Looking for the value in value

As we’ve explored in other posts, factor investing is one of the key pillars of quantitative asset management. The idea is straightforward: identify common characteristics in stocks that have historically led to outperformance, then tilt the portfolio in that direction.

One of the most widely used characteristics is value — the tilt toward stocks that appear cheap based on traditional measures like price-to-earnings (P/E), price-to-book (P/B), or price-to-cashflow. These stocks look “inexpensive” on paper, and value investors hope they’ll revert to their intrinsic worth over time.

Value as a Foundational Factor

The reason value has become so foundational in quantitative investing is simple: it has worked. Historically, value-tilted portfolios have outperformed their market-cap weighted benchmarks, which is why value has been built into countless factor-based strategies.

This success also helped fuel the rise of smart beta — low-cost products that offer exposure to styles like value in a systematic, rules-based format. Today, value is everywhere in portfolios. But one thing hasn’t gone unnoticed: performance has been poor.

The Recent Struggles of Value

Over the last decade — and especially in years like 2020 — value’s underperformance has been glaring. As a result, many quantitative strategies, smart beta products, and factor-based models have struggled.

So what’s gone wrong?

The main issue, as we see it, is the idea of mean reversion — the belief that stocks which become cheap will eventually bounce back. This assumption may have held true in the 1960s, 70s, or 80s (when much of the early research on value originates), but it’s far less reliable today.

Don’t Count on Mean Reversion

The core problem is that many parts of the market that appear cheap are experiencing structural change. And when structural breaks happen, mean reversion is no longer a given.

Take the energy sector. Today it looks historically cheap. But unlike in the 1970s — when the world was entirely dependent on fossil fuels — we are now transitioning away from them. Technology is becoming more energy-efficient, and policy is shifting toward renewables. In that context, it’s not obvious that energy stocks will revert to their former highs.

Something similar is happening in the materials sector. As economies become more digital, they need fewer raw inputs — we’re simply using less "stuff." These trends are secular, not cyclical.

Yes, these sectors can still experience temporary bounces (such as post-COVID reopenings), but that’s different from the sustained outperformance value investing is supposed to deliver.

So What Should Investors Do?

1. Recognise that value’s historical success may not repeat. Mean reversion is no longer a reliable assumption in parts of the market affected by long-term structural change.

2. Watch out for sector biases. Value strategies often overweight sectors like energy, materials, or banks. If you're not careful, you're making a sector bet, not a style one.

3. Consider regional implications. Value-heavy sectors are overrepresented in regions like Europe and parts of Emerging Markets — which may lead to persistent underperformance.

4. Be cautious with smart beta. Many smart beta funds simply load up on cheap sectors without considering the reasons behind the valuation. This can do more harm than good.

5. Use value dynamically. If you do use value, make sure it’s part of a flexible process — one that can capture short-term rallies, while adjusting for long-term structural decline.

Our Take at Forward Lucy

We continue to use value in our investment process — but we do so selectively and dynamically. It’s one part of a broader factor toolkit, and we apply it when the environment supports it, not as a static pillar of the portfolio.

Just because something worked in the past doesn’t mean it always will. And in investing, recognising that shift is key.