Andy Berkin Head of Research at Bridgeway bio image

Andrew Berkin, PhD

Christine Wang Portfolio Manager at Bridgeway bio image

Christine Wang, CFA, CPA

Tammira Philippe President, CEO, and Head of Strategic relationships at Bridgeway bio image

Tammira Philippe, CFA

Heard enough already about value’s underperformance and why the evidence suggests staying the course?  Just in case not, we will live our relational investing1 principle of stating where we stand and briefly summarize our research on value overall in the US market.  More importantly, we will move from Wall Street down a different street with a focus on US small-cap value for a discussion of One of These Is Not Like the Others2.

Overall US Value

Looking at the US stock market back to 19263, it’s pretty obvious to see that One of These (Columns) Is Not Like the Others. In general, over the entire period of history, the right most column with the deepest value exposure has had distinctly higher returns than others.

US Stock Market Since 7/1926 (Annualized, %), as of 9/30/2020

GrowthMid-GroMidMid-ValValue
Big9.979.5410.278.6510.44
Med-Big10.3810.7611.6112.3711.62
Medium9.2112.2812.2213.3712.66
Med-Sml7.5511.7712.4813.0614.29
Small2.626.6711.0413.8615.39

Source: Bridgeway, Ken French data library4, total US stocks formed into 25 portfolios based on size exposure defined by market capitalization and value exposure defined by price to book ratios.

For most value investors though, the past one, five, and 10 years has proven instead that One of These (Time Periods) is Not Like the Others. Notably, the results in the most recent decade are the opposite of the results back to 1926.

US Stock Market Last 10 Years (Annualized, %), as of 9/30/2020

GrowthMid-GroMidMid-ValValue
Big18.1113.4111.627.247.48
Med-Big16.6613.7310.297.986.45
Medium13.7214.069.3410.423.47
Med-Sml14.6013.039.786.766.86
Small7.9212.128.277.837.66

US Stock Market Last 5 yr (Annualized, %), as of 9/30/2020

GrowthMid-GroMidMid-ValValue
Big21.7513.319.722.704.94
Med-Big18.4812.989.170.361.80
Medium13.2111.146.577.09-1.52
Med-Sml15.8012.896.791.253.35
Small12.1911.607.843.494.20

US Stock Market 1 Year (%), as of 9/30/2020

GrowthMid-GroMidMid-ValValue
Big40.8313.57-2.01-20.60-16.12
Med-Big33.358.53-4.78-18.65-26.69
Medium22.6414.73-12.12-6.20-26.65
Med-Sml27.584.78-8.38-22.00-10.05
Small31.4930.962.44-15.21-8.49

Source: Bridgeway, Ken French data library4, total US stocks formed into 25 portfolios based on size exposure defined by market capitalization and value exposure defined by price to book ratios.

Based on the long-term evidence, the long and deep drawdown of value in the US is not surprising (though it’s still not fun). It has happened before with value, the overall stock market, and other factors.  While challenging to endure, underperformance provides confirming evidence of exposure to different sources of risk that investors should seek. Put another way, this underperformance is a manifestation of the “risk” portion of “risk premium” that ultimately has been rewarded; the higher historical returns of value are not a free lunch and require a strong stomach. 

On the positive side, historical evidence for value gives us optimism for the coming decade.  In the US, value5 has outperformed growth6 91% of the time over rolling 10-year periods going back to 1926.  Over those same periods, the US stock market7 has only outperformed the risk-free rate 86% of the time; thankfully, investors don’t typically question the benefits of staying the course with stocks over cash, and we believe the same holds for staying the course with value stocks.

We don’t know when value will recover, but when it does, history shows it has typically been strong.  Long-term evidence for the US shows that not only has using deeper value exposure and multiple measures produced higher returns when times are good, but also has helped in drawdowns and recovery.  For more on value overall, see Factoring in Bear Markets, Stress Test: How Factors Perform Before, During, and After Recessions, Value’s Defining Moment or Does Value Just Need Some Growth?, or email advisors@bridgeway.com.

A Deeper Look Into US Small Value

So, what about small-cap value in the US?  As with value in the market overall, the results for small-cap value over the last decade are starkly different than long-term results back to 1926. 

As the tables above and chart below shows for the period back to 1926, there has been a 2.33% annualized benefit in return for the very smallest and most value companies (15.39%) shown in the bottom row and last column of each table, compared to the next smallest and next deepest value companies (13.06%) shown in the fourth column and fourth row of each table for almost 95 years.  On the other hand, for the last 10 years, the benefit was only 0.90% annualized for the additional small value exposure even after including a 13.51% advantage in the last year. 

US Small Value Stocks, Annualized Returns as of 9/30/20

Source: Ken French data library and Bridgeway calculations. See disclosures for more information.

This concept is important to remember as we think about if One of These (Portfolios) Is Not Like the Others. The variation of returns reminds us that the level of capitalization and value exposure truly matters even among different small-cap value strategies. 

When a segment of the market does well, investors should expect the portfolio with the most exposure to the factors explaining the segment’s outperformance to have the highest return. And when a segment of the market does poorly, investors should expect that same portfolio with the most exposure to the factors will underperform.  

Performance across small-cap value portfolios can diverge significantly, particularly when the asset class is either doing significantly better or worse than the overall US market.  This has definitely been the case over the last decade.  Divergence is usually driven by meaningful differences in size of companies held, valuation of companies held, measures of value used, and differences in allocations across sectors like REITs and utilities. These performance differences rarely indicate that a portfolio is not efficiently delivering the expected returns. Instead, performance differences arise because of differences in portfolio design. A portfolio focused on the stocks with smaller size and deeper value will indeed not look like other small cap value portfolios lacking that depth of exposure.

Conclusion

So, as we sit in one of those periods that has not been like the others, what can investors do? We at Bridgeway focus on the intersection of what matters and what we can control and have discovered the power in the paradox that often the best thing for investors to do is “very little”

As leaders in relational investing, we suggest being guided by principles and staying invested in your outcome.  Diversification is a crucial concept for all investors, and for Bridgeway it includes not just the way we invest but also how we run our firm and the people we hire.  We do not make dramatic changes to our portfolios because we are in a pandemic, recession, bear market, or other challenging time, and we think all investors should avoid the temptation. These moves are potentially costly in terms of trading needed to implement those changes and the substantial risks of not getting that timing call exactly right.

For a PDF download of this thought piece, please use the following link:

https://bridgeway.com/wp-content/uploads/2020/11/Bridgeway-One-Is-Not-Like-The-Others-THOUGH-PIECE-1.pdf

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1Relational investing bridges the gap between results for investors and returns for humanity with a modern approach to asset management.  As a leader in relational investing, Bridgeway takes a statistical, evidence-based investment approach motivated by a passion for servant leadership and global impact which we accomplish by donating 50% of our firm profits to organizations making a positive impact for humanity. For more detail, please see https://bridgeway.com/perspectives/an-open-letter-on-relational-investing/

2If this reference is lost on you, at least one of the authors grew up on Sesame Street and fondly remembers the song “One of These Things”

3US stocks as defined by the Ken French Data library. See disclosures for more information.

4See disclosures for more information.  The portfolios shown in each row and column are the intersections of 5 portfolios formed on size (market capitalization) and 5 portfolios formed on the ratio of price/book as constructed in the Ken French data library. The size breakpoints for each year are the NYSE market capitalization quintiles at the end of June of each year shown in each row of the table. Big refers to the largest quintile in terms of market capitalization, Med-Big refers to the 2nd largest, Medium refers to the 3rd largest quintile, Med-Sml refers to the 4th largest quintile, and Small refers to the smallest quintile.  Price/book for June of each year is the market capitalization in December of the prior year divided by book value for the previous year’s fiscal year end. The breakpoints for each column are NYSE quintiles. Growth refers to the highest price/book quintile which have the least value exposure, Mid-Gro refers to the 2nd highest price/book quintile, Mid refers to the 3rd highest price/book quintile, Mid-Val refers to the 4th highest price/book quintile, and Value refers to the lowest quintile in terms of price/book which have the strongest value exposure.

