Quantitative Value is a stock investing strategy that selects the highest quality stocks out of a bucket of cheap stocks. Dr. Wes Gray and Tobias Carlisle were the first investors/researchers to design such a strategy, which they introduced in their book Quantitative Value.
I have rigorously tested my screener and strategy using the best-known methods to avoid curve-fitting and cognitive biases. Let’s see how it fared in the short-term (i.e., in 2019) and the long-term.
My implementation of a Quantitative Value Screener and portfolio strategy shares the same principles – investing in the highest-quality stocks selected out of a bucket of cheap stocks. Nevertheless, my implementation differ in a few aspects: The selections of the universe of stocks to choose from, cheapness filters, and the implementation of the Quality ranking system. In addition, I use portfolio management rules that reduce the asset turnover and thus help reducing transaction costs and even the tax bill.
Qualitative value (QV) Screener Performance During 2019
The following chart presents the performance of a quantitatively-selected portfolio of 30 QV stocks, with the market cap in the 40th percentile or larger. The smallest stock in the sample is Culp Inc (CULP), with a $169 market cap, and the largest is INTC with a $260B market cap.
All stocks were bought on January 1st, 2019, and held for exactly one year.
Unfortunately, Quantitative Value did not beat the market during 2019. It has returned 16.19% per year, on average, vs. the S&P 500’s 31.22%, including dividends. While a 16% annual return figure is a good result on an absolute basis, it is 15% lower than the benchmark’s return. Ouch.
Does it mean that Quantitative Value has lost its charm and is no longer a good investment strategy? Or maybe it means that my own proprietary implementation of Quantitative Value is not as good as I initially thought?
Since the guys at AlphaArchitect.com, led by Dr. Wes Gray, were first to popularize the Quantitative Value strategy, let us check how their implementation had performed during 2019. Their primary vehicle for Quantitative Value is the QVAL ETF, which comprises of approximately 40 mid-cap and large-cap long-only Quantitative Value Holdings.
QVAL also underperformed the S&P 500, delivering 19.65% for the past year. That is marginally better than our performance yet within the statistical error.
2019 was not a good year for value investors, regardless of their Style and specific methodology. We shall elaborate on that below.
Long-Term Performance of the Quantitative Value Screener
If we look at Alpha Architect’ss QVAL ETF from inception in October 2014, we can see that the fund lagged the S&P 500 by a substantial amount, delivering a total return of 16.42% over the four and half years, compared to the S&P 500 with almost 55%.
I do not think for a second that QVAL or my implementation of Quantitative Value is inferior to investing in a market fund or a benchmark ETF. On the contrary. I believe that QV is one of the best strategies that an individual investor can utilize for beating the market over the long term. The fact that it had underperformed in the short-term is not only a necessary evil that one has to bear in order to achieve long-term over performance. Actually, it is the reason for why the strategy overperforms over the long term. It works (over the long term) because it doesn’t always work (in the short-term). More on that later in future articles.
The following chart presents the performance of my version of the QV portfolio over a 5-years period, June 30th, 2014, to June 30th, 2019. The reason I do all my long term backtests starting June 30th is two-fold: 1) to be consistent with academic research who uses such convention 2) to be consistent across all my publications, enable readers to compare all my backtests, apples to apples.
We can see that the performance over a 5-years period was on par with the S&P 500’s performance. The QV model was ahead of the benchmark for the larger part of the 5-years period and stumbled below it just at the very end.
Testing the strategy over 20 years starting June 30th, 1999, and ending on June 30th, 2019, tells a totally different story.
Quantitative value delivered astonishing average annual returns of 17.35% vs. 5.82% for the S&P 500. Over the long term, QV beats the benchmark (and any other strategy I am familiar with) heads over feet. Moreover, it has done so with lower volatility, as measured by the standard deviation of monthly returns. The standard deviation of the strategy came in 13.39% vs. 14.51% for the S&P 500, as can be seen in the following table. Sharpe ratio is at a super high level of 1.13x vs. 0.32x for the S&P 500. The correlation with the S&P 500 benchmark is a mere 68%. It means that only 68% of the months tested, the S&P 500 and the model both appreciated or both declined. In all other cases, when the market declined during a month, the model appreciated, and vice versa. Over the long term, Quantitative Value develops a healthy margin over the market and runs much higher.
It is also interesting to see, in the tables above, the contrast between the wild overperformance in the long term (table on the right) vs. the mild underperformance during the last three years (table on the left).
Looking at the yearly performance in the following table, we see that in most of the years during the last 20 years, the QV model delivers positive excess returns over the market. It had underperformed the benchmark in only 6 of the last 20 years. Unfortunately, two of those years were 2017 and 2019, falsely leading some investors to believe that Quantitative Value, or any Value Investing method in general, had lost its touch. Some even go as far as saying that Value Investing is dead.
What Does The Future Hold For Quantitative Value?
Yet history should lead us to the exact opposite conclusion. The largest overperformance was achieved following the underperforming years. Following 1999, a disastrous year for Value Investing and a bad year for our model, lagging by more than 10%, came the year 2000 with a fantastic excess of 68% above the market. Following 2007, when QV lagged 6% after the benchmark, it gained 19.20% above the market in 2008. The under-performance of 2009 was fully covered and then some, during 2010 and 2011. And after mildly underperforming in 2012, came four years of significant overperformance. It is only reasonable that following the recent performance of value investing, nowadays, in 2017-2019, the future will be bright for Value investors.
The most telling graph I could find about the history of Value Investing a one taken from an article by Dr. Gray titled Alternative Facts About Formulaic Value Investing:
The chart shows the 10-year rolling returns (compounded annual growth rate, or CAGR) or Value vs. the S&P 500. Every point on the chart indicates the following: had you invested in a value portfolio (or the S&P 500) 10 years ago and held it until that date, what would have been your CAGR. We can see that during most 10-years periods starting the 1930’s, a Value portfolio had beaten the S&P 500. But there were four long periods where that was not the case. Those periods occurred in the late ’30s to early ’40s, during the late ’50s to early ’60s, during the late ’90s, and recently, since 2010. In those periods, Value Investing fell short of the benchmark, leading investors (different ones each time) to believe that Value Investing is dead. An important observation is that those periods of Value underperformance are long, prolonging for many years, even a decade.
Now, ask yourself, examining the historical trends for almost a century, do you believe that Value Investing will underperform forever? Where would you put your money? And if you, like I, believe that Value will re-emerge, as it always has, wouldn’t you want to be invested in the best-performing Value Investing strategy?