Why “value” ETFs underperform – and most ETFs are poison

Overview

Over the past few months, I’ve demonstrated that

• value stocks greatly outperform “momentum” stocks (for details, see Why value investing crushes momentum speculation, 9 February);
• value also thrashes “growth” (Want to shrink your returns? Buy “growth” stocks! 23 March);
• small caps outperform growth stocks, but value outpaces small caps (Why Intelligent Investors Avoid Small Caps, 13 April);
• on average and at extremes, value outperforms the S&P 500 Index, “growth” stocks and small caps. Moreover, value reliably succeeds not least because speculation usually fails (see Why Value Investing Outperforms, 29 April).

These results demonstrate that the benefits of value investing are real. However, as I show in this article, they’re not easy to obtain. Above all, it’s NOT a merely matter of selecting an exchange-traded fund (ETF) which contains the word “value.”

Value usually outperforms but the flagship “value” ETF never has. That’s because (1) as a rule so-called “value” funds don’t contain value stocks. Indeed, virtually no fund which claims it’s “value” really is: in reality, the typical “value” fund is closer to the “growth” – and thus the underperforming – end of the spectrum. More generally, (2) “value” ETFs are factor ETFs; and (3) factor, sector and thematic ETFs generally underachieve. That’s because they facilitate speculation, and speculation almost invariably disappoints.

Given these results, I also anticipate the results of combining today’s large number of speculators who mistakenly think they’re investors (many of whom are young and inexperienced) and the escalating number of factor, sector and particularly thematic ETFs.

To borrow the phrase of the American humorist, P.J. O’Rourke, this combination is akin to giving car keys and bottles of whiskey to teenage boys.

The implications for speculators are stark. They should also be clear to investors: if you want to reap the considerable benefits of value investing, you must diligently sow, i.e., devote substantial time and effort to (1) learning and doing it yourself, and/or (2) locating one or more of the handful of value investors worthy of the name (as opposed to the large number of impostors and wannabees).

What, then, to do? I suggest four ways to differentiate the sheep from the goats.

Why “Value” ETFs Underperform

Over the past century, it’s been a rule with few exceptions: value stocks outperform the S&P 500 Index as well as momentum, growth and small cap stocks. It’s easy to anticipate a glib reaction: “OK, outperformance is easy: all I have to do is buy a ‘value’ ETF.”

The reality is that value stocks usually excel but “value” ETFs – and factor, sector and thematic ETFs more generally – typically underachieve. That’s ultimately because appearances are deceiving.

S&P SPIVA

Let’s demonstrate this startling – and, to ETFs’ legions of credulous acolytes, hopefully disconcerting – conclusion by beginning with S&P SPIVA (“S&P Indices versus Active”). It’s a research report, published annually by S&P Dow Jones, which compares the performance of actively managed funds against key benchmarks.

Annually since 2002, SPIVA has shown that during 12-month periods, 70% or more (it’s usually more) of actively-managed equity funds underperform benchmarks such as the S&P 500 Index. As a rough rule, over periods of five years and taking into consideration underperforming funds’ high mortality (see below), the percentage of actively-managed stock funds which lag major benchmarks rises towards 90%.

Over long-term (ten-year) horizons, the probability of underperformance rises above 90%, and over 15 years it exceeds 95%.

These results wouldn’t have surprised Benjamin Graham. In his memoirs, mostly written during the mid-1950s, he stated: “I have little confidence even in the ability of analysts, let alone untrained investors, to select common stocks that will give better than average results. Consequently, I feel that the standard portfolio should be to duplicate, more or less, the (Dow Jones Industrial Average).”

Beginning in 1951, John Bogle advocated (and, in his letters to shareholders in 1993 and 2013, Warren Buffett agreed) that many people should allocate a considerable portion of their capital to low-cost “index” funds which closely track major benchmarks such as the S&P 500 Index. Their advice applies particularly to those whom Graham dubbed “defensive” investors – those who’re unwilling or unable to devote much time and effort to their investments.

