Dylan Grice Exposes Three Untrue "Truths" In Our Age of Disruption

Authored by Robert Huebscher via Advisor Perspectives,

Challenging conventional wisdom is a mainstay of financial conference speakers. I have seen few do so as effectively as Dylan Grice, who dismissed three mainstays of accepted beliefs, most notably that the value premium will deliver risk-adjusted outperformance.

Grice is a portfolio manager at Switzerland-based Calibrium AG. He previously served as an investment strategist at Societe Generale, and he spoke at that firm’s annual investment conference in London on July 9.

https://www.zerohedge.com/sites/default/files/inline-images/20180116_lies.png

Grice referred to his claims as “heresy from the mountains.” Here’s what he said.

1. Value investing is an intellectual fraud

“What is investing if not for value?” Grice asked, rhetorically. He defined traditional value investing as betting with the odds in your favor or buying dollars for $.75.

The “value” adjective is not necessary, Grice said. “It is like fast sprinting or wet swimming.”

Grice then drew a distinction between fundamental, Graham and Dodd-style value investing, and factor, or quantitatively-based, strategies. He acknowledged that the 1992 Fama-French research showed that you could exploit statistical patterns of cheapness.

He then presented data comparing the small-cap Russell 2000 index relative to its value counterpart, going back 15 years. The annual value premium has been -44 basis points, Grice said. It is not just the Russell indices where value has failed. He said that using the MSCI world index data, the value premium has been -38 basis points over the same period; with emerging markets it was -12 basis points.

It is widely known that growth stocks have outperformed value in the U.S. over most of the last decade, and that value has been the winning strategy over longer time frames. Grice’s analysis was important because he compared value to a broader index and over multiple markets, using only the last 15 years.

But what he said next should be carefully considered by devotees of quantitative investing.

The value premium is not like the liquidity premium, Grice said, which inherently justifies a higher return for its risk. The same is true of the premia associated with credit risk or duration.

“Why should I get persistent risk premium for a cheap multiple?” Grice asked.

“Value investing is far too easy,” he said. “Anyone with a Bloomberg for Factset terminal can do this. It was a historical anomaly because it was cheap.”

“It’s now gone,” Grice said. “The value anomaly has been arbed [arbitraged] out. Value does not equal cheap.”

Quantitatively-based value investing is not the same as fundamental research, he said. Fundamentally-based investing is “hard,” he said, “and it’s got to be harder than quantitative analysis.”

The challenge for advisors is that there is no way to conclusively prove Grice’s claim. We know that quantitatively-based value strategies, unlike the broad capitalization-weighted index, cannot be pursued by all investors. Eventually capital flows to value strategies must erode returns, but we have no way to know for sure when this will happen – or if it already has.

Grice’s assertion should not be dismissed. One cannot be certain that value will “revert to the mean” and resume its long-term outperformance relative to growth the broader market. We’ll have to await further research to see the extent to which asset flows to value strategies, which have been substantial over the 15-year period he studied, have eroded returns.

2. Absolute return is a myth (everything is relative)

It is generally understood that valuations, using metrics such as the Shiller CAPE ratio, are predictive of returns over long time horizons. The U.S. market is in the top quintile of historical valuations, Grice said, implying a sub-2% real return over the next decade.

“That seems clear cut and obvious,” he said, “but look closer and you see cracks.”

Grice provided data on the range of those return forecasts. Top decile valuations imply returns ranging from -2.4% to 8.7%. Thus, for the next 10 years one could “quite reasonably” make 8.7%, he said. “So how practically useful is this information? It should be a warning sign.”

Using U.S. equities, Grice then compared a buy-and-hold strategy to one based on market timing. His timing model was based on the CAPE ratio and it adjusted allocations depending on the quintile of historical valuations (he did not provide more specific details). His market timing model beat buy-and-hold, he said, but the bulk of the returns came in 1920s.

“There was no value added in the last 70 years,” he said. In addition to the S&P 500, Grice said that finding held for the FTSE 100, DAX 30 and Nikkei 225.

“Valuations matter,” Grice said, “but they’re difficult to measure and get right.”

Forward-looking return estimates are better than naïve extrapolations, he said. But the problem with focusing on U.S. equities is that there have been only seven signals in 100 years, based on valuations being in the top or bottom quintile. “There is not enough data to have statistically significant results,” he said. “The problem is that we don’t get enough movement.”

But if you look at signals across multiple asset classes, you get more useful data. Grice has analyzed valuation-based strategies using bonds and equities. He constructed a model that determines the equity-bond allocation based on the relative valuations of the two asset classes, and said that it outperforms a naïve buy-and-hold strategy. (He said his model used mean-variance optimization based on Sharpe ratios, but did not provide additional details.) Indeed, he said, his relative performance-driven portfolio “did very well.”