5Using HML (high minus low) for value and growth and US stock market defined as Rm-Rf with the data and methodology from the Ken French data library. See disclosures for more information. Rm-Rf includes all New York Stock Exchange, NYSE American, and Nasdaq firms. HML for July of year t to June of t+1 includes all New York Stock Exchange, NYSE American, and Nasdaq stocks for which they have market equity data for December of t-1 and June of t, and (positive) book equity data for t-1.

6See Footnote 5

7See Footnote 5

 

DISCLOSURES
The opinions expressed here are exclusively those of Bridgeway Capital Management (“Bridgeway”). Information provided herein is educational in nature and for informational purposes only and should not be considered investment, legal, or tax advice.

Past performance is not indicative of future results.  All returns are gross of any fees and expenses an investor would pay.

Investing involves risk, including possible loss of principal. In addition, market turbulence and reduced liquidity in the markets may negatively affect many issuers, which could adversely affect the mutual funds. Value stocks as a group may be out of favor at times and underperform the overall equity market for long periods while the market concentrates on other types of stocks, such as “growth” stocks.

Diversification neither assures a profit nor guarantees against loss in a declining market.

Data sourced from the Ken French data library uses their definitions and methodology although Bridgeway has used our preferred terminology in some cases.  Price/book is Bridgeway’s preferred term which refers to the reciprocal of book equity to market equity data from the Ken French data library.  US portfolios include all New York Stock Exchange, NYSE American, and Nasdaq stocks for which they have market equity data for the prior December and June, and (positive) book equity data for the prior year.

Andy Berkin Head of Research at Bridgeway bio image

Andrew Berkin, PhD

Geoff Crumrine

Geoff Crumrine

Bear markets and recessions are not identical, but investor responses should be.  Staying the course with multi-factor diversification through bears and recessions is our suggested course of action based on a review of the evidence.  This thought capsule is a follow-on to our analysis of recessions and factor performance.

By Andrew L. Berkin, Ph.D., Head of Research, and Geoffrey G. Crumrine, Head of Client Service and Marketing

In the early spring of 2020, investors found themselves in a situation they hadn’t experienced for a decade: Confronting a bear market. Global stock markets tumbled in February and March over concerns about the economic impact of the coronavirus pandemic. The S&P 500 Index, which had reached a high on February 19, ultimately fell more than 33% from its peak until bottoming out on March 23—putting the index well into bear territory.

Subsequent economic stimulus efforts from the U.S. government helped improve investor sentiment and stocks began to recover over the following months. Those gains drove the S&P 500 back to a new record high in late August 2020, signaling the end of the bear market. Despite the apparent short duration of the latest bear, stocks remain volatile and many investors are still wary about the future. However, bull and bear market cycles are to be expected when pursuing a long-term investing strategy. Unfortunately, we can’t predict when bear markets will occur or how long they will last, and we can’t control the external factors that help dictate broad market movements. But we can examine historical data to understand how portfolios have performed during past bear markets.

Following up on our recent analysis of recessions and factor performance, we wanted to take a similar deep dive into the phenomenon of bear markets and the performance of the underlying factors that shape stock returns. Bridgeway’s previous research into past recessions uncovered data that emphasizes the fact that it’s risky to try to time both the economic cycle and the market’s performance. Individual factors don’t move in lockstep during recessions. It’s not surprising, then, that we observe similar patterns in the historical record for factor performance before, during and after bear markets. But just as recessions and bear markets are distinct events, factor performance isn’t identical during each.

A Broad Look at Bear Markets Throughout History

Markets typically are considered to be in bear territory when they have fallen by 20% from their highs. Since 1926 through February 2020, we’ve identified eight bear markets according to this 20% peak-to-trough decline convention (not including the most recent February-March downturn)1.

The chart below illustrates this history. The line shows the growth of $1 invested in the broad stock market, with red sections representing bear markets and blue sections representing bull markets. Overlaid on this graph, we’ve also plotted economic recessions, represented by grey bars.

Growth of $1

Sources: Ken French Data Library, NBER, and Bridgeway calculations

First, we note that one dollar invested in the stock market in July of 1926 would have grown to more than $7,500 by the start of 2020. Despite recessions and bear markets, many stocks have been an excellent investment over the long term. In fact, we could replace the word “despite” in the previous sentence with the phrase “because of.” Stocks are a risky investment, but this risk comes with the potential for the higher rates of return that reward investors.

Interestingly, we also see that bear markets and recessions often—but not always—overlap. Since 1926, the market experienced 15 recessions and 8 bear markets. Even when recessions and bear markets coincide, they don’t share exact start and end dates. And sometimes, we have recessions without bear markets or bear markets without recessions. One example is the 1987 bear market, which includes the October 19 market crash often referred to as Black Monday. Although a painful bear market, it did not have a corresponding recession attached.

What are Factors?

Factors are the specific characteristics of stocks and other securities that both drive their returns and explain their performance across different market conditions and business cycles. For further discussion, please see the book “Your Complete Guide to Factor-Based Investing” by Andrew L. Berkin and Larry E. Swedroe.

Factor Performance and Bear Markets

While the data above displays how the overall market has performed since 1926, we also analyzed how individual factors performed before, during, and after bear markets. Table #1, below, shows average factor returns for Fama-French factors and momentum relative to market environment.

Table #1: 8 Bear Markets Going Back to June 1926

Fama-French Plus Momentum Factors, Average Monthly Returns (%)

 Market premium (Mkt-RF)Small size (SMB)Value (HML)Momentum (MOM)Profitability (RMW)Conservative investments (CMA)
All Months0.670.190.350.660.260.27
Bull Markets1.270.270.290.520.140.12
Bear Markets-3.70-0.340.761.641.101.32
12M Pre Bear Mkt1.760.14-0.031.44-0.240.21
12M After Bear Mkt3.251.021.16-2.06-0.240.26

*Average returns through January 2020. Mkt-RF, SMB, and HML data starts in July 1926. Momentum data starts in January 1927, and profitability and investment factors data start in July 1963
Source: Ken French Data Library and Bridgeway calculations

As we see in the second row, all factors did well in the more prevalent bull market months, although the company financial health related metrics of RMW and CMA were weaker than typical. Row three shows that, as expected, the market factor (Mkt-RF) was strongly negative during bear markets but recovered especially well in the 12 months following. Stocks tend to rebound dramatically after a bear market. There is an old saying that no one rings a bell at the top or the bottom of the market. Timing the markets is difficult, and as the recovery from bear markets shows, missing out can be quite costly.

The performance of other factors is quite different depending on the period. Small stocks suffered during the risk-averse times of bear markets but performed strongly in the recovery. In contrast, value stocks held up quite well during bear markets. Noting that value is negative on average in the 12 months beforehand provides some insight into this behavior. The market environment before the onset of a bear is often characterized by exuberance, with growth-led rallies. However, value has come back into favor during the ensuing downturn and subsequent recovery. The aftermath of the late 1990’s technology bubble is a well-known example of this pattern.

Perhaps somewhat surprising is the behavior of momentum, which generally holds up quite well during bear markets but fails miserably afterwards. This pattern was first described by Cooper, Guillen and Hamid.2 When markets bounce back, those stocks that have lost the most often lead the recovery, and momentum suffers. (For more in-depth analysis, see the Bridgeway white paper “When and Why Does Momentum Work – and not Work?” by Andrew L. Berkin.)

When we compare these returns to our previous analysis of factor returns during recessions, we see many similarities—but also important differences. For example, factors related to company financial health (RMW and CMA) perform strongly in both recessions and bear markets, as investors favor higher quality companies in both environments. In fact, the returns for RMW and CMA are even stronger in bear markets than they are in recessions. However, the performance of these two factors diverges in the aftermath of the different events. The profitability factor RMW, which has stronger-than-average returns in the 12 months following recessions, is actually negative in the 12 months after bear markets.

Another difference is the relative effectiveness of the value factor during and after bear markets. Value’s returns are reduced (but still slightly positive) during recessions, and its outperformance in the 12-months following not quite as strong as the substantial turnaround we see following a bear market.