Defensive investors should “set and forget” – that is, buy an ultra-low-cost fund which tracks a major index, and hold it indefinitely. Unfortunately, many people have either unwittingly misconstrued or deliberately corrupted Graham’s, Bogle’s and Buffett’s advice.

Once Were Investors, Now Are Speculators

Defensive investors buy funds and ETFs which reference a major, broadly-based index – and hold them indefinitely. In contrast, aggressive and overconfident speculators (most of whom misperceive themselves as enterprising investors) buy ETFs which reference a “factor” (such as “growth,” momentum, etc.), market sector (financials, technology, etc.) or theme (AI, crypto-currency, cybersecurity, intermittent energy, etc.) – and dart among them.

In particular, and in response to ever-changing “narratives,” today’s speculators are chasing a conga line of ETFs which have recently generated implausibly large returns (see, for example, “Oil, chips, bitcoin, and hydrogen: The top ETFs of the Iran war,” The Australian Financial Review, 6 May).

It’s the culmination of an invidious and decades-long trend. In his presentation to the U.S. House of Representatives’ Financial Services Committee (12 March 2003), Bogle testified that the average stock investor’s holding period has drastically shortened: in the 1950s and 1960s, investors held each of their stocks approximately 16 years. By the early 2000s this average plummeted to little more than two years; and in 2021, according to the World Economic Forum, it was less than six months.

Funds “churn” – that is, buy and sell – stocks ever more frequently, and speculators churn funds ever more rapidly. Whether by amateur or professional speculators, shorter holding periods necessarily produce lower average returns (see, for example, How Warren Buffett has trounced “the world’s greatest hedge fund manager,” 11 August 2025).

Higher-risk activities are accompanying this churning. According to The Wall Street Journal (“The Exotic Makeover of the Once-Boring ETF Market,”, 23 February), ever more market participants are investing relatively less in low-risk (i.e., major index) ETFs – and ever more in relatively high-risk factor, sector and thematic ETFs.

On 4 May it elaborated: “actively managed (funds) … made up a negligible portion of total ETF assets just five years ago, but a regulatory change … has quickly reshaped the market … A record 1,100 new ETFs launched last year, and more than eight in 10 of those were active. Active funds took in 32% of the $1.4 trillion in new money invested in U.S. ETFs in 2025, up from 9% in 2021.”

These ETFs are exacerbating the invidious effects of churning: speculators are rotating ever more among what have recently been outperforming actively-managed vehicles – most of which, as SPIVA has found over the years, eventually underperform major indexes.

ETF Speculators Chase Short-Term Returns – and Thereby Lose

Over the decades, considerable evidence has accumulated: speculators in managed funds chase high short-term returns. Similarly, evidence from the past few years is mounting: speculators in ETFs are chasing high recent performance. Various factors, such as the transient popularity of specific sectors and the mistaken assumption that recent past results predict future long-term results, drives this behaviour (see, for example, “Young & Invested: The illusion of ETF returns,” Morningstar, 10 December 2025).

Periods of short-term outperformance generate inflows of funds. High returns boost ETFs’ prices, can push them to extremes – and the higher they rise, the greater is the risk that they subsequently fall. Speculators thus succumb to “recency bias:” they over-weight recent outperformance and incorrectly assume that it’ll continue.

In this sense, recent past performance IS a predictor of future results, but NOT in the way that speculators suppose: by chasing recently high-performing ETFs, the risk of subsequent underperformance and loss rises.

Funds Managers Often Put Their Thumbs on the Scales

Most active funds underperform, and ever more speculators lose by darting from one ETF – whether active or passive – to another. Meanwhile, and like batters who act as their own umpires, a substantial percentage of funds – passive as well as active – encourage this speculative behaviour by exaggerating their returns (see, for example, Kevin Mullally and Andrea Rossi, “Moving the Goalposts? Mutual Fund Benchmark Changes and Relative Performance Manipulation,” forthcoming, Review of Financial Studies and How you – and managed funds – overstate your returns, 17 October 2024).

