Watts and Israel said combining other factors with value can help diversify a portfolio and prevent investors from falling into value traps. Watts said quality is a good factor to complement value.
For example, if an investor used only a value measure, like price-to-book, during 2007 and 2008, that person would have bought financial stocks, which had lost 22 percent in the preceding period. But a quality screen used in conjunction with value would have shown that measurements like mortgage quality, leverage and other metrics were grossly out of line, helping the investor avoid the purchase.
Israel said advisors can look at the idea of value broadly. There is the simple stock-to-stock comparison, but it’s also worthwhile to compare industries and even markets when thinking about value investing.
Advisors who use these complementary measures and look with greater breadth will be able to explain to clients why value investments make sense.
“Education is important,” Israel said. “You have to understand what you’re investing in. It’s a good long-term point of return, but you have to stick with it. It’s not just about the empirical, but also the theory.”
Advisors may need to explain the justification in other terms. For instance, Israel said, investors believe in the long-term returns of the stock market, even during times of subpar performance. The same should be true for value investing.
West agreed.
“Clients must understand that they need to be in the portfolio for a long time. They can diversify to an extent, but they need to go through the same rationale [they use in value investing] to believe in those [diversifiers]. They have their own issues and underperformance.”