Content provided by Rusty Vanneman, CLS Chief Investment Officer

Why does value investing work? Simply put, the expected return for any investment is determined by the price you pay. For example, a great company could still be a bad investment if the price paid is too high. Conversely, a sub-par company could be a good investment if the price paid is low enough. Or, to put it yet in another, though perhaps a bit simplistic, way, if you pay $10 for $1 of dividends, then that obviously should provide a better return than paying $10 for $0.50 of dividends.

There is plenty of academic research supporting value investing, including the well-known Fama & French study from 1992. Money managers like David Dreman have also published considerable research on why value investing works. A Google search will find numerous studies supporting value investing.

Perhaps more importantly, the proof isn’t just in academic studies, but in the actual results of great value-oriented money managers, past and present, including Warren Buffett, Bill Nygren, and the late Sir John Templeton. The list of great growth-oriented investors is a lot shorter, but names like David L. Babson, T. Rowe Price, and Peter Lynch were still very conscious of value.

Intuitively, we know that investors tend to underperform the market, and this underperformance is often referred to as the “behavior gap.” Arguably, the biggest reasons for the behavior gap is that investors follow the crowd and chase performance. However, value investors, by definition are not chasing performance, nor are they following the crowd.

A security only becomes a value when prices are down – and they are usually down for a reason.  And bad news flow follows lower prices. So to buy an ideal “value” investment, the security in question is not going to look that attractive in the context of the current market narrative. This is why value investing can be so hard to do. It is often seen as too risky, but not in the traditional sense of risk as tied to price volatility. Instead, value investing runs the risk of making the decision-maker look wrong. To buy such a security – and to see it continue to underperform – can be seen as a threat to credibility. In short, being a value investor runs the risk of looking foolish. Not many PMs want that risk.

Value investing is also hard because the data doesn’t change every day. This isn’t reassuring to people who crave constant information or action. More importantly, this isn’t very useful for traders (who need action items to spur volatility), or the financial media (who need to write stories). It takes a while for valuations to change, and the daily barrage of noise and chatter does little to change it. The daily noise might seem important – it’s always used to explain performance AFTER it happened – but it just doesn’t materially move the important needle of valuations.

The pipeline of daily noise includes a lot of forecasts and commentary, of course, but there is also a steady supply of economic data talked about each day. Again, the daily economic data might explain some short-term price volatility, but it’s also rare when any single data point is truly that significant when it comes to changing valuations.

This doesn’t just apply to the stock market either. It also applies to fixed income, which is why there is such a fascination in the daily wiggles in interest rates when arguably the more significant risk – credit risk – isn’t talked about as much (because credit spreads and default rates don’t change as much).

Being a successful investor isn’t necessarily about collecting and processing a vast amount of information and responding to news flow each and every day. Instead, successful investing is typically about discipline and patience. It’s also about having thick skin, because instead of going with the herd, you might be fighting the herd!







 This material does not constitute any representation as to the suitability or appropriateness of any security, financial product or instrument.  There is no guarantee that investment in any program or strategy discussed herein will be profitable or will not incur loss.  This information is prepared for general information only.  It does not have regard to the specific investment objectives, financial situation, and the particular needs of any specific person who may receive this report.  Investors should seek financial advice regarding the appropriateness of investing in any security or investment strategy discussed or recommended in this report and should understand that statements regarding future prospects may not be realized.  Investors should note that security values may fluctuate and that each security’s price or value may rise or fall.  Accordingly, investors may receive back less than originally invested.  Past performance is not a guide to future performance.  Individual client accounts may vary.  Investing in any security involves certain non-diversifiable risks including, but not limited to, market risk, interest-rate risk, inflation risk, and event risk.  These risks are in addition to any specific, or diversifiable, risks associated with particular investment styles or strategies.
Value investing refers to investment in undervalued securities in an effort to achieve greater overall returns.  A security which is considered undervalued might never achieve the level of return projected by an investor.  As such, value investing is subject to liquidity risks in addition to the general business risk. Fixed Income is an investment style designed to return income on a periodic basis.  Generally, fixed income strategies invest in bonds, real estate, loans, and other types of debt instruments.  Diversifiable risks associated with fixed income investing include, but are not limited to, opportunity risk, credit risk, reinvestment risk, and call risk.