This, noted The Wall Street Journal (“Fund Managers Tell Tall Tales,” 13 April), is “generally in a way that flattered their returns. That might mean swapping the S&P 500 for the Russell 1000 (as a benchmark), or moving to an index that emphasizes value or growth instead.”

This technique is most common among high-fee funds, and they adopt it because it boosts their inflows. It’s just one among a number of games they play. Perhaps most notably, it’s long been well-known that managers exaggerate their portfolios’ returns by only showing the returns of those funds they’ve retained – that is, by excluding those which they’ve closed. Dimensional Fund Advisors studied actively-managed funds between 1991 and 2020 (see “Why Worry About Survivorship Bias?” 12 October 2020). Over that time, an average of about 100 funds were liquidated each year; the highest number occurred at the trough of the GFC in 2009.

It concluded what studies before and since have also found: poorly-performing funds are most likely to get the chop.

According to Dimensional, the median surviving fund still trailed its benchmark (by 0.84 percentage points per year), but that gap would have been a much worse (1.44 percentage points) if defunct funds had also been counted.

Morningstar is a leading American financial services firm which provides independent investment research, ratings and management services regarding stocks, ETFs and managed funds to individual investors and professionals. It groups funds into more than 100 categories based upon class of assets (bonds, stocks, etc.), investing style, market segment, etc. It then compares funds within each category. Finally, it awards its top rating (five stars) to the top 10% of funds in each category; the bottom 10% get just one star, and the rest get two, three or four.

Some funds intentionally change their holdings in order to obtain a Morningstar category which earns them more stars. This technique is called “box jumping” (see Lauren Cohen, et al., “Box Jumping: Portfolio Recompositions to Achieve Higher Morningstar Ratings,” SSRN 4971228, September 29, 2024).

In WSJ’s words, this “is akin to a team switching to a weaker division midseason to earn a playoff spot based on the same record.”

Index Funds: Sensible but Hardly Risk-Free

“Vanilla” ETFs track broad indexes like the S&P 500 and thus provide low-cost, diversified exposure to equities as a whole.

For many people, “vanilla” ETFs can be sensible. But make no mistake: they aren’t risk-free.

Howard Marks, co-founder of Oaktree Capital Management, has repeatedly warned that “index investing” and “passive strategies” have encouraged the allocation of capital on the basis of market capitalisation rather than value – which, he contends, masks risks and eventually creates bubbles. Bill Gross, the co-founder of PIMCO, adds that indexing has become a concentrated bet on a few (“tech”) companies driven by a single (artificial intelligence) theme.

Noting that the top-10 (by market cap) companies presently comprise ca. 40% of the S&P 500, he warns that indexing is in effect a wager on the hype of artificial intelligence.

“It is certainly correct,” concluded Burton Malkiel, professor of economics at Princeton University, leading finance academic and author of A Random Walk Down Wall Street, etc., “that today’s stock market presents substantial risks. It is possible, perhaps even likely, that we are experiencing an AI bubble … (Index funds will) experience losses when a bear market comes, but most active managers will do even worse” (see “Best Protection Against an AI Bubble? Index Funds,” The Wall Street Journal, 22 March).

John Bogle identified the key risk: “if everybody indexed, the only word you could use is chaos, catastrophe. The markets would fail.” As indexing becomes more widespread, he reckoned, markets increasingly fail to perform their most essential function – price discovery – and thereby necessarily become more unstable and “less efficient” (see “Jack Bogle Envisions ‘Chaos, Catastrophe’ in Markets If Everyone Were to Index,” Yahoo Finance, 7 May 2017; see also Index Funds’ Key Flaws – and How We Overcome Them, 23 October 2023).