Critically, we see that factors don’t move in lockstep around these two distinct market and economic events. And in both cases, we see dramatic reversals in leading and lagging factors before, during and after both recessions and bear markets. As we said earlier, trying to time these shifts is difficult, which is why we emphasize the importance of maintaining diversification across multiple factors.

Case Study: Bear Market of 2000-2002

Moving down from the 30,000-foot view, let’s examine the bear market of 2000-2002. Previously, we analyzed the recession of 2001 to show that factor performance during that event did not line up with long-term historical averages. For this reason, we thought it would be interesting to look at a bear market that occurred around the same time.

The recession of 2001 started in March and lasted for 8 months, ending in October of the same year. In contrast, the bear market predated the recession (beginning in September 2000) and ran for 25 months (ending in September 2002). It was the second-longest bear market after the one that coincided with the Great Depression.

Table #2: Bear Market of Sept 2000-Sept 2002 (25 months)

Fama-French Plus Momentum Factors, Average Monthly Returns (%)

 Market premium (Mkt-RF)Small size (SMB)Value (HML)Momentum (MOM)Profitability (RMW)Conservative investments (CMA)
During Bear Market-2.510.732.401.513.001.97
12 M Pre Bear Mkt1.311.48-1.304.09-1.550.04
12 M Post Bear Mkt1.991.45-0.54-2.47-1.701.04

Source: Ken French Data Library and Bridgeway calculations

The data for the bear market of 2000-2002 offers a good example of the risks of attempting to time a bear market and tactically adjust factor exposure. While value’s positive performance on average during bear markets hasn’t been as strong as the returns for momentum, profitability, and conservative investments, the bear market of 2000-2002 saw value delivering substantial gains. Recall that growth stocks had been dominant in the tech bubble of the late 1990s and the first quarter of 2000. For the 12 months before this particular bear market, value lagged by an average of 1.30% monthly. The collapse of formerly high-flying growth stocks not only helped usher in the bear market and subsequent recession, but also set the stage for historically discounted and beaten down value stocks to recover strongly. Many investors who had abandoned value stocks during the run-up of tech stocks likely missed out on a substantial portion of value’s gains.

Key Takeaways

As noted earlier, we can’t predict whether a modest drop in stocks presages a dramatic slide into bear market territory. Likewise, we never know if a bounce from market lows will lead to a full recovery or is merely a temporary rally. Examining how factors have performed historically around bear markets is instructive, but also shouldn’t be taken as a prescription for portfolio changes. Remember, the factor returns shown in Table #1 are averages across multiple bear markets, and as we saw when examining the bear market of 2000-2002, they don’t hold every time.

For those reasons, investors should avoid making dramatic changes to their portfolios based on where they believe we are in the market cycle—just as we cautioned against making changes around recessions. Remember that factors have worked over long periods. They don’t always deliver positive returns, but when one is lagging others often provide a positive return cushion. What’s more, those lagging factors have rebounded in the past. For example, small size and value underperformed large growth in the run-up to the most recent bear market and continue to lag. But historical data showing that small size and value have recovered strongly after past bear markets gives us confidence that they will again — we just can’t predict when the turn will happen and how robust the recovery will be.

Considering this evidence, we believe building a well-diversified portfolio with exposure to multiple factors and rebalancing to return to those targets when a factor or asset class moves out of line with your chosen allocation target. That strategy may help investors avoid the costs associated with excessive trading and the substantial risk of missing out on gains by getting the timing wrong as the markets move through their inevitable cycle of bulls and bears.

1 As in our analysis of recessions and factor returns, we have not included the current recession or the 2020 bear market because we have not completed a full market cycle.

DISCLAIMER
The opinions expressed here are exclusively those of Bridgeway Capital Management (“Bridgeway”). Information provided herein is educational in nature and for informational purposes only and should not be considered investment, legal, or tax advice.

Mkt-RF or the equity risk premium is the expected excess return of the market portfolio beyond the risk-free rate. SMB or the size premium measures the additional return investors have historically received by investing in stocks of companies with relatively small market capitalization. HML or the value premium measures the additional return investors have historically received for investing in companies with high book-to-market values. MOM or the momentum premium measures the additional return investors have historically received for investing in companies with positive acceleration in stock price. RMW or the profitability measure is the difference between the returns of firms with robust (high) and weak (low) operating profitability. CMA or the investment factor is the difference between the returns of firms that invest conservatively and firms that invest aggressively.

Before investing you should carefully consider the Bridgeway mutual funds’ investment objectives, risks, charges and expenses. This and other information is in the prospectus, a copy of which may be obtained by calling 800-661-3550 or visiting the Funds’ website at bridgeway.com. Please read the prospectus carefully before you invest.

Past performance is not indicative of future results.

Investing involves risk, including possible loss of principal. In addition, market turbulence and reduced liquidity in the markets may negatively affect many issuers, which could adversely affect the mutual funds. Value stocks as a group may be out of favor at times and underperform the overall equity market for long periods while the market concentrates on other types of stocks, such as “growth” stocks. One may not invest directly in an index. Index returns are gross of trading and advisory fees and expenses.

Diversification neither assures a profit nor guarantees against loss in a declining market.

The Bridgeway mutual funds are distributed by Foreside Fund Services, LLC, which is not affiliated with Bridgeway Capital Management, Inc. or any other affiliate.

Tammira Philippe President, CEO, and Head of Strategic relationships at Bridgeway bio image

Tammira Philippe, CFA

We see the world differently at Bridgeway.  We are trailblazers in relational investing which bridges the gap between investment results and returns for humanity by taking an innovative approach to asset management.  It is a statistical, evidence-based investment approach motivated by a passion for servant leadership and global impact which we accomplish by donating 50% of our firm profits to organizations making a positive impact for humanity.  For decades now, our clients and partners have chosen us because we value independent thought and relationships, embrace a long-range mindset, and our profits directly benefit humanity.

We believe principles are the foundation of prosperity.  This belief pulses deeply through and beyond Bridgeway, in the work we do with our clients, our colleagues, and our community.

What is prosperity?  Prosperity is more than financial success.  Prosperity is the success we achieve when we follow principles and strive for our highest aspirations for ourselves and others.  It’s time to reclaim prosperity for all.

For clients, Bridgeway helps achieve prosperity through the discipline and conviction we have in investment principles that are enduring.  We build portfolios grounded in principles that are well researched, well developed and overall have withstood the test of time.  As our Head of Research, Dr. Andrew Berkin, explains in The Complete Guide to Factor-Based Investing, the factors we use in our portfolios must be persistent, pervasive, robust, investable, and intuitive.  These are some of the principles of relational investing that drive the portfolios we build for clients.

We draw upon our expertise in relational investing to analyze relationships in financial statements and market prices to understand how these relationships drive investment returns.  We then derive a set of principles and rules to govern how we systematically manage portfolios.  Principles and research give us conviction in our investment portfolios. Bridgeway is constantly investing in a methodical, intellectually disciplined way to continually confirm the relationships we’ve already tested. When new information is presented, we adapt and adjust. We have set up an environment and culture where questioning is the norm.  Our conviction has been tested over the last 25 years, and we are convinced that we can stick to those principles.  Moreover, principles govern how we think about decisions big and small at Bridgeway, asking “what is in the best long-term interest of our current clients?” to guide our actions.  We commit ourselves to the principles of stewardship in all that we do which we define as having the passion and discipline to care for an asset for the benefit of others.  Stewardship applies to the assets we manage for clients, the people at Bridgeway which our mission states are our greatest resource, the communities we serve, and beyond.

