Is (Systematic) Value Investing Dead?

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During their recent episode of the VALUE: After Hours Podcast, Taylor, Brewster, and Carlisle discussed Cliff Asness’ recent article titled – Is (Systematic) Value Investing Dead? Here’s an excerpt from the episode:

Tobias Carlisle:
Yeah, I saw Cliff Asness had a third bite at the value cherry, Is (Systematic) Value Investing Dead? Spectacular paper. I read it in one go and I’ve gone back and read it a few different times. I think it’s very thorough. I think Cliff writes incredibly clearly, and I like the conclusion to say, so I’ll be talking about that paper soon. What are you on, JT?

Jake Taylor:
I’ve got some more vegetables for us. This is going to be a thing that I learned about recently, that’s called Baumol’s Cost Disease.

Tobias Carlisle:
Yeah, I’ve heard of it before.

Bill Brewster:
Aren’t we fighting enough disease, right now? Just saying.

Jake Taylor:
We’ve been fighting this one for a long time and you probably didn’t know it, so …

Bill Brewster:
That’s fair. Those are the worst kind.

Tobias Carlisle:
This is VALUE: After Hours.

Bill Brewster:
Starting right now.

Tobias Carlisle:
Right now. You guys want to let me do Cliff first?

Bill Brewster:
Yeah, for sure.

Tobias Carlisle:
Get Cliff out of the sight?

Bill Brewster:
So I made a bunch of valued people tuned in, we might as well give them the porn first.

Tobias Carlisle:
Here’s the value porn. So great paper worth checking out on AQR’s little series, Cliff’s Perspective. I don’t know why they didn’t call it Cliff’s Notes. I feel like that was easy, low hanging fruit there.

Bill Brewster:
Missed opportunity for sure.

Jake Taylor:
How about, Going off a cliff.

Tobias Carlisle:
That’d be pretty good.

Bill Brewster:
That’s him on Twitter? Shout out to Cliff. I do like his stay on Twitter.

Tobias Carlisle:
He’s one of the 10, he listens to situations every week.

Bill Brewster:
For sure he does easily.

Tobias Carlisle:
It’s just because he wants me talking my book about value. It makes everybody feel good. So all of the guys who are deep in value with me, said very comprehensive review of the value spread for various different value metrics. And he shows what it looks like over the full data set that they have. Every chart looks almost identical. Basically what they show is that the spread is the widest now that it has ever been when you use the composite of all of those measures and you use the measures that AQR uses internally. Which, is something that I have seen too. When you apply all the things that you would normally do, the internal quality, balance sheet health, profitability, so on leverage, so on. You get these results now that basically show that the value spread is as wide as it has ever been wider now than the GFC wider now than the.com peak, which is kind of extraordinary to go back through this time again, given how recent the last peak was only 20 something years ago.

Tobias Carlisle:
And then he sort of asked, he goes through and he asks all these questions. Why, has the world changed? So is it due to some sort of several very highly profitable monopolies that are skewing the results he carves them out and still gets the same answer. So it’s not a winner-take-all monopoly or tech phenomenon. Basically he says, “All that’s happening is we’re paying more for some companies than we ever have in the past. And we’re paying less for other companies than we have in the past.” That’s created this massive spread. The other thing that he looks at is inside each of those portfolios, is it due to some sort of deterioration in value stocks or some sort of like better quality in growth stocks than usual? So what you typically find is that value stocks are at the time that you’re buying them they do look, they’re not as good as the growth year story stocks in terms of their leverage and profitability and so on.

Tobias Carlisle:
But the question is, it’s a mispricing question. You’re not trying to find the best stock on the stock market. You’re trying to find the most mispriced stock and value is very, very mispriced at the moment. And particularly, so when you break down the two portfolios on the basis of profitability and leverage, value is no worse than it normally is. The growth stuff’s no better than it usually is. It’s just an unusual phenomenon. It’s interesting that in 1999 and JT, you pointed this out that the value stocks are actually better than the growth stocks in 1999.

Jake Taylor:
So re return on assets, or for the cheapest decile, I think it was, was better return on assets across that segment than the most expensive, which is like really pretty shocking, right?

Tobias Carlisle:
Absolutely.

Bill Brewster:
That there were no returns, right? In 99 and high docile, right?

Tobias Carlisle:
It was less. Yeah. And then one of the other things you do that I just missed was he compares the most expensive stocks to the middle, to those in the middle and runs that for the full data series. And then he compares the middle stocks to the cheapest and runs that for the full data series to see whether is this an expensive stock phenomenon or is this a cheap stock phenomenon? Which side of the alligator jaws are driving the spread? What he says that, which is something that I didn’t expect to say, but it’s actually the cheapest stocks. It’s both. The spread is very wide on both sides, but it’s the cheapest stocks are wider now are cheaper relative to the middle than they were historically. And if I can square that up on an absolute basis, if you look at price to cashflow and the famous French series, you get a similar answer that we’ve got.

