On the comeback of value strategies

Among the risk-seeking factors, Sara focuses on value strategies and explains why this once downtrodden segment now may be worth considering.

At the beginning of the year, I outlined my predictions for smart beta strategies for 2017. My colleague Matt Tucker, iShares Head of Fixed Income Strategy, and I had a good chat about fixed income factors, one of the predictions, earlier this month. Today I’d like to take a deeper dive into another: The revival of risk-seeking factors, namely value.

Some background first

The rise of smart beta over the past several years has largely coincided with a low growth, defensive market environment. Investors sought after minimum volatility strategies for possible downside protection in times of crisis. But as the global economy improved and recessionary fears gave way to a more decidedly pro-growth, reflationary theme in markets last summer, many investors became less defensive. Securities with greater potential for capital appreciation, including value strategies—the most beaten down in past years—returned to favor. And for a good reason: value has tended to do well when market trends reverse (source: Ang, Andrew. Asset Management: A Systematic Approach to Factor Investing. Oxford University Press. 2014).

What is value?

Value investing is about finding bargains—companies with low prices relative to their peers. Over the long run, companies with low prices relative to fundamentals have tended to outperform the market (source: J. Lakonishok, A. Shleifer, R. Vishny. Contrarian Investment, Extrapolation, and Risk. Journal of Finance, 1994). This makes value an investment factor—a broad, historically rewarded driver of returns.

From an economic perspective, many value firms are in traditional businesses such as manufacturing, industrial production and financial services. These companies can’t easily change practices because they have specific business models, high levels of specialized equipment, or production processes that are not easily convertible for other purposes. While they have tended to lag in slow economic periods, they may capture the uplift more efficiently during times of booming economic growth.

Traditional value strategies have been around and practiced for decades, but not all value strategies are made alike. Careful examination into how value strategies are measured could yield vast differences in desired outcome.

Measurement matters: optimal value capture involves multiple metrics

A stock’s price alone is not a reliable measure of value. Rather, value strategies look at a company’s stock price relative to its intrinsic value, which takes into account one or more fundamental measures. Many investors focus on certain ratios, such as a company’s stock price relative to its book value, or stock price relative to expected earnings.

Individual valuation ratios have various limitations, however, so there are benefits to using more than one. It’s important to look at a company as a whole—its enterprise value. A company may appear cheap in relation to its outstanding stock, but it may be expensive when considering the debt it has taken on. Additionally, a company’s earnings may include short-term events that could reverse, or they may reflect temporary financial transactions compared to more permanent operational changes. Comparing a company’s enterprise value to its cash flow from operating activities can help us better understand the strength of a company’s operations relative to its outstanding stock and debt. A more robust and lasting measure of value uses all three valuation estimates: price-to-book ratio, forward-looking price-to-earnings ratio, and enterprise value-to-cash flow from operating activities.

A smart way to capture value with smart beta

Value exposures have long been part of well-balanced portfolios. However, as with every industry, principles of portfolio construction and asset management have evolved rapidly through technological advancement. We are seeing a new wave of low-cost, alternative benchmarks and beta exposures come to the fore. These strategies utilize many of the screening techniques of active managers, are rooted in decades of academic research, and may serve as even better proxies for the low-cost alternative to active management than traditional market cap weighted value benchmarks. So-called factor indexes (and the beta strategies that follow them), like the MSCI USA Enhanced Value Index and iShares Edge MSCI USA Value Factor ETF (VLUE), screen for securities using multiple metrics, and weight them not by market capitalization, but by their exposure to value price multiples. This allows for greater emphasis on valuation and therefore greater potential for exposure to “value” as a driver of returns.

Sara Shores is Global Head of Smart Beta for BlackRock and a regular contributor to The Blog.

Join BlackRock and industry thought leaders for our 2017 virtual conference, “Factors: The Next Era in Portfolio Construction,” on Tuesday, May 9th. 

Carefully consider the Funds’ investment objectives, risk factors, and charges and expenses before investing. This and other information can be found in the Funds’ prospectuses or, if available, the summary prospectuses which may be obtained by visiting www.iShares.com or www.blackrock.com. Read the prospectus carefully before investing.

Investing involves risk, including possible loss of principal.

This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of the date indicated and may change as subsequent conditions vary. The information and opinions contained in this post are derived from proprietary and nonproprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by BlackRock, its officers, employees or agents. This post may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any of these views will come to pass. Reliance upon information in this post is at the sole discretion of the reader.

The strategies discussed are strictly for illustrative and educational purposes and are not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. There is no guarantee that any strategies discussed will be effective.

This post contains general information only and does not take into account an individual’s financial circumstances. This information should not be relied upon as a primary basis for an investment decision. Rather, an assessment should be made as to whether the information is appropriate in individual circumstances and consideration should be given to talking to a financial advisor before making an investment decision.

Funds that concentrate investments in specific industries, sectors, markets or asset classes may underperform or be more volatile than other industries, sectors, markets or asset classes and than the general securities market.

There can be no assurance that performance will be enhanced or risk will be reduced for funds that seek to provide exposure to certain quantitative investment characteristics (“factors”). Exposure to such investment factors may detract from performance in some market environments, perhaps for extended periods. In such circumstances, a fund may seek to maintain exposure to the targeted investment factors and not adjust to target different factors, which could result in losses.

The iShares Funds are distributed by BlackRock Investments, LLC (together with its affiliates, “BlackRock”).

The iShares Funds are not sponsored, endorsed, issued, sold or promoted by MSCI Inc., nor does this company make any representation regarding the advisability of investing in the Funds. BlackRock is not affiliated with MSCI Inc.

©2017 BlackRock, Inc. All rights reserved. iSHARES and BLACKROCK are registered trademarks of BlackRock, Inc., or its subsidiaries in the United States and elsewhere. All other marks are the property of their respective owners.

RO-134368

Join the Conversation

Are you onboard with value? Are you onboard with value? Join in >