(PUB) Investing 2016

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Recapturing the Value Premium The Contrarian | Russel Kinnel

This deep-value strategy works nicely over the long haul, but it takes on sizable risks to get there.

FPA Capital FPPTX Value-Growth Score: 7.2

This Bronze-rated fund is closed to new investors, so I’ll be brief. Dennis Bryan and Arik Ahitov insist on a huge 35% discount to intrinsic value, thus limiting themselves to the cheapest of the cheap. The fund’s focus on cheapness led it to buy a lot of energy stocks and hold a lot of cash. As a result, performance has been dismal recently. American Beacon is a true believer in value investing, but it diversifies stock risk by hiring multiple subadvisors to do its stock selection. Thus, you’re going to get less extreme performance than some of our other deep- value choices. It farms out work to Hotchkis & Wiley, Barrow Hanley, Brandywine (not the growth managers who ran a fund by that name), and MFS . It’s a strong group, but to be sure the fund will lag when deep value is out of favor, as indicated by underperformance in 2008 and 2015 . Yes, you get all the value stocks, more or less, with this Silver-rated fund. The fund tracks the CRSP U.S. Large Cap Value Index. That index is based on CRSP ’s version of value-growth scores, which track short- and long-term earnings growth, sales growth, return on assets, book/price, earnings/price, dividend yield, and sales/price. Vanguard High Dividend Yield Index VHDYX Value-Growth Score: 27 Would you like some income along with your value premium? Then this Silver-rated fund is for you. It follows the FTSE High Dividend Yield Index, which screens for sizable yields and then weights based on market cap. It boasts low costs and appealing simplicity. K American Beacon Large Cap Value AAGPX Value-Growth Score: 20.3 Vanguard Value VVIAX Value-Growth Score: 26.6

As I spelled out in the cover story, we know that inves- tors tend to miss out on returns because of bad timing. In investing literature, it’s also well documented that there is a value premium. That is to say that value stocks outperform growth stocks over the long haul. Jason Hsu, of Rayliant Global Advisors, has written about the link between these two things. Would the value premium exist if investors didn’t sell stocks or stock funds with declining performance? To put it another way, Would value stocks become suffi- ciently cheap to generate superior returns if you didn’t have investors dumping them in recessions or other times of stress? In either case, Hsu found that fund investors squan- dered the value premium by giving it back through bad timing. But you don’t have to. I pulled together a list of some of the deepest-value Morningstar Medalists. To keep that value premium, though, you need to hold on through thick and thin—barring any fundamental problems like manager or strategy change. I used the value-growth score, which is what determines a fund’s spot in our Morningstar Style Box. Scores range from negative 100 to 400 . A score above 200 puts a fund in growth, and one below 100 puts it in value. The far left side of the style box is drawn at the zero value-growth score, and the right side is at a value-growth score of 300 . Harbor Mid Cap Value HIMVX Value-Growth Score: Negative 4.12 Now that’s value. The fund, with a Morningstar Analyst Rating of Bronze, maps all the way to the left side of the style box. This is no accident. This is a quantitatively run fund with deep academic roots that aims to capture the value premium with deep-value stocks. Subadvisor LSV Asset Management targets companies with strong earnings and cash flows, but whose shares are trading at steep discounts.

Our Contrarian Approach I go against the grain to find overlooked funds that may be ready to rally.