As colleagues at Bridgeway, we prosper as professionals by embracing and implementing leadership principles and a special culture that we’ve intentionally built since the first day we opened our doors in 1993.  Collectively, we are curious and purposeful servant leaders.  We strive for a different kind of commitment and relationship among colleagues, which is why we refer to all long-term staff members as Partners, and this is crucial to our leadership in relational investing. Elevated by our commitment to servant leadership, our principles guide difficult decisions and how our teams work.  We ask everyone at Bridgeway to find a place to lead and follow. Leaders ask “how can I serve?” first.  When there are team challenges, leaders ask “how am I contributing to the problem I don’t want?”.  We apply Robert Greenleaf’s Best Test to our actions asking “Do those served grow as persons?  Do they, while being served, become healthier, wiser, freer, more autonomous, more likely themselves to become servants? And, what is the effect on the least privileged in society? Will they benefit or at least not be further deprived?”  These are the principles at the foundation of prosperity and relationships with our colleagues at Bridgeway.

In communities, we invest in relationships with experts in the field to ensure that our contributions are making an impact and contributing to prosperity.  Shannon Sedgwick Davis, CEO of Bridgeway Foundation, highlights some of our heroes in her book To Stop A Warlord.  Moreover, in her article, The four strategies I used to help stop a warlord, Shannon highlights the principles at the foundation of prosperity in our work in communities including: 1) thoroughly dissect the goal or mission statement, 2) rethink the approach, start by listening, 3) ask what you’re willing to risk for what you believe in, and 4) step “out of bounds”.  Shannon says, “joining forces with diverse partners allows us to fill gaps and augment capabilities.”  Certainly, these principles are at the foundation of prosperity in communities and also with our clients and colleagues.

But it’s important to recognize principles must never become stagnant. They must be tended to, nurtured and present in our everyday lives in order to stay alive and effective. Principles also need to be challenged and tested.

How do we test our principles as an organization? We stay curious. We question and confirm everything we believe to be true, beginning with our investments.  Questioning principles is intrinsic to our organization.  Diversity of thought is celebrated, and we intentionally create our teams to foster that diversity. We stay open to criticism, and we wholeheartedly listen.

My heart is in this work.  Even as a little girl, I felt called to serve at my highest potential. Today, I feel fulfilled waking up every day knowing that I can take my deeply held principles and contribute to prosperity for our clients, our team and the world.  I am excited every day to lead a group of individuals positioned to help clients prosper, make a positive impact for humanity and, at the same time, to make our principles so prominent it changes our industry.

Wealth and other forms of success may be achieved, but prosperity can only be achieved through living and breathing our principles.  This is a cornerstone of the relational investing approach at Bridgeway designed to fulfill our extraordinary commitment to clients, colleagues, and community.  We are not at the end. We’re at the beginning. We are creating a new world of prosperity. Join us.

DISCLAIMER
Before investing you should carefully consider the Bridgeway mutual fund’s investment objectives, risks, charges and expenses. This and other information is in the prospectus, a copy of which may be obtained by calling 800-661-3550 or visiting the Fund’s website at bridgeway.com. Please read the prospectus carefully before you invest.

Investing involves risk, including possible loss of principal.

The Bridgeway mutual funds are distributed by Foreside Fund Services, LLC, which is not affiliated with Bridgeway Capital Management, Inc. or any other affiliate.

Andy Berkin Head of Research at Bridgeway bio image

Andrew Berkin, PhD

Geoff Crumrine

Geoff Crumrine

Examining factor returns from past recessions reinforces the importance of diversification and the dangers of market timing

It’s official. On June 8, 2020, the National Bureau of Economic Research (NBER) declared that the United States entered a recession in February of this year. Somewhat anomalously, on that same day the S&P 500 gained 1.21% to move back into positive territory for 2020. After falling roughly 33% from its high to usher in a bear market, the index rallied nearly 45% from its lows on March 23 through the date of NBER’s recession announcement.

So, while it is bad times for the economy, the stock market is regaining its former euphoria. It’s understandable if investors are wondering what this means for stocks going forward, and for the factors that shape their returns. While we can’t predict the future, we can examine how these factors have performed during past recessions—and what happened before and after those events.

Bridgeway’s research into past recessions uncovered data that reminds investors that it’s risky to try to time both the economic cycle and market’s performance. Individual factors don’t move in lockstep during recessions. Some, like momentum, hold up fairly well. Others, like small size and value, lag. However, our research on past recessions also shows that factor performance can turn around quickly, with small size and value enjoying strong returns in post-recessionary periods. We believe this encouraging evidence reinforces the importance of diversifying portfolios across factors and staying the course.

A Historical Look at Factor Returns and Recessions

What are Factors?

Factors are the specific characteristics of stocks and other securities that both drive their returns and explain their performance across different market conditions and business cycles.

Over the very long run, stocks and the economy are related. A better economy means better earnings and valuations for stocks. But the stock market is forward-looking. Investors don’t just wait for official confirmation of economic or company news, but rather act on what they expect to happen. How does this gap between economic performance and investor expectations play out in historic stock returns?

Chart 1 shows the average monthly returns for the Fama-French factors and momentum in a variety of economic environments. The data goes back to July 1926 and includes 15 recessions. The current recession is excluded as it has yet to run its full course.

15 past recessions going back to 1926

Fama-French Plus Momentum Factors, Average Monthly Returns (%)

Market premium (Mkt-RF)Small size (SMB)Value (HML)Momentum (MOM)Profitability (RMW)Conservative investments (CMA)
All Months0.670.190.350.660.260.27
Expansions1.020.290.390.670.240.19
Recessions-1.00-0.230.180.570.400.86
12M Pre Recession0.34-0.220.620.980.710.53
12M After Recession1.950.980.650.540.590.39

*Average returns through January 2020. Mkt-RF, SMB, and HML data starts in July 1926. Momentum data starts in January 1927, and profitability and investment factors data start in July 1963 Source: Ken French Data Library http://mba.tuck.dartmouth.edu/pages/faculty/ken.french/data_library.html

As we see in the chart’s top row, all factors have positive returns when invested over the long term. Performance differences first appear when we look at the next two rows, which assign these months into two categories: expansions and recessions1. During expansions, all factors are again nicely positive, and are statistically and economically significant. The story is somewhat different when we look at recessions: Both the market’s excess return and small size returns are now negative, and value returns are notably reduced.

These results are not surprising, given that the original Fama-French three factors, which built on the work of others, are often called “risk premiums.” While some have argued that these excess returns are due to behavioral considerations, there is ample evidence for both sides2. During the tough times of a recession are exactly when risk shows up. Investors flee from risky stocks—especially the riskiest beaten down names. Conversely, investors seek out quality companies with good financial health. This helps explain the better returns of the profitability and conservative investment factors, which are stronger than typical during recessions.

Given that we have entered a recession, should investors cut their equity allocation? Or should they move exclusively to larger stocks with good company financial health? The answer is no, not necessarily, because those moves present their own risks.

First, the results above are true on average, but do not happen every single time. Second, factor results depend not just on whether there is a recession, but also on the specific economic and market environment of each instance. What occurs before and after a recession matters, and timing can be crucial.

Timing Matters

Factor behavior can change dramatically during the run up to a recession and in the subsequent recovery. Unfortunately, we can’t know exactly when recessions will begin or end. Those dates are determined by NBER, often well after the fact and subject to subsequent revision.

We see evidence of these shifts in market behavior in the two rows of Chart 1 that give factor returns before and after recessions. There is no standard way to define these periods, so for consistency and convenience we have arbitrarily chosen 12 months3. Periods before a recession are often marked by euphoria: The Roaring 20’s, the tech bubble of the 1990’s, and the period before the recent Great Financial Crisis are well-known examples. Such an environment is particularly reflected in the strong returns for momentum, as stocks that have done well continue their positive run.

Periods following recessions are often filled with cautious optimism about an improving future and increased risk appetite. This is when the stock market—particularly small and value segments—typically put in their strongest performance, reversing their recession blues. Trying to time the market and factor performance runs the risk of missing out on these very substantial gains. It’s not just when you get out, but also when you get back in that matters.

One recent example is that when the impact of COVID-19 became clear, the market sold off rapidly. It then rebounded in anticipation that the unprecedented monetary and fiscal stimulus will moderate the economic damage. Investors who abandoned stocks in anticipation of a recession may well have captured the downside but missed the subsequent rally we have experienced.

