The Performance of Relative-Value Equity Strategies

Abstract

This paper examines investment strategies that combine time-series and cross-sectional stock sorts based on scaled price-to-earnings ratios, which I describe as relative-value strategies. Relative-value strategies buy (short) stocks that are below (above) their long-run historical absolute or market-relative valuation. I test the performance of relative-value strategies versus a traditional value strategy. I find that a relative-value effect exists, but is dwarfed by the traditional value effect. On average, the tested relative-value strategies deliver long-short returns of 1.25% p.a. and long-only excess returns of 0.69% p.a. over 1990 to 2014. The traditional value strategy produces long-short returns of 5.50% p.a. and long-only excess returns of 4.33% p.a. Relative-value strategies offer an alternative but not necessarily superior source of returns. I evaluate returns after adjusting for common risk factors. I explore the effect on returns from alternative portfolio formation and rebalancing rules. I discuss possible explanations for the findings and implications for investors.

Keywords: Value Effect, Value Investing, Relative Value, Behavioral Finance

JEL Classification: G12, G14