For Value Investing, Bittersweet Success
Sunday, November 12, 2006
Will success ruin value investing?
It's a spoilsport question to raise, smack in the middle of a golden age for the army of bargain-minded investors who march under the "value" banner.
But someone has to ask it. With value-stock mutual funds trouncing their growth-fund counterparts for a seventh straight year here in the waning weeks of 2006, the issue can't be avoided much longer: At what point do value stocks and value funds get so fat and happy they don't represent "value" anymore?
The first principle of value investing is to shun what is popular and buy what is overlooked and out of favor. So when value investing itself becomes the height of popularity, presumably it must be subjected to the same kind of hard-eyed reappraisal.
Sure enough, that has begun to happen in various corners of the investment world. And, though it is giving away the ending to say so, value investing so far has stood up quite well to the scrutiny.
Value investing is not some passing fancy. But the phrase may mean something quite different nowadays. Today's value manager is just as likely to be buying a computer or a health-care stock as a metals or paper manufacturer.
See Warren Buffett at Berkshire Hathaway Inc., the paragon of value investors, snapping up shares of drugmaker Johnson & Johnson. See value managers like Southeastern Asset Management Inc. in Memphis and Harris Associates LP in Chicago loading up on the stock of computer-maker Dell Inc.
It appears that yesterday's growth stocks may be today's value stocks, and vice versa. But no matter which category you aim to invest in, you're dealing with a moving target.
Value managers face an increasing challenge in the coming years: As more people glorify the idea of value investing and try to practice its principles, the harder it may become to find value opportunities that are truly worthy of the name.
The hard facts are these: From the end of the 1990s through the first 10 months of 2006, the Vanguard Value Index Fund, a standard-bearer of value investing, gained 5.2 percent a year. Over the same stretch, its opposite number, the Vanguard Growth Index Fund, lost 3.6 percent a year.
In 2006 through the end of October, Value Index has climbed 15 percent, Growth Index a measly 4.6 percent.
This tends to corroborate the observation of Jeremy Grantham, chairman of the Boston-based money manager GMO LLC, that value stocks enjoy a natural advantage. Investors, he says, naturally tend to overpay for "exciting" growth companies as opposed to "boring, struggling or sub-average" value stocks.
But Grantham also observes in the same commentary that "90 percent of what passes for brilliance or incompetence in investing is the ebb and flow of investment style." And, he adds, "Since opportunities by style regress, past performance tends to be negatively correlated with future relative performance."
Regression to the mean is a favorite subject of many value managers. In financial markets, nothing stays hot forever. And after seven strong years in a row, value investing would seem to be a prime candidate to feel some regressionary pressures.
So where does that leave us? I've argued both sides of the question -- that value investing is forever, but that it also may be due for a disappointing year or two.
Well, that's what happens in markets. Strong opposing forces, trends and ideas collide. Value investing stands every chance to prove its enduring worth in the years ahead. But probably not without a struggle.