I conclude that, despite their risks, for many people “vanilla” (index) ETFs can be a sensible option. But for virtually everybody, factor, sector and above all thematic ETFs are poison (for background, see John Bogle, The Little Book of Common Sense Investing, John Wiley & Sons, revised and updated 10^th anniversary ed., 2017).

Factor, Sector and Thematic ETFs Generally Underperform

“Vanilla” ETFs track broad indexes like the S&P 500 and thus provide low-cost, diversified exposure to equities as a whole. “Vanilla” ETFs are hardly risk-free – yet as Table 1 summarises, owners of “non-vanilla” (that is, factor, sector and thematic) ETFs face much greater risks. These ETFs typically charge much higher fees, sometimes use heavy debt and exotic derivatives, and encourage speculators to exploit various “trends” (which, it’s likely, are merely random fluctuations).

Table 1: A Comparison of the Risks of Two Types of ETF

Jason Zweig, who writes “The Intelligent Investor” column in The Wall Street Journal, observes: “cheap, reliable exchange-traded funds are a basic building block of investing. Increasingly, however, ETFs are becoming a high-cost conduit for concentrated, risky or weird strategies. So investors need to start approaching ETFs with caution” (“How Weird Are ETFs Getting?” The Wall Street Journal, 22 May).

“This year,” he elaborates, “466 ETFs have been launched through mid-May, amassing $62.3 billion in assets, according to Morningstar. Their annual (expense ratios) average 0.69%. That’s more than 20 times those of many traditional index funds. Six out of every 10 new ETFs carry annual expenses of at least 0.5%, and a fifth charge at least 1% annually. Only 16% of the newest ETFs are index funds.”

What are the consequences? “At more than a quarter of this year’s launches, results depend on the performance of a single stock, commodity or other asset … Dozens specialize in cryptocurrencies, often seeking to double the daily return of digital assets …” “All this,” Zweig concludes, “is a far cry from ETFs that buy and hold hundreds of stocks or bonds for fees as low as $2 or $3 a year on a $10,000 investment.”

It’s vital to appreciate: non-vanilla ETFs DON’T attempt to match the returns of major benchmarks; instead, and in reaction to ever-changing “narratives,” they encourage and facilitate speculative behaviour – and therefore underperformance and outright losses – rather than long-term investing.

According to The Wall Street Journal (“It’s Getting Harder to Tell Investing from Gambling,” 17 April), “a kind of gambling fever seems to be setting in. In February and March, asset managers filed to launch dozens of exchange-traded funds that would seek to quadruple or even quintuple the daily returns on stocks and other assets, even though regulators have reportedly indicated they might not be approved.”

In an interview with CNBC on the sidelines of Berkshire Hathaway’s AGM on 2 May, Buffett warned about the gambling mentality to which many “investors” have succumbed: over the years “I’ve compared the markets to a church with a casino attached. People can move between the church and casino, and (some years) I would say there are more people in the church and (in other years) more people in the casino … Today the casino has gotten very attractive to people. If you’re buying one-day options, or selling them, I mean that is – that’s not investing, … it’s gambling.”

Buffett concluded: “we’ve never had people in a more gambling mood than now … (That means) that (today’s) prices for an awful lot of things will (at some point) look very silly.”

Bogle created the traditional index fund in order to encourage long-term and low-cost investing. The rapid growth of factor, sector and thematic ETFs, and particularly of leveraged and “inverse” ETFs, has facilitated behaviour which is hard to distinguish from gambling.

These ETFs aid and abet a “let’s bet” culture which enables speculators to gamble on stocks much like they wager on sports.

In both cases, they chase short-term jackpots through high-risk products (for details, see “Made for gamblers: How the latest investment fad may incinerate your cash,” The Australian Financial Review, 3 September 2025). Non-index ETFs enable and encourage betting, and most gamblers eventually lose.