Case Study: Recession of 2001

Diving deeper into our data, the recession of 2001 is an interesting example of the risks of attempting to time recessions and adjust factor exposure. We chose to highlight this period because the strong returns for small and value stocks in the 2001 recession is a cautionary tale for those tempted to take refuge in large growth stocks now. The chart below shows the same factors as before, but isolates the months before, during and after this event only.

Recession of 2001 (March – October, 8 months)

Fama-French Plus Momentum Factors, Average Monthly Returns (%)

Market premium (Mkt-RF)Small size (SMB)Value (HML)Momentum (MOM)Profitability (RMW)Conservative investments (CMA)
During Recession-1.991.150.682.122.041.06
12M Pre Recession-1.76-1.744.54-1.054.372.82
12M After Recession1.950.980.650.540.590.39

Source: Ken French Data Library http://mba.tuck.dartmouth.edu/pages/faculty/ken.french/data_library.html

While small size (SMB) and value (HML) have typically been negative or weak during a recession, both factors had strong returns in the recession of 2001. Large cap and growth stocks had dominated in the tech bubble that grew during the last two years of the 1990s and the first quarter of 2000. Their collapse not only helped usher in the subsequent recession, but also set the stage for historically cheap and beaten down small and value stocks to recover strongly. This outperformance continued after the recession ended. It’s also interesting to note that in the case of value, this reversal actually began before the official start of the recession, which would have provided an important cushion for portfolios that had maintained exposure to value during the tech bubble. That certainly did not happen for value investors before the current recession, but we still believe there is strong evidence that value’s performance will turn around in the future.

Key Takeaways

If timing recessions is hard and picking which factors would do well even harder still, what can investors do? We at Bridgeway go back to the importance of diversification. It is a crucial concept for all investors, and for Bridgeway it includes not just the way we invest but also how we run our firm and the people we hire. Bridgeway focuses on the three broad investment themes of value, company financial health, and momentum. Those stocks with the strongest factor exposures are often smaller, typically giving our portfolios a tilt to smaller size as well. As seen in the top row of Chart 1, all of these factors have worked over time. They usually don’t all work at the same time, and when one is lagging, others often do well.

Bridgeway therefore does not make dramatic changes to our portfolios because we are in a recession, and we think all investors should avoid the temptation. These moves are potentially costly in terms of trading needed to implement those changes and the substantial risks of not getting that timing call exactly right. Instead, we stick with our process and monitor our portfolios to ensure they maintain their targeted allocations to diversifying exposures. The run up to the current recession saw smaller and deeper value stocks lag by historic amounts. If history is a guide, we expect the fortunes of these factors to reverse as the current market cycle runs its course. We don’t know when that turning point will come, but when it does, we believe that investors who’ve maintained a diversified portfolio with broad factor exposure will be rewarded for their discipline.

1 Recessions are defined by NBER. About 18% of the full period months and 12% of the months since July 1963 are in recessions. The remaining months are not in recessions.

2 For a broader discussion of this issue and factor investing generally, see the book “Your Complete Guide to Factor-Based Investing” by Andrew L. Berkin and Larry E. Swedroe.

3 In two instances recessions were less than 24 months apart, so some months were within 12 months of both the prior and next recessions. To give each month a unique classification, we simply divided the intervening time period in half. The before and after recession periods in those cases had less than 12 months.

DISCLAIMER
The opinions expressed here are exclusively those of Bridgeway Capital Management (“Bridgeway”). Information provided herein is educational in nature and for informational purposes only and should not be considered investment, legal, or tax advice.

Mkt-RF or the equity risk premium is the expected excess return of the market portfolio beyond the risk-free rate. SMB or the size premium measures the additional return investors have historically received by investing in stocks of companies with relatively small market capitalization. HML or the value premium measures the additional return investors have historically received for investing in companies with high book-to-market values. MOM or the momentum premium measures the additional return investors have historically received for investing in companies with positive acceleration in stock price. RMW or the profitability measure is the difference between the returns of firms with robust (high) and weak (low) operating profitability. CMA or the investment factor is the difference between the returns of firms that invest conservatively and firms that invest aggressively.

Before investing you should carefully consider the Bridgeway mutual funds’ investment objectives, risks, charges and expenses. This and other information is in the prospectus, a copy of which may be obtained by calling 1-800-661-3550 or visiting the Funds’ website at www.bridgeway.com. Please read the prospectus carefully before you invest.

Investing involves risk, including possible loss of principal. In addition, market turbulence and reduced liquidity in the markets may negatively affect many issuers, which could adversely affect the mutual funds. Value stocks as a group may be out of favor at times and underperform the overall equity market for long periods while the market concentrates on other types of stocks, such as “growth” stocks.

Diversification neither assures a profit nor guarantees against loss in a declining market.

The Bridgeway mutual funds are distributed by Foreside Fund Services, LLC, which is not affiliated with Bridgeway Capital Management, Inc. or any other affiliate.

The killing of George Floyd, Ahmaud Arbery, Breonna Taylor, and too many other Black people due to systemic racism and abuse of power in our country is wrong. Black Lives Matter. We cannot turn a blind eye to injustice or be patient with change. We stand in solidarity with the peaceful protesters on the streets of America and around the world demanding justice and reform. But words are never enough.

Bridgeway Capital Management remains steadfast in our longstanding commitment to peace, justice, and compassion. We commit 50% of our profits toward the prevention of oppression, genocide, and human rights violations around the world. Through the Bridgeway Foundation, we have been honored to support organizations leading these efforts in the US, such as the Equal Justice Initiative and the Center for the Healing of Racism.

We can and must do better. In this moment, Bridgeway is committed to deep listening, learning, reflecting, and acting to increase our support for organizations working to end systemic racism in America. We are united in the pursuit of a world free from fear, violence, and the abuse of power, for however long it takes.

Andy Berkin Head of Research at Bridgeway bio image

Andrew Berkin, PhD

Value stocks have been lagging their growth counterparts for some time now, and that difference has only widened. Through the 12 months ending March 31, 2020, the Russell 1000 Value Index (-17.17%) underperformed the Russell 1000 Growth Index (+0.91%) by 18.1%; in small cap stocks the gap was 11.1%.1 Over the past 10 years, that underperformance was 5.3% on an annualized basis in the large cap space (Russell 1000 Value Index minus Russell 1000 Growth Index) and 4.1% on an annualized basis with small caps (Russell 2000 Value Index minus Russell 2000 Growth Index). Some recent articles in the popular press proclaim that value investing may never recover its former long-term advantage, causing investors to wonder if they should shun value-oriented strategies.

There is a natural human tendency to abandon something that has not been working recently. In some situations, this may be the correct move. For example, children learn to be careful with fire after having been burned. Unfortunately, in investing there is evidence that such moves may be largely unsuccessful2, understanding that each individual investor’s suitability is very personal. As every piece of marketing material states, past performance is no guarantee of future results. That holds on the downside as well as the upside. So before abandoning any strategy, it is important to understand what is going on to drive that performance.

We at Bridgeway are firm believers in value. It is an integral part of our investment process. And despite its recent setbacks, we will continue to use it. Why? In my book with Larry Swedroe, “Your Complete Guide to Factor-Based Investing”, we look for a factor to be persistent, pervasive, robust, investable and intuitive. We found that the value factor meets those criteria for our portfolio construction process, and still find that to be the case today.

But wait, you may say, what about persistence? After all, value has been lagging for a while now. But we at Bridgeway are long-term investors, and it is important to take a long-term view on this issue. Consider the chart below, which shows the historical performance of various factors over different time horizons. All data is from Ken French’s data library3 for the longest history available. This data goes back to the 1920s for the market premium (Mkt-RF), small size (SMB), value (HML) and momentum (Mom). To interpret the data in the table below, each number represents the percentage of time each factor has outperformed for any given time period using monthly returns. For example, over any given one-year period since the inception of the data, the value (HML) factor has outperformed 61% of the time. The data presented shows all factors that have data available for the full duration beginning in July 1926 except for Momentum, which begins in January 1927. Growth is not an available factor in the Ken French data library, and therefore is not offered in the following table as a counterbalance to value. All data ends March 2020.

