Value stocks are supposed to beat their more glamorous growth brethren over time, but you wouldn’t know it from looking at the past decade.
Over the 10-year period through 2017, the Russell 1000 Growth index produced a 10% annualized return, dwarfing the Russell 1000 Value index’s 7.1%.
For the most part, value-oriented managers have lagged accordingly, but there are some funds that have acquitted themselves rather well.
These funds do not capture the value factor in the ordinary way – that is, overloading their portfolios with traditional value sectors such as energy, utilities, materials and financials. Instead, they tend to serve as all-weather funds that don’t require a value rebound. As a result, they haven’t been hampered by the value drought.
One value approach that has navigated the growth rally well is the Research Affiliates Fundamental index (RAFI).
This smart beta index ranks the top 1000 stocks on book value, sales, cash flow and dividends. This simple rearrangement betrays a value tilt without necessarily intending to. So, for example, the PowerShares FTSE RAFI US 1000 ETF has around 20% in financials – significantly more than the S&P 500's 16%. What’s more, the fund's value sectors haven’t hindered it. Its 9.02% annualized return over the past decade has outpaced the S&P 500’s 8.50%.
Another fund using this approach is the Pimco Fundamental Index Plus fund. Instead of owning the stocks in the fundamental index outright, this fund invests its assets in bonds and gains exposure to a derivative that tracks the index. If Pimco can beat the cost of the derivative with its bond portfolio, the fund can achieve an extra source of positive return.
Pimco can also override the rankings of the RAFI index, meaning that this fund is not purely rules-based. Despite having struggled with energy exposure in 2015 and 2016, the strategy has worked splendidly over the longer haul. The fund has posted a whopping 12.81% annualized return over the past decade – a 431 basis point annualized victory over the index, which lands it at the top of Morningstar’s Large Value category.
There are also two funds that use a sector approach. First, the iShares Edge MSCI USA Value Factor ETF, which accepts the sector weightings of the MSCI USA index and then chooses the cheapest stocks in each sector. Investors in this fund, therefore, aren’t making the same sector bets as an investor in a Russell 1000 ETF. That can be a benefit, but it can also be a drawback if out-of-favor sectors are poised to outperform and if recently favored sectors look overpriced.
Nevertheless, this strategy is a useful way to benefit from the value-based approach over time. The fund doesn’t have a five-year track record, but over the past three years, it has trailed the S&P 500 index by less than one percentage point annually, with a 10.73% annualized return.
The second sector-based fund is the DoubleLine Shiller Enhanced CAPE fund. Like the Pimco fund, this fund invests in bonds and uses them as collateral, gaining exposure to the Shiller CAPE US Sector Index through a Barclays derivative. That index consists of four of the five cheapest sectors on a cyclically adjusted P/E or CAPE basis (price relative to the past decade’s worth of real average earnings).
The process of choosing the four sectors in the index consists of identifying the five cheapest on a CAPE basis, each one judged against its own history, and then eliminating the one with the worst one-year price momentum. The sectors are rebalanced monthly, and – as with the Pimco fund – if the return on the portfolio outpaces the cost of the derivative, the fund nets itself an extra source of positive return.
The DoubleLine fund is unique in that it is not tied to what is normally considered the value ‘factor’. Its four sectors could be growth sectors if those are the cheapest on a CAPE basis. The fund is currently invested in technology, consumer staples, healthcare and consumer discretionary, none of which are considered traditional value sectors. However, they are among the five cheapest sectors on a Shiller basis. From November 1, 2013 – a day after its inception – through the end of 2017, the fund has delivered a 16.35% annualized return, outpacing the S&P 500 Index’s 12.95% by 340 basis points.
A ray of hope
So whether you think that the growth rally is long in the tooth or that today’s growth stocks aren’t all that expensive when compared with other sectors and their respective histories, it’s worth considering these kinds of all-weather funds that take valuation seriously.
These funds should even be able to ferret out value if the current growth rally keeps on rolling.