“Bogle’s big insight,” noted The Wall Street Journal (15 May), “was not that a passive index of the entire market provided magically better returns. After all, its returns are by definition average! It was that running this passive strategy would be inexpensive, and thus wouldn’t require charging large fees to the investor clients. And it was precisely these low fees, compounded over large periods of time, that created the outperformance compared with active managers.”

People who use factor, sector and thematic ETFs pay much higher fees than those who use the lowest-cost vanilla ETFs. Partly for this reason, the former usually underperform the latter; and because factor, etc., ETFs don’t mimic index funds, their “investors” often generate losses.

Morningstar (“You’re likely going to underperform with a thematic ETF,” 14 August 2025) put it mildly: “niche fund offerings built around hot trends tend to falter when the initial excitement fades, often leaving investors disappointed.” Morningstar Global Thematic Funds Landscape 2024 explored these issues in detail. “Two key findings stand out: most thematic equity funds fail to beat a broad global equity benchmark, and over 60% of them have shut down in the past 15 years. That’s a sobering record.”

Another Morningstar analysis, The Big Shortfall (2023), found that “investors” (who’re actually speculators) systematically mismanage their entry into and exit from these vehicles. Over the past five years, “thematic funds had a total return of 7.3%, while (their) investors only earned a 2.4% return.”

Speculators in thematic funds lose over two-thirds of their potential returns because they buy high and sell low. These funds experience significant inflows when they generate high returns – and substantial outflows when the tide turns.

Yet another Morningstar study (“Should you invest in thematic ETFs?” 23 June 2025) concluded that in the three years to mid-2024 only 9%-25% of thematic funds managed to outperform broader, low-cost global equity indexes. They provide exposure to “high-growth, transformative trends;” for this reason, they usually underperform traditional index funds (see also Want to shrink your returns? Buy “growth” stocks! 23 March).

Return on Capital ≠ Return of Capital

Jason Zweig writes: “you know it’s late in a bull market when financial professionals start talking about stocks as if they were bonds. The latest example: exchange-traded funds that offer ‘bondlike’ payouts. Most income-oriented investors should be risk-averse. The high yields offered by these new ETFs come with complex, unfamiliar risks” (see “How These New Funds Squeeze 14% Yields Out of Stocks,” 1 May).

These ETFs, called “autocallable” funds, are multiplying fast. At least a dozen have debuted over the past year; dozens more will appear soon. Their strategies vary widely. But one way or another these “bondlike” funds use derivatives to generate returns that, if they eventuated, major equity indexes would be hard-pressed to match.

These ETFs pay their stated rate of income only as long as the underlying assets don’t fall more than a predetermined percentage by certain dates. They also return their principal only if the target asset reaches a prespecified minimum at maturity.

“What,” asks Zweig, “if the underlying stock or index goes down by more than the predetermined amount? Then you might not get your regular income payment, and you could even lose a hefty chunk of your principal.”

If your financial adviser recommends an autocallable ETF, ask: “what happens to my income and principal if the underlying stock or index falls and stays down?” “The answer,” says Zweig, “needs to have numbers in it, and if the numbers don’t have minus signs in front of them, your adviser is misinformed. Then ask why you would want to pay up for a ball of complexity. Annual expenses at these funds aren’t cheap.”

Zweig concludes: “with autocallable funds, you’re getting that high yield, but you’re taking on the risk of the stock market, in a very complicated way, to get it. A lot of investors or financial advisers might not understand that. Whenever there’s a choice between simple and complicated, Wall Street goes for complicated. Investors should favour simple.”

“Value” ETFs Underperform: Two Major – and Startling – Examples

Why, if value stocks excel, do “value” ETFs underachieve? Table 1 summarised one reason: “value” ETFs resemble factor ETFs rather than index ETFs. Factor ETFs, like sector and thematic ETFs, usually underperform; hence “value” ETFs generally underperform.

