Value investors have faced a protracted period of underperformance globally that has tested the patience of even the investment strategy’s most committed adherents. Value stocks have underperformed the broad global stock market in six of the past seven calendar years (as measured by MSCI indexes in Canadian dollars). Based on trailing returns for three years and five years ended Oct. 31, 2019, value stocks have underperformed annually by 2.8% and 2.2%, respectively.

The underperformance has been particularly severe in the U.S. due to the combination of technology’s stronger performance and its greater relative market weighting. Over the past three and five years, value has underperformed the broad U.S. market annually by 3.7% and 2.6%, respectively.

Has the value factor — the tendency of value stocks to outperform growth stocks — faded into oblivion? Several recently published papers argue otherwise. The EDHEC-Risk Institute in France analyzed factor returns in the U.S. from 1977 to 2017 and concluded that value’s recent underperformance is not abnormal and occurs fairly frequently.

The analysis of macroeconomic influences suggests negative surprises over the past three years are in part a contributor to the underperformance.

A team at Boston-based GMO LLC analyzed the drivers of the value premium — the relative return performance of value vs growth — in the U.S. from 1981 through 2005, when value outperformed strongly, vs the period from 2006 to 2018, when value lagged. GMO’s research found that the primary reason that the value premium has gone negative over the past decade is relative valuation. The valuation multiples of value stocks have not expanded as fast as multiples in the overall market, with the result that value stocks have become comparatively cheaper. The team concluded that cheap value stocks still provide a value premium, although that premium may now be smaller.

Several studies have found that the value spread — a measure of the valuation difference between cheap value stocks and more expensive growth stocks — is extraordinarily large at this time. As of Aug. 31, global value stocks had a trailing price/earnings (P/E) ratio of 14.1 and a price/book (P/B) ratio of 1.6. That compares with a P/E ratio of 25.5 and a P/B ratio of 4.3 for global growth stocks. Relative to growth, value stocks are very inexpensive.

Research has found that wide value spreads are associated with higher future expected returns for value stocks. California-based Research Affiliates LLC currently forecasts that concentrated value strategies in developed and emerging markets will outperform their respective broad market by 3.1% and 3.5%, respectively, annually over the next five years.

Importantly, although global and U.S. value strategies have disappointed in recent years, the Canadian value premium has continued to reward investors. Based on trailing returns for the three, five and 10 years ended Oct. 31, value stocks have outperformed the overall Canadian market by 1.7%, 0.9% and 1.4%, respectively, annually.

Advisors who use value-oriented portfolio managers for client portfolios should resist the urge to abandon these strategies due to their protracted underperformance. There is substantial evidence the value factor is alive and well, and a period of outperformance may be in the offing.

An expanding array of ETFs in Canada and the U.S. as well as several low-cost quantitative active portfolio managers provide investment strategies that pursue the value premium.

Michael Nairne, CFP, CFA, is president of Tacita Capital Inc. of Toronto, a private family office and investment-counselling firm.