The Brandes Institute is a subsidiary of value-investing firm Brandes Investment Partners and it publishes investment research in academic and professional journals as well as on its website. I have included a link to their research in the Value Investing Resources section to the right. It was long overdue.
In BI’s latest paper, “Equity Dispersion: Value Stocks Yet to be Rewarded” published in January 2011, the authors show that few active managers have been able to distinguish themselves lately because of high correlations among all stocks and low dispersion of return magnitudes.
Historically, periods of below-average return dispersion have not lasted long. However the current environment is the first period over the last 20 years marked by the simultaneous occurrence of high correlation and low return dispersion across managers, asset classes, and sectors.
While return dispersion is low, dispersion of valuations remains relatively wide by historical standards…Furthermore, there has been a strong relationship between valuation spreads and subsequent outperformance of value stocks (relative to glamour stocks).
In summary, valuation discrepancies across equities are not being recognized, creating a fertile environment for value-based stock pickers…
Translation: If you know a good, disciplined, value-focused portfolio manager, it is time to load up on your investment in their fund.
As the authors note, there has been a dramatic rise in passive investment management relative to active management in the last seventeen years. The pendulum has swung. Passive strategies are tied to indexes created by firms such as Standard and Poor’s and Russell in which stocks in the index are weighted by their market capitalization. So, if the prices rise for certain stocks in an index today, then their weights will rise, causing more buying of those same stocks tomorrow by passive managers. Those stocks will have momentum regardless of their fundamentals. The rise of passive investing–index fund investing–is leading to disparities in valuations just as they did in the late 1990s when Technology, Media, and Telecommunications companies grew to an unprecedented weight in the S&P 500 Index during the bubble.
I for one have been amazed at the influence that momentum strategies have had on stock prices lately. Companies like Netflix, Luluman Athletica, Open Table, and Mako Surgicals seem to rise every day solely because they rose the day before. OPEN trades at over 22-times sales, MAKO at 14.5, and LULU at 8.5; those are absurd valuations for companies with serious questions about where profitable growth is going to come from. But, trees do not grow to the sky. Glamour investors are all betting that they will be the first one out the door with all of their possessions when the wrecking ball hits the house. However, by definition, many glamour managers will be below average at exiting, and woe be to the investors in their funds. Are you feeling lucky?