Table 2: Top-10 Holdings, Vanguard Value ETF (VTV), 30 March 2026

Table 2 summarises another reason: despite their names, “value” ETFs don’t hold value stocks. Let’s take Vanguard’s Value Index Fund ETF (VTV) as an example. It’s the world’s largest (currently ca. $US165 billion under management) and oldest (established in 2004) “value” ETF. It holds “established ‘blue-chip’ companies with strong track records of stability and dividend growth” – which, it’s important to note, isn’t the same as value stocks.

Table 2 enumerates its largest holdings on 30 March. Are these “value” stocks? I’ll limit myself to three brief comments:

1. To some extent, what is and isn’t “value” is a matter of judgement.
2. On that basis, several of these stocks certainly qualify. Yet it’s highly questionable that, considered as a whole, this group – and the remaining 80% of the portfolio – does.
3. Most importantly, from this portfolio I don’t discern a clear and consistent rule, such as the one which Kenneth French and his colleagues have applied since July 1926, to ascertain what’s a value stock.

As The Wall Street Journal (“AI Chip Mania Sows Seeds of Its Own Destruction,” 16 May) noted, “two weeks ago (Micron) was the S&P’s third-cheapest stock measured by price to forward earnings, and it’s still at under 10 times, tame for a highflying stock.” That’s one problem: value investors should regard consensus earnings estimates VERY sceptically (see, for example, How “consensus expectations” harm your financial health, 13 October 2025). 

Another problem is that a low price-to-earnings (PE) ratio per se doesn’t make Micron a value stock: “it just means investors recognize that the boom times in memory chips never last. Something similar happened in the mid-1980s and 1990s cycles. When it peaked in 1984 – at a level it took another nine years to surpass – it traded at only 15 times forward earnings. In the 2018 cycle the stock peaked at just 5.5 times (earnings).”

“Losses for investors who were fooled into thinking they were buying a bargain,” WSJ concludes, “were vast.” Much the same point applies to Cisco Systems, Intel and Applied Materials (Table 3).

In “Wait, Tesla Is a Value Stock? Welcome to the Wacky World of Factor ETFs” (The Wall Street Journal, 9 January), Zweig generalised some key points – and detailed some of their consequences. “When you crack open several funds that sound the same,” he found “you can find very different investments inside.”

“As exchange-traded funds have become the default choice for millions of investors (sic), it’s vital to understand that you can’t know what you’re going to get unless you take the time to look inside first.”

“To see what I mean,” Zweig continued, “consider factor ETFs … A ‘factor’ is a set of characteristics, shared by large numbers of companies, that shape risk and return – for example, value or momentum … Among funds with similar names and objectives, return differences of 10 percentage points or more were common in 2025.” He cites iShares’ Edge MSCI USA Value (return of 29.5%) and VTV (12.8%).

Why the huge disparity? According to Zweig, it’s partly because “different ETF managers define the same factor in drastically divergent ways.” (A similar point applies to bonds. See, for example, “Not All Total Bond Market ETFs Are the Same. Here’s What to Know.” The Wall Street Journal, 3 May).

Consequently, he notes, “although Tesla sounds like the polar opposite of a value stock, it meets the technical definition of ‘value’ at the indexes that several funds use as benchmarks. So such ETFs as Fidelity Value Factor, iShares Morningstar Value, iShares S&P 500 Value and State Street SPDR Portfolio S&P 500 Value all hold it as a top-10 position. Meanwhile, other funds, such as Schwab U.S. Large-Cap Value, own little or no Tesla.”

Table 3 lists the top-ten holdings of iShares’ Edge MSCI USA Value Factor ETF. Here, too, and to put it mildly, it’s arguable that collectively these are value stocks.

