In their study “Value and Interest Rates: Are Rates to Blame for Value’s Torments?,” published in the May 2021 issue of The Journal of Portfolio Management, AQR’s Thomas Maloney and Tobias Moskowitz examined the evidence to determine empirically if the fall in rates and the flattening of the curve were, in fact, the cause of value’s underperformance. The literature does at least suggest possible links between the value premium and rates. For example, several papers (e.g., the 2020 study “Duration-Driven Returns”) have characterized value stocks as low-duration assets with near-term cash flows, and growth stocks as high-duration assets. Another explanation relates to differing debt characteristics of value and growth companies, suggesting value firms have higher levels of shorter-dated debt and are therefore more vulnerable to rises in short rates, whereas growth firms have higher levels of longer-dated debt and benefit more from falling long rates. The implication is that falling bond yields from 2010 to 2020 acted as a strong tailwind for growth stocks and a headwind for value stocks, driving value-tilted portfolio returns lower.
Maloney and Moskowitz analyzed various aspects of the yield curve (levels and changes in short- and long-term rates, as well as the slope of the yield curve) applied to different measures and implementations of the value factor: the Fama-French HML, using book-to-market; AQR’s HML Devil, which updates the book-to-market data using timelier price information; AQR’s HML Devil Intra, which is designed to be industry neutral; and a value composite factor, which uses multiple measures of value in addition to book-to-market to sort stocks. They also examined different periods as well as global evidence (the U.K., Germany, and Japan). These varying choices served to provide a broad and robust view of the relationship between value and interest rates.
Following is a summary of their findings:
There were no statistically significant value sensitivities to the levels of short- or long-term rates and no significant exposure to the yield curve slope.
Evidence of a mild relationship between changes in interest rate variables and value’s performance was found for some value specifications but not others—the findings were not robust.
There is no evidence that companies with a higher proportion of short-term debt tend to be value firms or exhibit any sensitivity to rates factors—there is little support for the theory that shorter debt duration explains value’s sensitivity to changes in yield curve slope.
There is some evidence of a relationship between value factor returns and changes in yields or changes in the yield curve slope. However, the economic magnitude of this relationship suggests falling rates may have been more of a mild headwind than a major driver of value losses in recent years. For example, although the yield curve steepened by around 100 basis points in the 12 months after August 2019, further value losses occurred.
Despite eye-catching patterns during a few episodes in recent years related to changes in bond yields or the yield curve slope, the economic significance of any relationship between interest rates and the value premium was small and not robust in other samples. For example, the results were weaker in the period 1926-1953 than in the period 1954-2019.
The performance of value is not easily assessed based on the interest rate environment. Thus, factor-timing strategies based on interest rate-related signals are likely to perform poorly.
The results were even weaker internationally—inconsistent with an economic reason for value to be affected by interest rate regimes. In fact, Japan had by far the highest average value return during the sample period and the lowest interest rates.
There is no evidence in the historical data that a change in interest rate environment (level of interest rates) is a necessary condition for a value recovery.
Their findings led Maloney and Moskowitz to conclude:
“The potential connection between the interest rate environment and value returns is suspect. The strongest and most statistically reliable result we find is between changes in the slope of the yield curve and value returns. However, the economic significance of this relationship is weak. During the period of 2017 to 2019, when a steep value drawdown coincided with a flattening yield curve slope, this connection can only explain a small part of value’s losses, leaving the majority of value’s underperformance unconnected to interest rate changes.”
Mahoney and Moskowitz did acknowledge that their analysis had limitations, and thus they could not rule out the possibility that interest rates played some role in value’s losses. And referring to the lack of sensitivity to levels in rates, they added:
“The clear implication is that the low-yield environment that pervaded the last decade and continues at the start of the 2020s says very little about the past performance or future prospects of value investing.”
Providing an explanation for the lack of causation, they explained:
“Interest rate changes reflect economic conditions, which almost surely are reflected in cash flows and risk premiums, and the combined effect of these changes may dominate the duration effect.”
And finally, they explained:
“The right explanation is often the simplest one (albeit less satisfying perhaps)—large drawdowns are simply an unwanted feature of factor premiums such as value (and the market premium). The paucity of evidence that these drawdowns can reliably be explained or predicted by observable variables—despite narratives with the benefit of hindsight—may be precisely why these factors are risky and therefore why they provide long-term positive return premiums that are not easily arbitraged away.”
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As Chief Research Officer for Buckingham Strategic Wealth and Buckingham Strategic Partners, Larry Swedroe spends his time, talent and energy educating investors on the benefits of evidence-based investing with enthusiasm few can match. Larry was among the first authors to publish a book that explained the science of investing in layman’s terms, “The Only Guide to a Winning Investment Strategy You’ll Ever Need.” He has since authored seven more books: “What Wall Street Doesn’t Want You to Know” (2001), “Rational Investing in Irrational Times” (2002), “The Successful Investor Today” (2003), “Wise Investing Made Simple” (2007), “Wise Investing Made Simpler” (2010), “The Quest for Alpha” (2011) and “Think, Act, and Invest Like Warren Buffett” (2012). He has also co-authored eight books about investing. His latest work, “Your Complete Guide to a Successful and Secure Retirement was co-authored with Kevin Grogan and published in January 2019. In his role as chief research officer and as a member of Buckingham’s Investment Policy Committee, Larry, who joined the firm in 1996, regularly reviews the findings published in dozens of peer-reviewed financial journals, evaluates the outcomes and uses the result to inform the organization’s formal investment strategy recommendations. He has had his own articles published in the Journal of Accountancy, Journal of Investing, AAII Journal, Personal Financial Planning Monthly, Journal of Indexing, and The Journal of Portfolio Management. Larry’s dedication to helping others has made him a sought-after national speaker. He has made appearances on national television shows airing on NBC, CNBC, CNN, and Bloomberg Personal Finance. Larry is a prolific writer and contributes regularly to multiple outlets, including Advisor Perspective, Evidence Based Investing, and Alpha Architect. Before joining Buckingham Wealth Partners, Larry was vice chairman of Prudential Home Mortgage. He has held positions at Citicorp as senior vice president and regional treasurer, responsible for treasury, foreign exchange and investment banking activities, including risk management strategies. Larry holds an MBA in finance and investment from New York University and a bachelor’s degree in finance from Baruch College in New York.
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