Time and the payoff to value investing
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Roland Rousseau is responsible for quantitative investment strategies and risk management research with Deutsche Bank in South Africa. He was rated as the top quantitative analyst in 1999, 2001 and 2003 by institutional investors. He has a degree in international banking and finance (BSc Econ) and an MBA.
Paul van Rensburg* is the Professor of Finance at the University of Cape Town. He is also Senior Portfolio Manager and Head of Equities at Kagiso Asset Management. His research interest is the pricing of equity securities. *School of Management Studies, University of Cape Town, Private Bag, Rondebosch 7700, South Africa. Tel: ⫹27 21 6502 481; Fax: ⫹27 21 6897 570; e-mail: [email protected]
Abstract Using a simulation study methodology it is found that the rewards to value investing become both larger and more reliable as the investor’s holding period lengthens. Value investors appear to be rewarded for time. Evidence is also found of a right skewness in the distributions of returns to value portfolios that becomes more pronounced over longer horizons. This implies that the rewards to value investing are not distributed evenly across stocks and time. Rather it is a minority of shares over particular periods that constitute the majority of the value effect. Keywords: asset pricing, value investing
Introduction and prior research ‘In the short run the market is a voting machine. In the long run it is a weighing machine.’ Benjamin Graham Since the seminal paper of Basu (1977), who documented that New York Stock Exchange low price-earnings ratio (P/E) shares significantly outperformed high P/E shares on a risk adjusted basis, there has been substantial confirmation of the existence of a ‘value’ effect. Providing a perspective from a fresh data source, similar results have been observed in the South African financial
318
Journal of Asset Management
environment. Plaistowe and Knight (1987) found evidence of a market-to-book effect on the Johannesburg Stock Exchange (JSE) over the period 1973 to 1980 while Page and Palmer (1993) documented that a P/E effect existed over the period 1973 to 1984. Van Rensburg (2001) applied a cluster analysis methodology to the monthly time-series returns of 28 characteristic-sorted hedge portfolios over the period February 1983 to March 1999. Three primary clusters of style-based risk were identified: ‘value’, ‘momentum’ and ‘quality/size’. It was suggested that earnings yield (or P/E) be used to
Vol. 4, 5, 318–325
䉷 Henry Stewart Publications 1479-179X (2004)
Time and the payoff to value investing
represent the value cluster of style-based risk on the JSE. Purchasing ‘cheap’ shares is not the only facet to the value investor’s approach, however. The academic literature has, to date, left unexamined the well-known fundamental analysts’ adage that value investing is best viewed as a ‘long-run’ approach to obtaining stock market outperformance. The aim of this study is to empirically examine the payoffs to purchasing low P/E securities over varying time horizons. Are val
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