Focused Value

Abstract

Deep value strategies hold concentrated stock portfolios that trade at significant discounts to their intrinsic value. Such stocks tend to have significant risks: stocks with high stock-specific volatilities may have transitory low price movements; stock prices may be low because of recent negative price trends; and stocks’ earnings quality may be poor giving rise to their low valuations. In addition, the risk of value traps—that low prices may remain low for a long time—is exacerbated with deep value strategies. The authors develop a systematic deep value strategy that is designed to combine the concept of deep value investing while mitigating these risks. Using hypothetical backtested data, the deep value strategy has exhibited attractive risk-adjusted returns, including offering diversification to traditional value strategies. TOPICS: Analysis of individual factors/risk premia, factor-based models, style investing