Percentage of Time of Outperformance for Various Factors as of 3/31/2020:

Market
(Mkt-RF)
Size
(SMB)
Value
(HML)
Momentum
(Mom)
1 Year 70% 54% 61% 78%
3 Years 78% 54% 72% 85%
5 Years 78% 59% 80% 82%
10 Years 85% 70% 92% 79%
20 Years 100% 84% 100% 97%

Source: Ken French Data Library http://mba.tuck.dartmouth.edu/pages/faculty/ken.french/data_library.html

A few things stand out. Over the long term, all of the factors have a positive chance of outperformance no matter the horizon. And as that time horizon lengthens, the percentage of time the factor outperforms tends to improve. But even over 10 years, every factor has had periods when it lagged. In fact, value has had the best track record of success over 10 years, even surpassing that of the stock market beating riskless T-bills. So the underperformance of value today is not unexpected, nor out of line with any other factor. And while some factors have never lagged over 20 years, that doesn’t mean it couldn’t happen in the future.

What might cause value to lag growth? A common saying among investment practitioners is that when growth is scarce, growth stocks will do well. While at first glance this statement may seem paradoxical, it is really just supply and demand. However, quantifying what is meant by growth is not necessarily so easy.

The approach I use below is an analysis by William Bernstein from the early 2000s4, which was the last time value underperformed growth over a 10-year period in the wake of the late 1990s Tech bubble. I have updated the analysis with more recent data to include the latest decade of underperformance of value. In this approach, Bernstein examined the relationship between value and inflation. The relationship is noisy on a monthly basis, but becomes clearer at annual horizons and is even more impressive when examined by decade.

Chart showing Value(HML) versus Inflation

Source: Ken French data library, Federal Reserve Bank of St. Louis,
7/1926-12/2019 (most recent decade data available)

Historically, as inflation increases, value typically does better. In the world of equity investing, this is remarkably close to a straight line. The reason it is not perfectly straight is because inflation is not a perfect proxy for investors’ estimations of growth and other variables also influence value’s performance. On the first point, inflation and economic growth are certainly closely (although not perfectly) related. Greater growth in the economy ratchets up demand and increases inflationary pressures; the opposite happens with slow economic growth. What have we seen in the past ten years? Slow growth and low inflation coming out of the Great Financial Crisis, with the accompanying poor performance of value stocks.

This analysis is explanatory, rather than predictive. We know now what inflation was over the past decade. What about the next ten years? We can find reasons to be hopeful that economic growth will pick up. With the Fed having just cut interest rates and the government running annual deficits over a trillion dollars, extraordinary monetary and fiscal policy is trying to stimulate the economy. Given near zero interest rates and the recent stimulus package, strong growth could follow. But the real answer is that I don’t know what inflation will be over the next decade. And neither does anyone else. As Yogi Berra said, “It’s tough to make predictions, especially about the future.”

The second reason inflation doesn’t perfectly align with value is that other effects also determine how value stocks perform as a whole. Such effects include investors overpaying for growth stocks such that their value counterparts lag. Research by Bridgeway5 has shown that when factors like size and value lag the most, they do eventually rebound with very strong returns. Additionally, such underperformance tends to make these factors relatively cheap, which also leads to subsequent strong long-term returns. We cannot say when such a reversal will start and, as with all of this research, the effects of market disruptions such as the current COVID-19 pandemic is not yet fully known. But history tells us that such reversals have been very strong indeed for the factors such as value that we believe in and utilize. So, perhaps what value needs is some (economic) growth? Time will tell.

1 The gap between small cap growth and small cap value is represented by the return of the Russell 2000 Growth Index minus the return of the Russell 2000 Value Index.

2 See for example, “Absence of Value”, by Scott D. Stewart et al, Financial Analysts Journal 65(6), 34 – 51 (2009).

3 https://mba.tuck.dartmouth.edu/pages/faculty/ken.french/data_library.html

4 http://www.efficientfrontier.com/ef/701/value.htm

5 Contact us for more insights into our research in the value and size factors.

DISCLAIMER
The opinions expressed here are exclusively those of Bridgeway Capital Management (“Bridgeway”). Information provided herein is educational in nature and for informational purposes only and should not be considered investment, legal, or tax advice.

The Russell 1000 Growth Index measures the performance of the large-cap growth segment of the U.S. equity universe. It includes those Russell 1000 companies with higher price-to-book ratios and higher forecasted growth values. The Russell 1000 Growth Index is constructed to provide a comprehensive and unbiased barometer for the large-cap growth segment. The Index is completely reconstituted annually to ensure new and growing equities are included and that the represented companies continue to reflect growth characteristics.

The Russell 1000 Value Index measures the performance of the large-cap value segment of the U.S. equity universe. It includes those Russell 1000 companies with lower price-to-book ratios and lower expected growth values. The Russell 1000 Value Index is constructed to provide a comprehensive and unbiased barometer for the large-cap value segment. The Index is completely reconstituted annually to ensure new and growing equities are included and that the represented companies continue to reflect value characteristics.

The Russell 2000 Growth Index measures the performance of the small-cap growth segment of the U.S. equity universe. It includes those Russell 2000 companies with higher price-to-book ratios and higher forecasted growth values. The Russell 2000 Growth Index is constructed to provide a comprehensive and unbiased barometer for the small-cap growth segment. The Index is completely reconstituted annually to ensure new and growing equities are included and that the represented companies continue to reflect growth characteristics.

The Russell 2000 Value Index measures the performance of the small-cap value segment of the U.S. equity universe. It includes those Russell 2000 companies with lower price-to-book ratios and lower expected growth values. The Russell 2000 Value Index is constructed to provide a comprehensive and unbiased barometer for the small-cap value segment. The Index is completely reconstituted annually to ensure new and growing equities are included and that the represented companies continue to reflect value characteristics.

It is not possible to invest directly in an index.

Mkt-RF or the equity risk premium is the expected excess return of the market portfolio beyond the risk-free rate. SMB or the size premium measures the additional return investors have historically received by investing in stocks of companies with relatively small market capitalization. HML or the value premium measures the additional return investors have historically received for investing in companies with high book-to-market values. Mom or the momentum premium measures the additional return investors have historically received for investing in companies with positive acceleration in stock price.

Before investing you should carefully consider the Bridgeway mutual funds’ investment objectives, risks, charges and expenses. This and other information is in the prospectus, a copy of which may be obtained by calling 1-800-661-3550 or visiting the Funds’ website at www.bridgeway.com. Please read the prospectus carefully before you invest.

Investing involves risk, including possible loss of principal. In addition, market turbulence and reduced liquidity in the markets may negatively affect many issuers, which could adversely affect the mutual funds. Value stocks as a group may be out of favor at times and underperform the overall equity market for long periods while the market concentrates on other types of stocks, such as “growth” stocks.

The Bridgeway mutual funds are distributed by Foreside Fund Services, LLC, which is not affiliated with Bridgeway Capital Management, Inc. or any other affiliate.

Andy Berkin Head of Research at Bridgeway bio image

Andrew Berkin, PhD

Cindy Griffin Director of Institutional Relations at Bridgeway bio image

Cindy Griffin, CIPM

One of the important concepts underpinning Bridgeway’s investment philosophy is that strong factor exposure and diversification improve portfolios. When we talk about diversification, we mean not just across differing factors, but diversification also within the factor itself. Bridgeway’s more than two decades of research has shown us that factor definitions matter. But with the past decade of underperformance of the value factor, how much have different definitions mattered? Below, we look at the historical evidence for investing in the value factor and why different factor definitions have mattered less in the most recent period, one of value’s defining moments in history.

The past decade has not been kind to value investors. From 2010 through 2019, value stocks lagged growth stocks by an average of 2.61% a year.1 Such returns are in contrast to history, where value has outperformed growth 93% of the time over rolling 10-year periods going back to 1926. As of March 31, 2020, the market remained in the other 7% of the time where growth beats value. For investors who believe in value, it does not feel good. However, this underperformance is not unprecedented nor should it be a surprise. In response to this rare period, academics and ardent value investors have been taking deep dives into the factor itself and this has led many to question whether value is being measured correctly.

