 (Small Growth + Big Growth). Exclusions: ADRs, investment companies, tracking stocks, non-US incorporated companies, closed-end funds, certificates, shares of beneficial interests, and negative book values.

Value Premium: The return difference between stocks with low relative prices (value) and stocks with high relative prices (growth).

Disclosures

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