Got Value?

Value stocks have had higher long-term returns than growth stocks.  In the US market, going all the way back to 1926 through April 2022, the Fama/French US Value Index compounded at +12.8% per year compared to +9.9% for the Fama/French US Growth Index—almost a 3% annual difference.  The “value premium” has been significant, to put it mildly.

To make sure what we’re seeing isn’t an anomaly, we can review the data on international stocks going back to 1975.  Through April of 2022, the Fama/French International Value Index outperformed the Growth Index by 4.5% per year (+12.8% compared to +8.3% per year). Different countries, different time period, same result.

But not all investment funds have the same approach to targeting value stocks.  Traditional active managers look for just a handful of the most “mispriced” stocks with the greatest rebound potential.  As I’ve shared repeatedly, that approach doesn’t work.  The vast majority of active managers don’t beat their index—a collection of all of the stocks they’re choosing from, such as the S&P 500 Value Index or the Russell 2000 Value Index.  

The graphic below reports the results of all of the actively-managed stock and bond mutual funds that existed 20 years ago and their subsequent performance.  Only about 50% even survived, with the rest mostly being closed down due to bad performance.  Only 18% and 20% actually managed to outperform their index, four out of five funds underperformed. Those are lousy odds.

We don’t invest in traditional actively-managed value funds because they will likely deliver us lower long-term returns that we’re trying to avoid.

So value-oriented index funds are the most logical alternative to traditional active management.  But which ones?  Vanguard has index funds, Standard & Poors has their indexes, Russell has others.  And multiple fund families offer multiple indexes.  How to choose?

To decide, we should look under the hood of what the funds actually own and how they’re managed and ask some intelligent questions:

  • How deeply do they delve into the lowest-priced segment of the market?  If value outperforms growth over time, then the cheaper the stocks we buy, the better.  
  • How diversified are they?  Holding more stocks compared to less means a more reliable return and less extreme price swings.  
  • How do they handle other return factors that are well documented, like profitability?  All things being equal, we’d rather own value stocks with high or at least average profitability, not low or negative profitability.  

When you work through this exercise, you find that none of the traditional value index funds or fund families comes out ahead on any of the metrics.  Instead, it’s the structured asset class mutual funds and ETFs from Dimensional Fund Advisors that has the best approach.

DFA value funds hold approximately the cheapest 30% of stocks vs. 50% for indexes, at the same time they are as or more diversified than traditional value index funds, and they explicitly control for profitability while value index funds have yet to directly incorporate that as a factor.  And they are managed on a daily basis, using cash inflows/outflows to rebalance the portfolio, while traditional value indexes only “reconstitute” or update their portfolios annually or bi-annually.

All this is well and good, and most people believe due diligence counts for something when selecting funds.  But we also like to see results that correspond to our expectations.  What good is smart design if all you get is lower actual returns?

Unfortunately, for a few years starting in 2014, lower returns from Dimensional’s value funds is exactly what we saw.  Growth stocks shot up to astronomical heights led most notably by the FAANG stocks.  The greater value orientation of Dimensional’s value funds created a headwind, and they tended to underperform all of the traditional value index funds and ETFs from Vanguard, S&P and Russell.  I never thought the underperformance indicated there was something wrong with Dimensional; when you’re targeting a segment of the market more purely and consistently thatn others, and that area is struggling, you’d expect to do worse.

But in October of 2020, the cycle finally shifted, and value stocks have returned to prominence in a major way.  For example, the iShares Russell 1000 Growth Index has averaged just +8.2%/yr while the DFA US Large Value Fund has earned +25.1% annually.  The small cap iShares Russell 2000 Growth Index did even worse, averaging just +1.2% per year while the DFA US Small Value Fund averaged +42.3%.  Just to restate that to affirm it’s not a typo, in US small cap stocks we’ve seen a value premium of over 40% per year since October 2020!  

See why I was so adamant about not changing our allocation and chasing growth stocks in 2018, 2019, and early 2020?

But we also have to ask, how have Dimensional’s value funds performed compared to their value index counterparts?  I told countless clients in the lean years of 2018-2020 that when value returned to favor, we would likely be rewarded for staying disciplined with our highly engineered and expertly managed DFA funds, even if they carry expense ratios of 0.1% or 0.2% higher than traditional value index funds.  Was I right?

If we look at US large value stocks, my expectations have borne out.  The DFA US Large Value Fund has outperformed its closest value index fund counterparts by 2% to 4% per year.

What about in small cap stocks?  If the value premium has been bigger, wouldn’t we expect to see DFA’s focused value approach perform even better than it’s large cap companion?  Indeed we have.  The DFA US Small Value Fund outperformed Vanguard, S&P and Russell small value indexes by about 10% per year.

Also notice how the order of index returns is the mirror opposite of the large cap results?  What you’re seeing is that all of these traditional indexes are basically the same.  The only difference of importance is between indexing and strucutured asset class investing.

Finally, what about outside the US? Even though international stocks have underperformed US stocks, value has still trounced growth stocks since October 2020 as well.  The iShares EAFE Growth ETF is actually negative over this period, -0.0% versus +23.7% per year for the DFA International Value Fund.  

But how did DFA compare to value indexes and the Vanguard offering (actively managed)?  Again, the results are impressive.  The DFA International Value Fund beat it’s closest investable index fund, the EAFE Value ETF, by 9% a year, and the Vanguard fund by almost 12%.

Clearly, Dimensional’s superior approach to value investing isn’t constrained by geographical boundaries.

As we saw during the strong value market from 2000-2006, and then again from 2009-2013, Dimensional’s structured asset class approach to investing is squeezing more returns out of the market, which is why we use DFA funds and not the slightly cheaper value index funds from Vanguard or iShares.  

We can never predict how long the outperformance for value will last—these cycles are unpredictable and all we can say is the longer we maintain our tilts to lower-priced value stocks, the more likely it is that we will earn higher returns, returns that will be invaluable in funding our most cherished long-term goals.  

Being reminded again that we have the right asset allocations and that we’re using the best funds to implement our allocations should be another example of why it’s so important that we stay the course and not give up on or bail out of our portfolios in challenging times.  Discipline is the only assurance we have that we’ll earn the returns we deserve, and very likely, higher returns than other investors.


Past performance is not a guarantee of future results. Index and mutual fund performance includes reinvestment of dividends and other earnings but does not reflect the deduction of investment advisory fees or other expenses except where noted. This content is provided for informational purposes and should not to be construed as an offer, solicitation, recommendation or endorsement of any particular security, products, or services.