There are a number of different ways to measure value, and each metric has a number of variations. Each of these metrics captures a different aspect of value. As firm believers in the power of diversification to help strengthen portfolios, we believe that diversification extends to using multiple ways to measure value. We also believe the details in the definitions of these metrics can matter as well. But in the recent environment, such differences in definitions did not overcome the difficulties that value has faced, as we will see below.

A value metric typically compares two parts: a measure of what the market will pay, such as current share price, and a measure of worth, such as earnings per share. Dividing them gives the price-to-earnings or P/E ratio. By this measure, a value stock typically offers a higher amount of earnings for a lower price. Price-to-book is another value measure commonly used by both practitioners and academics that uses the book value of assets to measure worth. For both metrics, when the price goes lower, the stock becomes deeper value or cheaper. Thus, value investing often involves buying stocks that have been beaten down for some reason. That reason may vary from stock to stock, but whatever the cause, it acts as the risk element in a risk premium that ultimately could be rewarded.

However, there is another proxy for value that does not involve a measure of worth: long-term reversals. The first thing to understand about long-term reversals is the concept that stock returns tend to continue in the same direction over intermediate horizons such as one-year, giving rise to the momentum factor. With long-term reversals, looking back over longer periods, such as five years, we see that returns tend to revert. Past losers go on to outperform while past winners subsequently lag. Long-term reversals tend to be a good proxy for value because just as with measures that incorporate metrics of worth such as price-to-book, both share the feature of a beaten down stock price, which has made the stock cheap.

The chart below shows the long-term performance for price-to-book and long-term reversals for ten-year rolling periods. For each metric, we plot the excess returns of the top 30% of value stocks relative to the bottom 30%. As can be seen, the two sets of historical returns tend to resemble each other. Long-term reversals are indeed a reasonable proxy for value. The chart provides a few key take-aways to emphasize.

First, both sets of lines are typically above zero, indicating a positive excess return for that measure. Value tends to work! But sometimes the performance dips into negative territory. As noted earlier, value does sometimes lag even over ten-year horizons, and we are currently experiencing one of those times. But value has always recovered, and that recovery historically has been sudden and strong. A recent example of this occurred in the aftermath of the internet bubble, when price-to-book value’s 10-year returns went from lagging growth by 1.75% annually in early 2000 to beating it by 6.79% annually at the end of 2001.

Chart showing Value Measures Rolling Annualized 10-Year Returns

Source: Ken French Data Library

Next, the line for price-to-book is typically above that of long-term reversals. As we see, on average, including a measure of worth with a price-based measure helps to give a better value metric. This is true of other measures of worth as well, such as those based on earnings and cash flow. In keeping with Bridgeway’s strong belief in diversification, we use a combination of various measures to get exposure to the value factor.2

Finally, the right side of the plot shows that it has not been a pretty decade for value. Some have argued that the problems with value are because of how it is measured and have suggested various refinements. But in recent years, despite long-term reversals not having a worth component, the performance of value stocks as measured by price-to-book or long-term reversals looks quite similar. We see the same behavior using other worth measures besides book value.3 What this implies is that value’s recent underperformance is less about how that worth aspect is measured. Instead, it is the price aspect. What has been beaten down and become cheap has not bounced back as it historically has, but instead has continued to be beaten down further and become even cheaper.

As noted earlier, we at Bridgeway believe that how a financial metric is measured does matter, as does how it is combined and put into use. For value, these differences have mattered less of late, but using decades of data as our guide, we remain confident for the future. This underperformance of value has happened before; it is part of the “risk” aspect of risk premium that ultimately has been rewarded over time. And while value has lagged, it has become even cheaper, reaching valuation spreads that are historically large relative to the rest of the market and creating attractive opportunities as such extreme cheapness has ultimately been highly rewarded in the past. If history were to repeat itself, the underperformance of value today puts the odds in favor for stronger performance in the future. However, keep in mind with all of this research, the market volatility associated with the COVID-19 pandemic is not yet fully known.

Key Takeaways

  • The long and deep drawdown of value is not surprising; it has happened before with both value and other factors, although the current volatility is fairly uncommon.
  • Historical evidence for value gives us optimism for the coming decade.
  • Differing definitions of value have mattered less in the most recent period as a lot of what was cheap has become cheaper regardless of value measure.
  • Current valuations are creating attractive opportunities for potential future outperformance.

1 All data referenced is from the Kenneth R. French Data Library.

2 Contact us for more insights into the potential benefits of diversification of value measures.

3 Not shown for brevity.

DISCLAIMER
The opinions expressed here are exclusively those of Bridgeway Capital Management (“Bridgeway”). Information provided herein is educational in nature and for informational purposes only and should not be considered investment, legal, or tax advice.

The Russell 1000 Growth Index measures the performance of the large-cap growth segment of the U.S. equity universe. It includes those Russell 1000 companies with higher price-to-book ratios and higher forecasted growth values. The Russell 1000 Growth Index is constructed to provide a comprehensive and unbiased barometer for the large-cap growth segment. The Index is completely reconstituted annually to ensure new and growing equities are included and that the represented companies continue to reflect growth characteristics.

The Russell 1000 Value Index measures the performance of the large-cap value segment of the U.S. equity universe. It includes those Russell 1000 companies with lower price-to-book ratios and lower expected growth values. The Russell 1000 Value Index is constructed to provide a comprehensive and unbiased barometer for the large-cap value segment. The Index is completely reconstituted annually to ensure new and growing equities are included and that the represented companies continue to reflect value characteristics. It is not possible to invest directly in an index.

Before investing you should carefully consider the Bridgeway mutual fund’s investment objectives, risks, charges and expenses. This and other information is in the prospectus, a copy of which may be obtained by calling 1-800-661-3550 or visiting the Fund’s website at www.bridgeway.com. Please read the prospectus carefully before you invest.

Investing involves risk, including possible loss of principal. Diversification neither assures a profit nor guarantees against loss in a declining market.

The Bridgeway mutual funds are distributed by Foreside Fund Services, LLC, which is not affiliated with Bridgeway Capital Management, Inc. or any other affiliate.

The fear and uncertainty around the coronavirus — and its impact on our families, fellow citizens, the economy, and the markets — can make it hard to find assurance in many things. One assurance that Bridgeway can offer is that our commitment to our clients, colleagues, and community is unwavering. Bridgeway’s primary expertise and service to clients is our approach to statistically driven, evidence-based investing, so the focus of this note is to share our perspective on the markets and investing during this time.

Let’s review some of what we know and don’t know at this point, and how Bridgeway is responding.

Some things we know

Sometimes, fear of risk helps us do the right thing. Sometimes it fails us miserably. Fear of the coronavirus can help us follow guidance from the CDC and other experts. Fear surrounding market downturns and turbulence can lead us astray.

The best equity investors think in decades, not days. Time is our friend.

However, markets incorporate new information with extreme efficiency. For some, it seems the markets overreact and then adjust. We see this occurring when markets decline significantly, as they have recently, and when they rise dramatically, as they did just a few months ago in December 2019. Even though down markets are hard to experience as human beings, investors can look at them as evidence that markets are processing information and uncertainty and performing as designed.

Disciplined investors who stay the course during market swings have been rewarded in the past. Based on historical evidence, we expect them to be rewarded again. Using Ken French’s data, looking at the worst 8 drawdowns since 1926 as presented in chart one below, the forward returns from trough were higher for larger drawdowns as expected, and the biggest bounce back has been in the first year. In fact, the bigger the drawdown, the more of the bounce back that happened in the first year. Thus, it is highly risky to try to time getting out of the market and then back in before the bounce back. Investors who hang on are typically rewarded, and those who sell miss out.

Chart showing Bounce Back Years Following Bear Markets of More Than 20%

Source: Ken French monthly data, Bridgeway
*Based on the eight 20%-plus bear markets since 1926. Click here for underlying data.

