Abstract
The value premium does not statistically exist in the benchmark opportunity set of stocks, as represented by market indexes, whether observed at the top level of index returns or within the constituency of at least one major index. These findings potentially offer a better explanation for why value managers do not systematically outperform growth managers, sometimes hypothesized because of decision error, costs and so on in earlier published work. Results also hint that prior research, which successfully observed a value premium in the constituency of the Russell 2000 index, may have been specific to the data. Finally, results point to a seasonal value premium when comparing the first quarter of each calendar year to the fourth quarter of the prior calendar year. Such seasonality is consistent with portfolio window dressing and may hint at a path for value managers to tactically capture the premium. Although selected value managers might be shown at times to successfully capture the premium, its absence in the benchmark opportunity set for these managers makes it quite unlikely that active value managers as a group will systematically outperform growth managers over time – with consequences for asset allocation strategies and performance benchmarks that are constructed as a function of risk.
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Notes
This literature largely began with Fama and French (1992, 1993) for US data, while favourable evidence for the presence of the value premium was extended internationally by Fama and French (1998). Although the source of the premium is debated, within the academic literature its presence appears robust. Indeed, some recent work, Fama and French (2011) and Israel and Moskowitz (2011), confirm the presence of the value premium, particularly in small stocks.
Similarly, Faff (2003) used style portfolios constructed by consultant firm Frank Russell and did not find a positive risk premium for the BE/ME factor in the Russell managed portfolios.
Data available from mba.tuck.dartmouth.edu/pahes/faculty/ken.french/data_library.html.
Extending this analysis and methodological approach to yet further indices will inevitably provide greater certainty in understanding whether such a premium exists in index data and remain an ongoing line of research.
Of course, this is notwithstanding the fact that other definitions are used in the academic literature and, indeed, considered below.
Scislaw and Evans (2004) find the S&P/BARRA style index series and those of similar construction to be poor statistical benchmarks for differentiating between styles. The index series was subsequently discontinued, replaced by the S&P/Citigroup equity style series.
The FF benchmark portfolio returns are offered separately on the Website of Kenneth French from the traditional 2 × 3 research portfolios formed from stocks that have been independently sorted on size and book-to-market. French states that ‘academics use the research factors when explaining the cross-section of returns with the three factor model’, which is not the goal of this research. The main difference between the two is that research portfolios rebalance annually at 30 June, whereas the benchmark portfolios rebalance at the end of each calendar quarter. The above quote is taken from the data library Website of Ken French.
Three-factor regression tests of the FF benchmark portfolios (not shown) indicate the explanatory power of the book-to-market effect seems to weaken in the period following January 1979. HML coefficients for the FF large-cap portfolios fall monotonically from 1.08 in the pre-1979 sub-period to 0.84 in the most recent sub-period, 1995–2006. T-statistics for the coefficients also fall commensurately but all coefficients remain strongly significant. HML coefficients for the FF small-cap portfolios remain fairly stable (0.89, 0.94, 0.94) over the three sub-periods.
Monthly HML results are similar to those in Table 3.
See a discussion about small-cap and large-cap premia in Fama and French (2006).
See, in addition, Phalippou (2008) for an analysis about the value premium and liquidity; Bogle and Malkiel (2006) for a criticism about fundamental indexing and style tilt strategies.
The sample period is unfortunately restricted by several conditions: first, the historical time series of S&P 500 and 600 index constituents are only identified in Compustat from 1994 to the present. Second, sales figures in Research Insight are only available for the 10 years beginning 1998. It is also worth noting that this time period has been a particularly turbulent one for the stock market, covering part of the dot.com bubble and crash, then the subsequent recovery and crash emanating from the onset of the liquidity crisis. This period has also seen numerous notable political events. Whether such events are specific to this sample and thus impact the results can only be determined in future replications of the approach taken here.
Results for tests of the S&P 1500 broad market index (not shown), July 1998–April 2008, are similar.
In 2 × 3 sorts on size and then either ME/BE, P/E or P/S, the annual median ME is observed for S&P 500 and S&P 600 index constituents to identify the size breakpoints. Stocks with negative ME/BE or P/E at month-end December of year t−1 are omitted from the breakpoint ranking, as well as all other stocks with no P/E, P/S or ME value.
A second methodological issue in Dhatt et al (1999) is the authors’ use of equal weights rather than market weights when testing portfolio returns ranked by fundamental characteristics. It is known that equal weights magnify the value premium. In addition, equal weights subject large market samples to considerable small-cap noise related to illiquidity, non-synchronous trading among other maladies. However, using equal weights in the small but relatively liquid universe of the Russell 2000 or S&P 600 index is not likely problematic for the above reason. The question of whether the superior returns observed by Dhatt et al for the Russell 2000 constituents are magnified as a function of the weighting scheme employed is not re-examined here, as no statistically significant value premium is observed in Table 4.
Results for tests of the S&P 1500 broad market index (not shown), July 1998–April 2008, are similar.
These indexes are examined because of the substantial length of their return back-history, with the exception of the S&P 600.
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Scislaw, K., McMillan, D. The search for an exploitable value premium in market indexes. J Asset Manag 13, 253–270 (2012). https://doi.org/10.1057/jam.2012.2
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DOI: https://doi.org/10.1057/jam.2012.2