The Problem With Value Investing

An overvalued stock market is causing value indicators to fail, Man Group argues.

Value investing is not proving so valuable for investors, according to new research from Man Group.

The asset manager’s report examined the risk-adjusted returns of simple value indicators, including the cyclically-adjusted price to earnings ratio (CAPE), the current price to earnings ratio (P/E), dividend yield, and the replacement value to market ratio, or Tobin’s Q.

While long-term equity returns were found to be partially predictable, the results delivered by directional value investing were “mediocre,” with Sharpe ratios close to zero across all signals. Furthermore, the strategy underperformed the S&P 500.

Man Group found similar results in Japan, the UK, Germany, and France, with value indicators underperforming each country’s respective index.

According to the report, the failure of value as an investing signal results from booming stock markets, particularly in the US. “If the stock market keeps rallying aggressively, even after it is fully valued, then value trading will fail by construction,” Man Group argued.

The asset manager blamed the last two decades of Federal Reserve policies, which have focused on the idea that rising asset prices should benefit the broader economy. This was backed by the research, which showed results worsening for value indicators after 1987, when Alan Greenspan took office as Fed chairman.

Other possible explanations for mediocre performance of value strategies were the rising popularity of value investing following the success of Warren Buffett—which made it more difficult to capture premiums—as well as a decline in risk.

But while directional value investing had underperformed, Man Group said it was not permanently doomed to failure. The research showed the US stock market to be overvalued by 57% to 102%—subsidized by “unsustainably stimulative” policies and high leverage.

Additionally, the study found investors could still find some success in relative value strategies, which outperformed directional trading and were found to have “desirable” risk-adjusted return characteristics. However, Man Group noted that a relative strategy cannot stand on its own, and should instead be a part of a wider array of investment styles.

Related: Clarifying Quality: How to Spot a Real Value Stock & Asness: This Is Why Factor Investing Will Survive