This is an especially challenging environment for value investors. Value continues to lag growth, and it has gotten worse during the recent dramatic down market. This performance gap has caused many portfolios to underperform, including Bridgeway’s, since our portfolios typically have stronger value exposure than their primary market benchmarks.

Yet this is where Bridgeway’s investment process helps a great deal, as we rely on evidence and not emotions for actions. The evidence found in historical data shows that the value premium has been remarkably pervasive and consistent. In 10-year rolling periods since 1926, the value factor outperformed 93% of the time based on Bridgeway analysis of the Ken French data library. We are currently in one of those 7% periods when value has not provided a return premium. However, history strongly suggests that these periods don’t last and that they eventually turn around.

Historical data also tells us about the magnitude of value’s previous bounce backs. The value factor as measured by the Russell 1000 value and growth universes is currently in the cheapest 10% of its history, going back 40 years to 1980. After prior periods of such extreme cheapness, the Russell 1000 Value Index outperformed the Russell 1000 Growth Index by an average of roughly five percentage points per year over the next 5 and 10 years. By carefully rebalancing portfolios to maintain value exposure, investors can be poised to ride the tailwind we expect to see when value returns to favor. We are certainly rebalancing to maintain our targeted value exposure in Bridgeway portfolios.

History does not repeat itself, but it rhymes, as Bridgeway’s Head of Research, Dr. Andrew Berkin likes to say.1 Our investment and risk professionals have been working together for more than a decade on average, and we have first-hand experience through past health and market crises such as Ebola in 2014, SARS in 2003, the post-tech bubble bear market of 2000-2003, and the recession of 2008-09. Our analysis of decades of data and academic evidence, plus our experience, tells us that investors are rewarded for taking risk and managing their behavior.

People have an amazing capacity to innovate and perform at extraordinary levels in some of the most difficult circumstances. These people drive families, companies, communities, and entire nations to outperform expectations in times like this. We believe they will again.

Some things we don’t know

Of course, we can’t predict exactly when a market turning point will come. We believe that trying to time the market or even a factor is an expensive and fruitless exercise.

We don’t know how long value will continue to underperform, but we do expect it to change.

We don’t know for sure which individuals will have the opportunity, the will, and the fortitude to rise to the occasion in this environment. In turn, we don’t know which companies will get rewarded for their innovation and extra effort in the coming weeks, months, and years. But we expect many to do so, and we expect to be among them at Bridgeway.

What we are doing

Bridgeway remains fully operational with a resilient, team-managed approach to every client portfolio. We have been working diligently to understand how the pandemic and the challenging market environment might affect our clients, colleagues, and community. More details on that work are available here.

When facing risk, we try to focus only on what we can do that would help. In the film Bridge of Spies, Tom Hanks plays an American lawyer representing a Russian spy, and he asks his client essentially the same question three different times throughout the course of the movie:

Hanks: You don’t seem alarmed.
Spy: Would it help?
Hanks: Do you never worry?
Spy: Would it help?
Hanks: So, you’re not worried?
Spy: Would it help?

The advantage of casting aside unproductive worry over things we can’t control is that we can infuse our lives with more joy and focus on more productive things—like strong relationships, rebalancing portfolios, and building a strong immune system.

We also will keep listening and learning. We’re committed to supporting the critical role that financial advisors and institutional consultants play in helping our mutual clients develop and stick with long-term plans to meet their goals—even in unprecedented times such as these.

Finally, in turbulent markets that command our attention and focus as stewards of assets, we also remain engaged with partners in our local and global community who need our support. To step up further, Bridgeway has made donations to the CDC Foundation to help with global efforts to combat the coronavirus and the Houston Food Bank to help mitigate the negative repercussions locally. We are soliciting more ideas from our team, and we welcome yours as well. As always, Bridgeway’s vision and mission keeps us focused and steadfast as we find new and creative ways of partnering to create an extraordinary future for our clients, community, and world.

1 Dr. Berkin quotes Mark Twain, but there is some controversy on this point.

DISCLAIMER
The opinions expressed here are exclusively those of Bridgeway Capital Management (“Bridgeway”). Information provided herein is educational in nature and for informational purposes only and should not be considered investment, legal, or tax advice.

The Russell 1000 Growth Index measures the performance of the large-cap growth segment of the U.S. equity universe. It includes those Russell 1000 companies with higher price-to-book ratios and higher forecasted growth values. The Russell 1000 Growth Index is constructed to provide a comprehensive and unbiased barometer for the large-cap growth segment. The Index is completely reconstituted annually to ensure new and growing equities are included and that the represented companies continue to reflect growth characteristics.

The Russell 1000 Value Index measures the performance of the large-cap value segment of the U.S. equity universe. It includes those Russell 1000 companies with lower price-to-book ratios and lower expected growth values. The Russell 1000 Value Index is constructed to provide a comprehensive and unbiased barometer for the large-cap value segment. The Index is completely reconstituted annually to ensure new and growing equities are included and that the represented companies continue to reflect value characteristics. It is not possible to invest directly in an index.

Underlying data for chart: Bounce Back Years Following the Eight 20%-plus Bear Market Declines from 1926 through 12/31/2019 of More Than 20%

Date Downdraft Next 1Y Year 2 Year 3 Year 4 Year 5
06/1932 -83.71 157.49 -4.39 9.45 45.78 10.83
05/1947 -24.23 23.31 -10.95 41.28 23.43 13.77
06/1962 -23.04 30.27 19.32 6.6 6.66 14.02
06/1970 -33.59 44.45 11.22 -7.82 -15.55 19.04
09/1974 -46.42 39.55 30.85 0.23 17.36 13.85
11/1987 -29.91 23.76 29.32 -7.31 24.9 19.87
09/2002 -45.09 26.75 14.21 14.31 10.02 16.85
02/2009 -50.39 55.26 24.12 4.38 13.39 27.89
Average -42.05 50.11 14.21 7.64 15.75 17.02

Source: Ken French monthly data, Bridgeway

Before investing you should carefully consider the Bridgeway mutual fund’s investment objectives, risks, charges and expenses. This and other information is in the prospectus, a copy of which may be obtained by calling 1-800-661-3550 or visiting the Fund’s website at www.bridgeway.com. Please read the prospectus carefully before you invest.

Investing involves risk, including possible loss of principal.

The Bridgeway mutual funds are distributed by Foreside Fund Services, LLC, which is not affiliated with Bridgeway Capital Management, Inc. or any other affiliate.

Like all of you, we have been monitoring development of the coronavirus (COVID-19) pandemic over the last several weeks and have witnessed the tragic consequences it has had on so many lives around the world.  Our condolences to all the families who have suffered losses from this disease.

Bridgeway remains fully operational. We have been working diligently to understand how the pandemic might affect our clients, colleagues and community. Our goal in this work was to implement the necessary steps—supported by the recommendations of health policy experts and the best available data—to protect the health and well-being of all Bridgeway Partners, while ensuring we continue to serve our clients.

With that in mind, we have taken several steps to maintain our business operations:

  • We moved all Bridgeway Partners to mandatory remote-work status on Friday, March 13.
  • All traveling Partners returned home as of Friday, March 13, and we have halted all business travel through April 15.
  • Bridgeway has had a Pandemic Incident Plan in place since 2009, which includes business continuity practices related to remote working, offsite data backup and recovery, and other critical functions. We’ve supplemented this plan by engaging a business continuity expert who will modify our procedures as needed while the COVID-19 situation continues to evolve.
  • We have also deployed an incident response team to work through the exceptional circumstances of this pandemic. The team will be evaluating the situation on an ongoing basis, while also monitoring recommendations issued by the Centers for Disease Control and Prevention (CDC) and state/local authorities, to make any necessary adjustments.

Over the years, we have invested significantly in our remote working capabilities and procedures to prepare for events like this. We’ve also communicated with our external partners to ensure that our firm can continue to function without disruption.

We will continue to monitor this evolving situation and pay close attention to the guidance of health policy experts. Everyone at Bridgeway is committed to caring for one another and working together to get our company—and our clients and community —through this challenging period.

For the latest information on COVID-19, and to learn more about how you can support your families and communities during this time, please consult the CDC’s website.