Tobias Carlisle:
I think value is cheap or by itself, the spread is very, very wide. The final question that everybody wants answered is when does it turn around? When does Valley start working again? Cliff, didn’t answer that question. Nobody can answer that question. He says that the odds are very good right now, value is a very good strategy. So it’s just a matter of kind of waiting. So nothing’s really changed, I guess it’s just more food for my bias, which I love.

Jake Taylor:
Yeah. One of the things they used in his report was the… I was curious about debt levels always with this, because I’m more an enterprise value type of guy. And he talked a little bit about that, but they used a debt to book value, basically equity book value. And I would have liked to have seen something more in like of a cashflow type of coverage ratio comparisons over time. I’d be curious to see if that gave you a different answer as far as leverage ratios go.

Tobias Carlisle:
Could Ev/EBITDA or EVBitz answer that question for you?

Jake Taylor:
Yeah. Ev [inaudible 00:09:03] would answer that.

Tobias Carlisle:
Wes’ website has that EVE, but to get into that website you got to scale a wall and swim through the mud. It’s hard to get into it’s free and anybody can get into, it’s just hard to get into. The last time I checked both of those Ev/EBITDA was sort of saying it’s a 1999 type opportunity and EVE, but was like pretty close to that. So at least a 2007 type opportunity.

Jake Taylor:
When I looked at it last week, it was not as pronounced as 99 was. So you have sort of a… There’s probably a little bit more debt and then there’s, the assets are probably not as good as 99. So it makes it like a little bit less obvious to me, a little bit harder to really pound the table. But it’s definitely we’re in the ballpark of where, like you could create some value gurus from that starting point.

Tobias Carlisle:
Raining on my parade JT almost [crosstalk 00:10:08] almost.

Jake Taylor:
It’s pathological for me at this point.

Tobias Carlisle:
Well, you got to, I mean, valley has let us down so many times you’ve got to be asking the hard questions too.

Jake Taylor:
Try to.

Tobias Carlisle:
I just need the inspiration to keep going.

Jake Taylor:
That’s fair.

Bill Brewster:
I don’t know where I stand on this. I guess let’s go back and add back COVID, [inaudible 00:10:36] if it weren’t for COVID I think I would be more willing to really bet on the data right now. And this is why the opportunities exist. I mean, I had sent out a tweet about the small value factor when I read Dan Rasmussen’s piece. And I was like, I just don’t know that, that’s the place you want to fish anymore. Not that there are not opportunities, there clearly are within the set, but as far as a factor goes, it’s like 15 years of under-performance. I mean, at some point you got to kind of ask what’s going on here. And I guess that what my perception, and this is fraught with bias and why I’m running my portfolio the way I am, but my perception is just that access to capital and size are so important right now that running to that sector of the market was certainly rational in March.

Bill Brewster:
I mean, whether or not it’s still is sort of a different question, but I think that as a basket it would not shock me to see that basket outperform. Certainly at some point it’s going to just rip, I just don’t know how to handicap the odds within a particular stock. I mean, it’s obviously everything is a situation dependent, but man small scares me right now. Just because I think the path of the outcomes is so wide that the ability to raise the liquidity is so important. And I mean, I just don’t know. And I know that the natural, like if I’m arguing with myself, I’d be like, “Yeah, dude, well, when’s that ever not been the case?” And I get that, but like right now it just feels scary.

Tobias Carlisle:
[crosstalk 00:12:31] I mean, it’s a pretty good argument.

Jake Taylor:
Major bifurcation.

Tobias Carlisle:
That’s a pretty good argument for it.

Jake Taylor:
Yeah.

Tobias Carlisle:
If I look at [crosstalk 00:12:39] where’s the opportunity sitting out, like the top end of the market tech has just run as far, not as far as it can go, obviously I’m not saying you can run as far as it can go. Who knows? I’d never be that mad to say that it’s run as far as it can go, but gee, it’s run a long way relative to the fundamentals. And value sort of just has kind of been falling behind further and further, particularly small Valley. At some stage the opportunity just becomes so great that you kind of compelled to bet on some main reversion. Like I would’ve said that that bet was pretty pronounced a year ago, but I think that the bet is I mean, it’s just more pronounced now. Who would’ve thought that we’d get to like close to [inaudible 00:13:26] whether we’re through it or not. We’re kind of at, we’re close to the peak of the last time that value had a really spectacular run.

Bill Brewster:
Yeah. I mean, I fully understand all the psychological reasons that what I just said is stupid. I just think that it’s I don’t know. It’s going to be interesting.

Tobias Carlisle:
[crosstalk 00:13:48] You can wait for it to start working.

Bill Brewster:
… independent.

