The Evidence for a Value Tilt
As an investor, you are likely familiar with the concept of owning a balanced portfolio. However, one strategy that has been well-documented over time to outperform a perfectly balanced portfolio is a “value tilt.”
A value tilt approach to investing is a strategy that involves overweighting companies with a lower price-to-earnings (P/E) ratio than the overall market. The rationale behind this strategy is that these undervalued stocks have the potential to deliver higher returns in the long run as the market corrects its mispricing.
The evidence for a value tilt is compelling. For example, a study by Fama and French (1992) found that small-cap and value stocks outperformed the market over the long run. They found that value stocks had an average annual return premium of 2%-3% per year over the long run. Since 1926 value stocks have grown at 12.7% while growth has grown at 9.7% (Dimensional Fund Advisors, Squire Wealth).
While academics disagree over why this premium exists, the most compelling argument I have found helpful in understanding this is that investors have always favored growing companies over stable or even declining companies. Because of that, investors overprice growth companies and underprice value companies, creating a premium for investors willing to own less desirable companies.
While the value tilt theory is backed by evidence, the real world can be messy. For one, there have been long periods of time when this evidence has been tested. From 2010 until 2020, growth stocks outperformed value stocks by over 80%.
These periods of underperformance are a feature, not a bug. If there were never periods of underperformance, the premium would not exist in the first place.
However, going through something like that will test your conviction in a strategy. Who knows – maybe this premium won’t last forever. And even if it does, a retiree in the withdrawal phase may not be able to own it for a long enough period to see the trend reverse. For these reasons, if you are going to have a value tilt, I think a modest overweight that is rebalanced regularly makes more sense than going all in.
Happy Planning,
Alex
This blog post is not advice. Please read disclaimers.