Darren Jaroch: Value investing has indeed underperformed growth by a dramatic amount over the past 10 years. At the core of the problem is what the central banks were trying to do to respond to the global financial crisis, and that was to flood the market with liquidity and encourage people to move up the risk curve.
For much of the past 10 years, the low interest rates encouraged risk taking
Prior to the current cycle, there have been three periods of tightening monetary policy in the past 24 years during which short-term rates rose by an average of 3%.
It has really moved investors toward the growthier names, some of the more beta-sensitive parts of the market. It has also forced a lot of people out of value and into growth.
Now, growth is a scarce commodity. After the global financial crisis, growth was really hard to come by. People will pay up multiples for that growth in a scarce growth environment.
I think a second issue is the way value is defined. A lot of people have been using metrics like price-to-book value over time. These older measures of value are actually less relevant today than they were just 10 years ago. In place of book value, more relevant metrics are things like intangible assets.
Why Darren Jaroch defines value daily
Most value indexes are reconstituted only once a year, but undervalued opportunities are constantly changing.Read about Darren's disciplined process
Darren Jaroch: One of the shortcomings that the benchmark indexes have is that they define value and growth once a year. Russell does this, for example. They also use a very simple notion of what value is. As we just discussed, they use price-to-book as their key value determinant. What this does is it focuses the style benchmarks within sectors, so you tend to get sectors with very cheap book value in the value benchmarks, in very concentrated bets within the sectors.
In addition to this concentration, there is the question of the relevance of book value today. Even some of the long-term acolytes of book value, like Warren Buffett, have recognized that book value is much less relevant today than it has been in the past. And the reason is that the vast majority of assets of a lot of companies now are intangible assets: it's patents, it's IP [intellectual property], it's R&D [research and development]. All of those things show up in intangible assets. They don't show up in the denominator of book value. I think that's a key difference between now and as recently as 10 years ago.
Darren Jaroch: That's right. Financials is the most obvious category. The financials' weight in the value benchmarks is always very high — virtually the entire financials sector resides there. It's because historically they've had low price-to-book values. And again, book value is a very hard thing to determine. It used to be things like plant, property, equipment, things that were easy to value. Nowadays it's much more difficult to value those things.
The way we think about value is across the spectrum, and we define value every day because what a value stock or sector looks like today could be very different just three months from now. And now that volatility has returned to the market, I think that's an important distinction.
In May or June each year, Russell determines its value universe. But value characteristics can change throughout the year. We've designed our process around the fact that we want to identify value based on our methodology. It is much more cash-flow focused than earnings focused, and certainly much more cash-flow-focused than book-value focused. I think defining value every day puts you in some places where classic value characteristics don't actually apply.
Most value indexes are reconstituted only once a year, but Portfolio Manager Darren Jaroch has a disciplined process to define the value universe daily and position his portfolios in more compelling undervalued opportunities.
A large-cap value fund with over $12 billion in assets