Brace yourself – value investing is supposed to be a bumpy ride

In investment, as in life, human beings are inclined to don rose-tinted glasses. From time to time, then, investors need to remember: ‘Objects in the rear-view mirror may appear smoother than they actually are’

There are people well into their investment careers – yours truly included – who are yet to witness value outperforming the market for a sustained multi-year period. That said, value has had the upper hand since late 2020 and the three-year performance numbers of those who stuck to their process now reflect what a deep-value active investment strategy is capable of delivering.

Given it is not in the nature of value investors ever to feel comfortable during the good times, though, we feel compelled to remind you that, within any period, there will be downs as well as ups. Yet a heady cocktail of hindsight bias, emotional filtering, cognitive dissonance and memory reconstruction mean, as humans, we are inclined to emphasise the good times and do our very best to block out the bad.

In reality, of course, life is always a lot messier – and investment returns a lot bumpier – when you are living through them day-to-day, week-to-week and month-to-month than when you are looking back at them. Or, to misquote that well-known warnings to drivers: “Objects in the rear-view mirror may appear smoother than they actually are.”

Rose-tinted glasses

So what does three years of great outperformance really feel like? To be honest – at times – very tough. To understand why that could be so, let’s consider the period from 1971 to 2019, which happens to take in the two biggest secular value rallies in modern market history – the mid-1970s, after the oil crisis, and the early 2000s, in the period following the dotcom boom and bust.

These were multi-year periods of extremely strong relative performance for value and, looking back, it is easy to see them through rose-tinted glasses as truly outstanding times to have been a value investor. And yet, if we zoom in on those great secular value rallies, a very interesting truth emerges: this ‘greatness’ was also home to some of the worst relative monthly returns for value versus growth in stockmarket history.

The following chart shows the monthly returns of US largecap value from 1971 to 2019, ordering the size of returns from worst to best. And what we find is that no fewer than six of the 10 worst months on record for value versus growth occurred during those periods of stellar outperformance –  periods value investors now look back upon fondly as golden ages for their chosen discipline.

Past performance is not a guide to future performance and may not be repeated. The value of investments and the income from them may go down as well as up and investors may not get back the amount originally invested.

A clear conclusion to draw from this is that – in the short term at least – the market can be hugely noisy. Which means trying to extrapolate what will happen over the next three to five years based on monthly swings in sentiment is a dangerous game as it can be hugely misleading. So, yes, value did indeed endure a more difficult month in March 2023 – but history would suggest this is simply par for the course.