Jeremy Grantham: Quality Stocks Have Outperformed…Since 1965

By on June 11, 2010

Eric Falkenstein has highlighted some writings by big-time money manager Jeremy Grantham, who doesn’t believe risk is related to return.

Grantham on risk and returns:

In fact, Quality stocks have outperformed the market since 1965 (when our quality data begins) … On noticing this outperformance, embarrassingly late in my opinion, Fama and French adopted a circular argument rather typical of finance academics in the 1970 to 2000 era: the market is efficient; P/B and small cap outperform, ergo they must be risk factors. That the result in this case happens to get to the right result is luck. The real behavioral market is perfectly happy not rewarding “risk” when it feels like it, as is shown by the 70-year underperformance of high beta stocks. But this time it worked. Price-to-book, despite its low beta, is a risk factor because of its low fundamental quality and its vulnerability to failure in a depression. This is true with small cap as well. But what about “Quality?” This factor has outperformed forever. (The S&P had a High Grade Index that started in 1925 and handsomely outperformed the S&P 500 to the end of 1965 when our data starts.) Since the market is efficient, to Fama and French quality must be a risk factor! So, by protecting you in the 1929 Crash and in 2008, and by having a low beta for that matter, Quality as represented by Coca-Cola and Johnson & Johnson must be a hidden risk factor. Oh, I know: “The real world is merely an inconvenient special case!”

Source: Business Insider
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