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Tough Times for Classic Value Investors

February 19th, 2013

by Laurence B. Siegel

Documenting the value underperformance since March 2009

Let’s home in visually on the crash and post-crash periods when value has underperformed growth. Figure 3 shows the benchmarks and managers from Figure 2 but with a starting date of February 28, 2009, when the market hit its lowest point (on a month-end basis) of the 21st century.

Figure 3

Cumulative Total Returns of Value Managers and Benchmark in Excess of S&P 500

March 2009-November 2012

In Figure 3, as well as in Figure 2, the S&P 500 return has been subtracted from all returns shown, so we are looking at relative, not absolute, performance. Starting in late 2010 or early 2011, just about all of the selected value managers had weak performance, relative to the Russell 1000 Value benchmark and to the S&P 500. Of the managers shown, Berkshire Hathaway had the worst performance, and the formerly high-flying Longleaf Partners had the best, but none of them were particularly impressive. Summary statistics of the returns in Figures 3 are shown in Table 1 below.

Table 1

Performance of Selected Value Managers from March 2009 (market bottom) to November 2012

Ticker

SGENX

TWEBX

FAIRX

LLPFX

WGRNX

LUK

BRK.A

WVALX

SP500

Full fund names:

First

Eagle

Global A

Tweedy

Browne

Value

Fairholme

Longleaf

Partners

Winter-

green

Investors

Leucadia

National

Corp

Berkshire

Hathaway

A

Weitz

Value

S&P 500

Index

Compound annual return

17.0%

18.0%

19.0%

23.8%

20.8%

12.3%

14.8%

22.5%

21.6%

Annual return in excess of S&P 500

-3.8%

-3.0%

-2.1%

1.8%

-0.7%

-7.7%

-5.6%

0.8%

Reasons for the difficulty

Let’s now examine the reasons why so many value managers fared poorly over the last several years.

Interviews with executives at two of the funds profiled in this study provided insights into that question. A recent (January 22) Advisor Perspectives issue featured an interview with Wally Weitz, the founder and manager of the highly respected Weitz Value Fund. It is ranked in the top 1% of its peer group by Morningstar and managed according to traditional value-oriented principles. Second, Southeastern Asset Management runs the legendary Longleaf Partners Fund, which nearly quadrupled its investors’ money between January 1997 and May 2007. Lee Harper, its head of client portfolio management, spoke on behalf of the firm.

With those interviews as background, here are four explanations for the value underperformance:

Mean reversion has been impeded

The Federal Reserve has kept both short- and long-term interest rates at historic lows for an extremely long period. This has a dual effect: the fixed-income markets have been artificially manipulated and investors have been given an incentive to move to riskier asset classes such as equities.

Consequently, one might argue that capital markets have not functioned in the traditional manner. Marginal companies, for example, have been able to avoid bankruptcy by securing inexpensive debt that would otherwise be unavailable. Corporate profit margins have been at historically high levels for much of the last couple of years. This impedes the reversion-to-the-mean process on which value investors rely.

On a broader scale, value investors are notorious for being agnostic about the effect of macroeconomic factors on their stock-specific analyses, as James Montier of GMO noted in a recent commentary. Indifference to the effects of non-traditional monetary policy may have blindsided value investors over the last several years.

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