You shouldn’t dive into value stocks just because they’ve gained a great deal so far this yeariStockphoto/Getty Images/iStockphoto
Norman Rothery is the value investor for Globe Investor's Strategy Lab. Follow his contributions here and view his model portfolio here.
Christmas came early for value investors who, after years of privation, can afford to be a little more generous this festive season.
The second half of 2016 was unusually good for traditional value investors who like to buy stocks at modest price-to-book-value ratios. Their portfolios enjoyed a particularly big bump after the U.S. election and, while the final tally might change a bit during the last few trading days of the year, value is poised to do very well.
You can track the value segment of the U.S. market with the iShares Russell 1000 Value (IWD-N) exchange-traded fund (ETF). The fund charges an annual fee of 0.20 per cent and follows a portfolio of roughly 700 large U.S. stocks with modest price-to-book-value ratios.
The value ETF gained an average of 5.7 per cent annually over the 10 years through to Dec. 22, 2016, according to Morningstar.com. As a result, it was a profitable but not particularly inspiring decade for the U.S. value index.
But the value ETF failed to keep up with the market as represented by the iShares Russell 1000 ETF (IWB-N), which aims to track the largest 1,000 stocks in the U.S. and charges a 0.15 per cent annual fee to do so. The market ETF gained 7.1 per cent annually over the last decade and handily beat the value ETF. (All of the performance figures are provided in U.S. dollar terms and quoted on an after-fee basis.)
The poor relative performance might have caused some value investors to add a little more rum to their eggnog over the years.
But, with just a few trading days to go, 2016 is shaping up to be a good one. The value ETF is currently sitting on gains of 18.2 per cent for the year. That's 5.2 percentage points more than the market ETF. With a bit of luck, the positive value trend will continue into the new year.
While I fully expect that patient value investors will be handsomely rewarded over the very long term, I have some reservations when it comes to encouraging others to take up the practice.
The problem is, investors have a bad habit of jumping from one investing style to another at the wrong time. Those who were in the markets in the late 1990s may have personally suffered from a bout of poor timing. The temptation to pile into the hot high-tech funds (and stocks) of the day was intense. Those who made the leap often saw a bit of upside prior to the peak and then a great deal of downside during the subsequent collapse.
Investors in value index funds are not immune to similar tendencies. For instance, the institutional version of the Vanguard Russell 1000 Value Index Fund (VRVIX) gained an average of 14.6 per cent annually over the five years to the end of November. But the fund's institutional investors gained an average of 12.9 per cent annually over the same period.
They underperformed because they didn't buy and hold the fund for the full period. Instead they moved money into – and out of – the fund at less than optimal times.
Nearly all investors, from the very large to the very small, run into similar timing problems. Generally speaking, most investors should try to diligently follow a proven strategy rather than flipping and flopping between different methods.
The key is to find an approach that fits your investing personality like a glove and then to stick with it. To do otherwise usually leads to disappointment.
That's why you shouldn't dive into value stocks just because they've gained a great deal so far this year. Instead, pick up a copy of money manager Benjamin Graham's book The Intelligent Investor. If it proves to be a revelation to you, then welcome to the value club. If it doesn't, there are plenty of other ways to make money in the market that might be more suitable for you. It's something to consider while sipping a cup of eggnog by the fire this year.
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