“The importance of valuation reveals itself when you add more asset classes to the portfolio,” he said. He has tested his findings for markets in Japan, across Europe and in different European countries. “Valuation is phenomenally powerful but only on a relative basis,” Grice said.

Right now, he said, equities are attractive relative to bonds. “Equities are not that bad,” he said, “given the unattractiveness of the opportunity set.”

3. There is no bond “bubble”

Bubbles, Grice said, are characterized by a get-rich-quick mentality. That was the case with the dot-com and real-estate bubbles, and is the case today with bitcoin.

But bonds, especially those with negative yields, “are not a get-rich-quick” scheme, he said.

With quantitative easing, many have wrongly claimed that there has to be an inflation problem, he said. But it hasn’t happened and that belief was clearly wrong.

“Bubbles are destined to pop,” Grice said. “Bonds are distorted but not destined to pop.”

The risk premia for bonds are not out of kilter with historical levels, he said. Spreads for BAA-rated corporate bonds versus 10-year Treasury bonds are at their 100-year historical average. The duration risk on the 10-year Treasury bond is normal, according to Grice. Even the equity risk premium is not overly distorted, he said, only slightly below average.

The issue is with the risk-free portion of the market – real yields, Grice said. This is evident in German government real yields, which have been negative since 2011. It is true in other markets as well, he said.

The underlying explanation for bond valuations lies in nominal GDP growth, he said, which historically tracks 10-year yields over time. Nominal GDP growth is low in Germany and elsewhere. “The current stretch in government yields relative to nominal GDP growth has never been seen before,” he said.

“Just because we don’t like negative bond yields,” he said, “it doesn’t mean that they have to go up.”

“We are in a low nominal GDP growth world,” Grice said. “Yields are low because nominal GDP growth is low.”

Comments

Cognitive Dissonance sabaj49 Tue, 01/16/2018 - 09:12 Permalink

Since Long Term Capital Management in 1998, nothing is as it should be simply because the FED and other central banks have never really taken their foot off the throttle. Sometimes they ease up a little, but the next time they just do "MOAR".

This distorts EVERYTHING including the toothpaste in the tube. There is no frame of reference other than then and now. Financial history is confined to the last 20 years.

The problem with this article and the author is he is assuming today's financial environment is sane, rational and 'normal'. It is not.

In reply to by sabaj49

Hugh_Jorgan sodbuster Tue, 01/16/2018 - 10:26 Permalink

And then we add in removal of SEC & Congressional oversight/regulation, then the dawn of HFTs and the "flash crash(es)", then in 2008 we add in the TARP, TALF control/takeovers, ZIRP, and an utter lack of accountability for a disaster in banking. Last we add in 10 years of flying out into the great beyond with no plans to refuel the aircraft.

I love these technical write-ups of things the big boys have been grappling with and have finally quantified after 20 years. Meanwhile, many of us here have comprehended the common-sense understanding of this problem for over a decade. Yet, here's your Dylan Grice getting paid to describe the forensic details of the trap we've been in for YEARS, a day late and a dollar short.

What's next Dylan? Isn't it obvious?

In reply to by sodbuster

Troy Ounce Hugh_Jorgan Tue, 01/16/2018 - 10:37 Permalink

This cartoon is what it is all about. I have it on my mobile and show it to everybody ad nauseam

People rather want to hear a reassuring lie than an inconvenient truth. 

We are hard wired to accept BS and our amigdala prefers a flight over a fight.

Paper money, corrupt politicans, manipulation of everything: nobody gives a fuck as long as the music plays on.

Makes one think. Why are we so docile?

 

In reply to by Hugh_Jorgan

Hugh_Jorgan Handful of Dust Tue, 01/16/2018 - 11:20 Permalink

Indeed. But so many of us are in limbo whilst the rest of the world keeps acting to the Reassuring Lie script. It is exasperating.

The hard part for me is living in this age of rife, open lies. At least when everything went in the ditch in the 1930's it was talked about and people confronted it (not that anything they tried worked very well), but there was a sense of unity on the problem. WELL, they couldn't let THAT happen again. They want to try the same kinds of idiotic voodoo economics but THIS TIME were going to do it behind a curtain of bubbles and foster a gold rush mentality around as many things a possible. Meanwhile the economic sickness underneath grows each month, quarter, year.

In reply to by Handful of Dust

hound dog vigilante Consuelo Tue, 01/16/2018 - 12:04 Permalink

 

Markets have largely ignored geo-political & geo-economic conditions since before 9/11, thus analysts who also ignore these variables are less at risk than we might think...

 

The fact that markets continue to ignore geo-political/economic risk speaks volumes about the market itself - it isn't real... the market itself is a fiction, a theater production.

 

Serious analysis of a fully-rigged market seems credible... until you remember the baseline: markets are completely rigged (& not in your favor).

