The concept of value is such a natural concept that the quantitative world of investing jumped onto this idea years ago. Various academic papers have started to provide structure and theoretical rigour to the properties that represent value investing.

We can think of the value factor as a systematic method to identify and invest in stocks that appear to be priced cheaply compared to their fundamental balance sheets. One simple example of this can be observed by looking at the book-to-market ratio of a company.

If a company has a high book-to-market ratio it means the theoretical price of the equity of the company is higher than the stock price multiplied by the shares outstanding (market cap). This means that the market as a whole has priced this company at a theoretical value that is lower than the company equity. As a result, this means that the company is priced cheap or represents a value company. Growth companies represent the opposite to value and therefore trade at prices that mean their book-to-market ratios are very low - as investors are banking on future increases in the company assets or equity and so buy the stock today which leads to very high prices.

The value premium is often referred to as the spread between value companies, with for example high book-to-market ratios, versus growth companies with low book-to-market ratios.

We have given one simple and explicit example of one value metric but there are many more such factors. In reality value strategies use more than one factor in their construction, some examples are

• price to free cashflow
• price to earnings ratio
• EV/EBITDA
• price to book value (terminology example: this is just the inverse of book-to-market)

Investors like to buy cheap things or feel like they are getting a bargain. If something can be bought for less than what it is arguably theoretically worth then it represents some value. Cigar butt investing, made famous by Warren Buffet, is one such example where he attempts to invest in companies that might have one big run left in them to maximise return.

Over the last 15 years though, value has been through a tough time as growth stocks and technology focused stocks have tested some of the logical reasons for value investing. Growth stocks, no matter what the price, have been accumulated by investors to the detriment of the value factor.

The value factor (labelled hml), as seen in the graph below, tends to historically have a lower rolling volatility than momentum. hml is constructed based on the book-to-market ratio that we previously discussed. The Fama-French hml portfolio goes long the highest (highest value/most cheap) 30% of stocks based on book-to-market and sells the bottom 30%. On average the long-short value factor has a 1y rolling volatility of less than 10% during the decade 2010-2020. However, since covid began in 2020, the volatility of value has increased significantly and has essentially matched the volatility of the momentum factor. This increase in volatility has also been directional with the market, with values correlation to momentum increasing as the rebound from covid occurred in Q2 2020.

The rolling 1-year volatility of the value factor compared to other style Fama-French style factors. Value (hml) and momentum, especially since covid pandemic in 2020, have structurally higher volatility than quality.

The value factor tends to have some naturally intuitive properties due to the impact of price in its construction. By this we mean that value stocks heuristically can be viewed as cheap stocks to some degree and therefore their recent performance may not be that good or significantly lag its peers. Momentum on the other hand is purely based on recent performance so we would expect value and momentum to be negatively correlated.

It is nice to see that the correlation graphs align with our thinking in terms of illustrating that value tends to be negatively correlated with quality and momentum.

Correlation of the long-short value factor to other Fama-French style factors such as value (hml), size(smb) and momentum (mom), based on a 2 year lookback window

The long-short value factor had a miserable decade from 2010-2019 and there was widespread talk within the quantitative investment community, did the value factor exist anymore. Typically, and after peak pessimism, the long-short value factor since covid began in 2020 has had a stellar two years and has cumulatively returned over 30% since Jan 1st 2020. Long-only value stocks have also significantly outperformed the broader market.

Value tends to do well coming out of a recession or during periods of inflation and can be focused on defensive sectors such as utilities and consumer staples. Value does not tend to do well during the mid-to-late stages of a bull market i.e periods of exuberance such as what the market experienced preceding the tech bubble and also after the financial crisis - these were periods where growth stocks really outperformed.

Value factor performance against other Fama-French style factors, time period 2010-2022

Next we plot the Fama-French style value factor, which is long-short market neutral and based on a book-to-market metric, a very simple naive value metric. If we compare the return spread of yearly returns for value versus say for example quality it is evident that, during the last 15 years anyway, value has been significantly more volatile than quality.

Value factor yearly performance paths since 2010, long-short market neutral construction. Black line with red dot is performance in 2022 so far.

However, the doomsday forecasted for value seems to have abated for now as the decade of 2020 has started with a massive rebound for value, compared to 2010-2019. The value factor has been the best performing factor for the last two years and so far in 2022 the value factor has again matched the 2021 performance year-to-date and if this continues value could yet again return 20% during 2022.

Given the returns from 2021 and 2022 have only recouped a small percentage of the lost 2010 decade, there is continued speculation that the renaissance of value has a lot more room to go and the performance could continue for the decade starting 2020.