BACKGROUND
LSV Asset Management runs a fund with the ticker LSVEX. This mutual fund has a minimum investment of $100,000 making it less accessible than an ETF that invests in similar things.
LSVEX invests in companies that meet certain criteria. For example, they invest in common stock shares with a market cap. greater than $1 billion at the time of purchase. Additionally, they look for securities that qualify as value stocks as measured by indicating fundamental ratios that also show signs of recent improvement.
Value stocks are often thought of as well established companies that have a higher payout ratio. This high payout ratio means they are putting less cash back into their businesses and as a result won’t grow as much. Lower growth means lower valuation which could be illustrated by a low PE ratio. If a company announces a stock buyback program it could prop up share prices, this is the kind of stocks LSVEX targets. Based on that criteria and more, an algorithm ranks stocks both in and out of the portfolio and determines what to buy and sell in regards to the portfolio.
INVESTMENT THEORY
Among the many ways people have historically thought about financial markets there are two common theories that have battled it out over the past two decades. The first being the efficient market hypothesis, this theory claims that stocks are accurately priced at any given time because they reflect all information known to investors. Eugene Fama, the mind behind this theory, works for Dimensional Fund Advisors (DFA). DFA, similar to LSV, also invests in value stocks due to their personal belief that value stocks are more risky and therefore provide higher returns.
LSV on the other hand believes in market behaviorism, which essentially means that the market is not efficient and can over react based on emotion. It sees value stocks as low risk because beaten-down stocks are underappreciated by irrational investors. On the other side of the spectrum, the price of some growth stocks like TSLA can be greatly influenced by emotion as opposed to actual quantitative reasoning.
THE NUMBERS
Looking at historical monthly pricing data during the period of March 2009 to September 2019 we get the following basic statistics in regards to the monthly returns of SPY and LSVEX. As we can see from the figure below, SPY has a higher average return while also having a lower standard deviation which gives it an overall better Sharpe ratio. When using adjusted close numbers which account for dividends we can see LSVEX catches up to SPY but it still remains subpar to the performance of the market (SPY).
CAPM & THREE-FACTOR MODEL
After regressing LSVEX against the market as provided by the Ken French data set, we get a beta of 1.13 and an alpha of -0.50. This shows that you would be better off just buying a fund that tracks the marker like SPY because it would have a lower beta and higher return.
A regression with the three-factors provided by Ken French reveal a slightly lower beta of 1.09 and a slightly improved but still negative alpha of -0.40. This indicates you’d be better off owning a fund that owns the market as described by these three factors.
SPLITTING THE SAMPLE PERIOD IN HALF
To better understand the trends LSVEX may exhibit, I broke the sample period in half and the regression results reveal something unsettling but widely known about a value stock fund’s performance during an expansion. In the CAPM regression from period 1 to period 2 the fund’s beta grows and its alpha underperforms the market by a larger margin. The three-factor model shows the same outcome.
During an economic expansion like the one that exists during the 2009-2019 period growth stocks tend to outperform value stocks. People give into the bull market and start to care less about the safe dividend a value stock usually pays. Instead, they want to maximize returns by investing in a company that is betting its own cash on its own growth. Take AMZN for example, from March 2009 to market close on 10/16/2019 its stock has grown from $69.96 to $1,777.43. The baffling returns growth stocks like this have provided over the most recent expansion gets investors to take money out of value stocks and dump it into growth stocks at an increasing rate to the extent that value stocks under-perform the market.
RECOMMENDATION
I recommend that in regard to the big picture of stock performance during differing economic conditions my clients adjust portfolios as the tides swing. During a recession value stocks won’t fall as much as growth stocks as investors fall back on the safety of their dividends but during an expansion like the one from 2009-2019, growth stock definitely seem to be where the more substantial profits and alpha lie. As far as investments in LSVEX, I recommend opting for a similar holding in the form of an ETF or just buying SPY instead.