 

In reply to by Consuelo

MrSteve Cognitive Dissonance Tue, 01/16/2018 - 11:38 Permalink

The Greenspan Glut is upon us now! Your quotes on 'normal' denote the new normal under which we labor. The utes and REITs are showing the way of all capital intense enterprises in a bankrupting bond environment. Bonds discount future inflation or the value of currency and so they collapse ahead of the currency. If REITs and utes are the canary in the bond coal mines, I'm shorting bird seed!

In reply to by Cognitive Dissonance

HillaryOdor sabaj49 Tue, 01/16/2018 - 09:24 Permalink

“We are in a low nominal GDP growth world,” Grice said. “Yields are low because nominal GDP growth is low.”

I love these claims. "We just got all this extra government (which we must need and can never get rid of) and the economy just isn't growing as much anymore.  It's a real mystery, a new normal."

In reply to by sabaj49

Memedada Tue, 01/16/2018 - 09:14 Permalink

”With quantitative easing, many have wrongly claimed that there has to be an inflation problem, he said. But it hasn’t happened and that belief was clearly wrong.”

What a tool. No inflation in stocks, housing prices, luxury items, yachts, art – or any other asset class that the ownership class buys with all their free fiat? And no inflation in tuition costs and healthcare costs (for the US plebs)?

+ a real economist (and not a neo-liberalist propagandist) would know that inflation refer to an expanding monetary supply. Rising prices are the result of inflation and not the inflation itself. In other words “quantitative easing” is just new-speech for inflating

Deep Snorkeler Tue, 01/16/2018 - 09:14 Permalink

Truthful Truths 

1. military/security costs are breaking American society

2. the middle class is being broken on the Globalist Wheel

3. Americans are semi-conscious, purposeless people

breaking themselves 

BidnessMan Chupacabra-322 Tue, 01/16/2018 - 09:59 Permalink

A little (only a few $ Billions) got skimmed off by various corrupt Federal Procurement and Accounting civil servants, political appointees, K Street Lobbyists and law firms, and elected officials. Most went to DoD contractors and as baksheesh for oil and weapons contracts to OPEC members.  Going back to the 1960's at least.  Then a lot starting in 1974.  Lose count of a few $100M airplanes, accounting entry oops, and such, and $50B a year adds up over 40 years.  

The DoD books haven't balanced since almost back to the last real Federal Reserve Fort Knox Gold audit back in 1953.  Don't lose track of $2 Trillion overnight.

President Eisenhower was right.  But he rang the bell for the MIC to cover their tracks well.

When oil goes from $3 to $120 a barrel, all kinds of loose change can fall down into the sofa cushions.

In reply to by Chupacabra-322

LawsofPhysics Tue, 01/16/2018 - 10:21 Permalink

"With quantitative easing, many have wrongly claimed that there has to be an inflation problem, he said. But it hasn’t happened and that belief was clearly wrong." --  Really?  What a disingenuous cunt.  All "stimulus" is in fact fungible and just because all that new "money" has been gifted to a select few in banking and finance it will eventually get to main street.

No matter, such "let the majority eat cake" monetary experiments have been tried before.  this author has their head up their ass or is simply another useless fucking paper-pusher who has benefited from the money printing. 

 

Fuck em, jump you fucker!

 

Herdee Tue, 01/16/2018 - 11:33 Permalink

Trillions of printing by multiple Central Banks along with their trading desks and market manipulation has distorted any "true value". Risk always morfs into other entities. When confidence disappears because of the debt of the U.S. government it will be based on continual high deficits without the needed tax receipts coming in. When they lose the confidence it's game over. Just remember that the flaw in the current monetary system that we are on is it needs exponential increases in both currency printing and asset prices to sustain itself. They'll choose hyperinflation don't worry.

BigSpruce Tue, 01/16/2018 - 12:39 Permalink

He just had to get in that dig about bitcoin being a bubble asset. Why don’t these mainstream type just stick to what they understand. 

Its like Buffet gasbagging about it and its taken as some sort of gospel from an Oracle on high...yet in the next breath he admits he doesn’t really understand anything about it.  

venturen Tue, 01/16/2018 - 14:06 Permalink

remind us again the purpose of the Federal Reserve...because it no longer appears to care about anything other than Wall Street Banks and Stock Market

surf@jm Tue, 01/16/2018 - 14:28 Permalink

"With quantitative easing, many have wrongly claimed that there has to be an inflation problem, he said. But it hasn’t happened and that belief was clearly wrong"........

LMAO!.......Yeah, right......Go tell grandma that her higher medical, rent, food, and every other bill that's going through the roof, is just a myth......

Is-Be Tue, 01/16/2018 - 15:21 Permalink

The reason humans cannot understand markets is because they use unhuman  logic.

Do you think the FED has no advanced AI? No self-learning reflective neural network?

No Go boss?

Welcome my son.

Welcome to The Machine.