Value Investing: Tools and Techniques for Intelligent Investment

Chapter 6. Is Value Really Riskier than Growth? Dream On^[6]

Is value riskier than growth? This simple question lies at the heart of one the most contentious debates in modern finance. The zealots of market efficiency argue that the value premium must be the result of investors taking on fundamental risk. The behaviouralists argue that value outperforms because investors regularly make mistakes such as overpaying for growth. Looking at a wide variety of measures of risk we find that value stocks are no riskier (and often less risky) than growth stocks. The risk-based explanation of the value premium is as vapid and useless as the rest of the efficient markets hypothesis.

• As regular readers of my work will know I am a major advocate of a behavioural approach to markets. However, in an effort to practise what I preach and avoid confirmatory bias, I have decided to see if I can find any evidence of the value premium being driven by risk factors, as claimed by fans of the efficient market view of the world.

• At the most basic level, finance theorists equate risk with standard deviation. I believe this to be ludicrous. However, suspending my disbelief and using their measures I find that value stocks have generally had higher returns and lower risks than growth stocks. This is a direct violation of the basic tenet of classical finance that risk and return should be related.

• Not to be easily dissuaded from their faith in the efficient markets hypothesis (EMH), the believers then turn to beta, ...