(James Saft is a Reuters columnist. The opinions expressed are
By James Saft
Sept 7 If you want to understand why value
strategies have trouble attracting inflows, look not at
investors but at the people they hire.
Value investing, it must be said, has had a terrible run.
Despite long-term evidence that seeking out undervalued stocks
works, the last few years have not been pretty. Large-cap value
stocks have underperformed growth stocks and the S&P 500
for seven of the past nine full years.
That may help explain why only 20 percent of equities held
by public-sector pension plans are value stocks.
Take a longer view and use a value- and cap-weighted index
and the merits of value come into focus. The S&P 500 has offered
2.9 percent annualized excess return above 20-year Treasuries
from 1962-20l5. That's against a 1.8 percent annualized excess
return for a Research Associates value index, but with about a
quarter of the risk and more periods of outperformance over
rolling three- and 15-year periods.
Why, in other words, do investors show a strong bias towards
stocks but not towards value?
Part of the trouble, both with attracting funds to value
approaches, and with sticking with them during the sometimes
long periods of underperformance, may be traceable to the
inevitable mismatch between what is best for the owner of the
money and what is best for the manager hired to advise or
execute a strategy.
"Principal-agent conflicts arise from contradictory
motivations between the owner (the principal) and the person
delegated to act on behalf of the owner (the agent)," John West
and Amie Ko of Research Affiliates write in a note to clients.
"The time horizon for owners can span decades. The time
horizon for agents is the span over which their own performance
is judged - years or even shorter time periods. As such, agents
face a powerful incentive to minimize short-term drawdowns
relative to peers and benchmarks."
In other words, advisors and fund managers find it hard to
advocate for value, or execute it, because it carries higher
career risk, the risk that they will lose assets or their jobs.
It is one thing to stick with a value strategy if you are Warren
Buffett. Quite another if you are a typical pension fund advisor
or fund manager being judged on your latest three-year results.
MOMENTUM IS A SOCIAL AND ECONOMIC FORCE
Much of this thinking accords with that of Paul Woolley, a
veteran IMF official and fund manager, and Dimitri Vayanos, of
the London School of Economics, who have argued that the very
activity of benchmarking puts fund managers in a position where
they are all too likely to follow the crowd.
A fund manager who is judged by a benchmark has an inbuilt
reason to buy that which has just gone up in value. If a fund
manager is underweight Amazon and Amazon is
outperforming, the pressure mounts to buy in or look bad when
mandate review rolls around. That pressure often leads to
cynical buys of stock not based on fundamentals. Those
defensive, or self-interested, stock purchases extend the
momentum cycle. Amazingly, that's despite risky stocks
historically underperforming less volatile ones.
Value, Woolley and Vayanos assert, can work, but requires
trust and a long horizon by savers.
The issue may also be partly one of conditioning, according
to West and Ko of Research Affiliates. Over the past 45 years
most generations of asset managers have experienced long periods
of strong outperformance of stocks against bonds, reinforcing
convention wisdom, but less good results for value.
"In the last decade, current practitioners have tangibly
felt value investing's severe disappointments alongside
brilliant value-add generated by stocks versus bonds; not only
are these recent events shared by nearly everyone in today's
investment community, they may also unconsciously and more
heavily weigh on our memories and expectations, crowding out the
wins experienced from value investing in earlier years," West
and Ko write.
The rise of passive investment, which now accounts for 40
percent of the money invested in U.S. stocks, has probably
raised pressure on managers to stick with convention and
emphasize the short term.
After all, if you are working in a declining industry, which
active investment shows many signs of being, you might want to
emphasize remaining employed over creating long-term returns.
Ultimately, it will be up to investors to bring their agents
(Editing by James Dalgleish)