Tobias Carlisle:
You can wait for it to start working. That’s that’s one thing that I’ve… I don’t think you necessarily have to be betting on the way down in the factor that right now, I think you could wait for the turn because I think that it’s going to work for 10 or 15 years.

Bill Brewster:
Yeah, I think that’s arguably fair. And I know like personally, when I look at [crosstalk 00:14:14] well, when I look at the mistakes that I made, I’m often early on something. And I think that I have not… I’m so focused on trying to not bottom tick, but get a deal that I find myself buying and then stuff immediately goes down, 10, 20%. And it’s like, Oh man, if I had just sort of like forced a little bit of patience, not that you can pick the bottom, but the other side, it’s not like something re rates 100% on you over a day, unless it’s like Roku, but that’s sort of a different issue.

Jake Taylor:
Premature accumulation.

Bill Brewster:
Yes.

Jake Taylor:
Happens to the best of us.

Tobias Carlisle:
What’s your concern there JT, you didn’t want to fully endorse my wait and see?

Jake Taylor:
I just think that the real returns are made, I think like Buffet says about, waiting until you hear the Robbins for spring, it’s kind of too late. Until it gets all cleared up, I guess when it comes down to it, the bifurcation that we saw in 99 was this story around, the dot.com and new economy, and really having like lower cost structures because you don’t need brick and mortar, et cetera. And probably all true, right? It just like took longer. Well, and that was how quick it was going to happen was mispriced I think. So you were able to buy a lot of stuff that was going to last for a long time and was earning better than their counterparts, at least at that juncture. Fast forward to today, similar bifurcation. But now is the question, is it mispriced in the consequences of COVID and the damage that’s being done to these businesses versus the ones that are holding up and is that mispriced at this point?

Jake Taylor:
And I don’t know, I’m not sure what the answer to that is, as it’s not as easy, I guess it was probably harder then, like when the new economy seemed to be working and yeah, of course, all these dinosaurs are going dead. This was a meteor that hit right? I guess you could say the same thing right now about all this stuff that’s in a value basket, energy, retail travel, a meteor hit, right? These are all dinosaurs that are going to die. This game is not easy I guess, is what I’m trying to say.

Bill Brewster:
My perception of how value works and where I like to fish is like energy. I don’t know anything about EMP. I would get destroyed trying to pick, like junior oil companies or some shit like that, forget that noise. But like energy infrastructure assets. I can get my head around that and I can get my head around why that’s a long duration asset and I can get my head around why the future probably looks a lot more rosy than people are contemplating right now. And like, that’s a way that I can understand value right? Or travel. I have a bias and have bet on and will continue to probably bet on that people will come back to travel. I understand searching for really good assets and beaten up sectors.

Bill Brewster:
I am less at least running a discretionary portfolio. I am less certain that I can pull up like small value as a factor and then go through and pick the winners out of that that subset. I guess that’s sort of where I’m coming from when I say what I say. And I’m sure there is some listener being like, he doesn’t understand that the entire reason that value works is because no one wants to buy it. I’m telling you I get it. But that’s how my mind works. I’ve accumulated some exposure that’s tangentially related to energy over this time period. I’ve accumulated a lot of travel related exposure. So that’s sort of how I’m trying to play value [inaudible 00:18:37].

Jake Taylor:
Would you say that a bottom up in that kind of stock-picking makes it really hard to buy anything out of the basket of small cap value and at your price better serve, not thinking about it bottom up and more, making a broader bet kind of shotgun, that some of these are gonna work out better than the ones that don’t work out. I’m going to capture that asymmetry and that I’m just betting on the entire population. Not bottom up research of like, well, this one’s really crap. I’m going to throw that out.

Bill Brewster:
Yeah. That’s what I mean. I get it from like a quant basket approach. It makes sense to me in that type of approach. It just doesn’t make that much sense to me, like for me to go in and pick discretionarily. I mean, I don’t deny there’s some great opportunities there. Right. But it’s just, how am I going to find them and know and all that is sort of the questions that I ask.

Tobias Carlisle:
I think that’s a legitimate concern. I think that’s where you go… That’s where you run into trouble when you try to discretionarily pick out of some of those more beaten up names. Although, there are definitely folks out there who are doing it pretty well. I don’t know how, I don’t think Ian castle, Oh, I think I name check him every single time I record these things, but impressive returns. I think that he’s… I don’t know if he would characterize himself necessarily as a value guy, but he might say that he’s more growth in his… But he’s certainly doing that, picking them out named by name.

