Value without HML

Abstract

Investor interest in value stocks (stocks with high book-to-market ratios) is tempered by the greater economic and financial distress risk of value stocks compared with growth stocks. The author proposes an investment strategy that has no significant high-minus-low (HML) exposure, but nonetheless is able to deliver value-like returns. The strategy is constructed by intersecting stocks with high gross profitability (“good growth stocks”) and low betas (“good value stocks”). He shows that this blended portfolio has much higher Sharpe ratios than conventional value stocks, making it a compelling investment for long-term investors. In the short term, the profitable, low-beta strategy is shown to have substantially lower maximum drawdown and lower downside risk in recessionary periods.