Bill Brewster:
Yeah, like here’s the plug for his service. I mean, I have been trying to think about what is a good, I’ve been trying to figure out, like when will I have the time to research a micro cap to submit to that network group. Right? Because, Micro-Cap club is something that I want to get involved in. I do want more focus on Micro-Cap and my network group is really focused. We’re mostly focused on media and experience. I mean, that’s most of the conversations that I’m having day to day. I’m not in the Micro-Cap network. And I would like to work on my network that way, because I do think that you can find great ideas and stuff. But I think that you cultivate them in a similar way that I cultivate what I do. And that’s like talking the ideas with a network of people. So that’s why I’m not inclined to just like pull up a small factor or a small value factor and then just go through the list.

Tobias Carlisle:
It won’t work. It took me a decade to get from when you do a back test and you get the output from the back test to like the output from the back test, it’s garbage. It takes a long time to get a back test that delivers a list of names that you would actually buy as a sane individual. That then also tests. Well that is really the challenge of the process. Because the first time you run it, it just pulls up all this stuff that has somehow filled the screen. Like it’s just through there. Because, it’s got some obvious problem with it. And it’s not [crosstalk 00:21:43].

Bill Brewster:
Like data fitting or something like that with your prospectus.

Jake Taylor:
All the horses have broken legs and the model doesn’t know it.

Bill Brewster:
Yeah.

Tobias Carlisle:
Yeah. There’s genuinely something wrong with it. Like it’s just for whatever reason. So if you use Ev/EBITDA and you pull up some financials, you’ll see that it’s just wrong. You need to be doing those other things. Some little quality cashflow checks, very sort of things to get to a point where it produces a portfolio that is sensible.

Jake Taylor:
And that you could psychologically hold.

Tobias Carlisle:
Yeah.

Jake Taylor:
Half of it, even if its not the best. Even if maybe it was a suboptimal return than just picking the pure flat, whatever it showed, the fact that you couldn’t handle it and ride the horse to the finish line matters also.

Tobias Carlisle:
That’s a lot of it, that’s under appreciated how difficult that is to do that. You really have to believe. I mean, people are seeing that with value as an entire strategy. Like just, it’s hard to believe in it, given how badly it has performed. It’s hard to see what needs to happen for it to start working again, even I would struggle to explain to somebody why I think it’ll start working and I’m sort of fortunate to have invested through a period of time in the early two thousands when it did work very, very well. And so I have seen it work and I’ve also seen the flip side of that, which is that even very high quality companies with very high rates of growth. If they get extremely expensive, they’ll just go sideways for a decade. That’s what happened in the early two thousands. There were great companies in there, things that were darlings in the late 1990s, they just didn’t do anything for 10 years.

Tobias Carlisle:
Fundamentals look great every time, just it’s not like this thing now, where you put on Microsoft at 2.8% free cashflow yield and it goes up, you put a Microsoft at a 2.8% free cashflow. The sales go up 30%, and now it’s a 3.5% cashflow yield. And it hasn’t gone anywhere. That can happen.

Bill Brewster:
But your 10 years is only 0.8%.

Tobias Carlisle:
That’s true.

Bill Brewster:
In theory, true is how high it could go.

Tobias Carlisle:
But is it? So this is the thing, right? The direction of the interest rates [crosstalk 00:23:59].

Bill Brewster:
I say that [crosstalk 00:24:01] pulled their eyeballs out. [inaudible 00:24:03] serious.

Tobias Carlisle:
That’s a fair question. Probably the direction of interest rates is more important than the absolute level of interest rates, right? Where everybody just adjusts to the absolute level, but it’s the change that maybe we go negative. I don’t know what happens then. I have never, I can’t… That’s through the looking glass who knows what happens in that scenario?

Bill Brewster:
I was thinking about that today. I was like, man, you could really get valuations going nuts. And then a negative rate environment. People almost certainly put a floor under it, but who knows?

Tobias Carlisle:
I mean, it’s infinite run. It’s infinite at zero. Like what happens when it goes through zero? Who knows?

Bill Brewster:
It’s just so tough to handicap the odds because there’s a lot of money. I don’t do this kind of work, but like the incremental flows, right. If you have negative rates out there, what do you do if you’re a pension manager? You just have to plow and [crosstalk 00:25:02].

Tobias Carlisle:
You just assume 8%, you just keep on putting 8% into your model.

Jake Taylor:
PE VC who are going to mark to whatever you need them to market to.

Tobias Carlisle:
Mark to model.

Bill Brewster:
Yeah. It’s a very, very hard question. I mean, the answer is probably you raise taxes and then try to actually fund that way. But that’s not fun for anyone.

Tobias Carlisle:
Did you look at Japan? Is Japan going negative? Like when did Japan get actually negative?

Bill Brewster:
I don’t know, but Greek Fire on Twitter, that dude, he roasted Trump today was saying, if everybody else says negative rates, like we should enjoy the gift too. And he was like, yeah. Because those continents and [crosstalk 00:25:44] that’s really who we want to be.

Tobias Carlisle:
That’s funny. Right? It’s so hard, because I have no idea. Macros too hard for me. I’ve got no idea.

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