Table 3: Top-10 Holdings, iShares Edge MSCI USA Value Factor ETF, 30 March 2026

“So the first thing you should do when shopping for a factor ETF,” Zweig concludes, “is look at its list of holdings …” The second thing is to calculate its CPI-adjusted total returns (including dividends), expressed as CAGRs, since its inception. I calculated VTV’s since its debut in January 2004; I also compared them to value stocks (as defined by Kenneth French and his colleagues) and the S&P 500 Index. Figure 1 plots the results:

• Until 2020, the values of investments in value stocks and the S&P 500 were mostly equivalent. Since then, value stocks have underperformed the Index.
• Virtually from the start – and increasingly since ca. 2012 – VTV lagged both value stocks and the Index.
• As a result, in December 2025 the value of the three investments was $5.11 (S&P 500 Index, CAGR of 7.6% per year), $4.47 (value stocks, 7.0% per year) and $2.76 (VTV, 4.7% per year).

Figure 1: Cumulative, CPI-Adjusted Total Return of $1 Invested in January 2004

Clearly, VTV has markedly underperformed value stocks. That’s because it’s NOT a value fund: its name contains the word “value” but it doesn’t, by and large, hold “value” stocks.

Two Crucial, Apparently Unknown and Utterly Astonishing Findings

Financially, the benefits of value investing are real. Psychologically, however, they aren’t easy to obtain. Above all, it’s NOT a simple matter of selecting a “value” exchange-traded fund (ETF), relaxing and outperforming.

Value investing usually outperforms but “value” funds and ETFs seldom do. That’s because they claim that they’re “value funds,” but in fact astonishingly few actually are. Similarly, many people occasionally claim that they’re “value investors” – but very few really are.

#1 Virtually No Fund Which Claims It's a "Value Fund" Really Is

The shortcomings of “value” ETFs are more general than Table 1 and Table 2 imply. They’re also longer-lasting – and far more fundamental – than Zweig realises. Virtually no fund which contains the word “value” consistently – never mind exclusively – buys what, by a reasonable standard, could reasonably be regarded as value stocks. One recent study examined thousands of funds and ETFs; it found that the average “value” fund actually buys stocks which are closer to the “growth” end of the spectrum.

This finding explains SPIVA’s results: portfolios of “growth” stocks usually underperform major benchmarks such as the S&P 500 Index; most managed funds and ETFs – regardless of their names – hold “growth” stocks; accordingly, and as SPIVA has long demonstrated, most funds underperform major indexes.

According to Martin Lettau and his colleagues (“Characteristics of Mutual Fund Portfolios: Where Are the Value Funds?” National Bureau of Economic Research Working Paper 25381, February 2021), barely a handful of the almost 3,000 mutual funds and ETFs they examined consistently invest in the lowest (“value”) quintile of stocks ranked by ratio of book value to market price.

Astonishingly, only two of almost 3,000 managed funds and ETFs (that’s a mere 0.07%!) in their database consistently – never mind exclusively – fished in the lowest quintile of book value to market price (value) stocks. Even more incredibly, the average so-called “value” fund buys stocks which are two quintiles above the most value-oriented 20%.

The average “value” fund and ETF, in other words, is closer to the “growth” than the “value” end of the spectrum. Vanguard’s “value” ETF is an example. No wonder it has consistently – and cumulatively greatly – underperformed! (See also Want to shrink your returns? Buy “growth” stocks! 23 March.)

In an interview with The Wall Street Journal (“Want to Invest in a True ‘Value’ Fund? Good Luck Finding One,” 3 February 2019), Lettau emphasised that this startling – indeed, staggering – fact doesn’t result from the “style drift” which often occurs during and after the infrequent periods when value lags growth. At such times, in an attempt to boost their short-term returns, managers of value funds are tempted to buy popular – which are typically growth – stocks.

But that’s not what’s happening: Lettau et al.’s findings have existed since at least since the early 1980s; during these years, value has mostly outperformed growth.

Nor do these findings stem from the use of measures of value other than the price-to-book ratio: Lettau et al. reached practically identical conclusions when using alternatives such as price-to-earnings ratios, price-to-cash-flow ratios and dividend yields.

Why are genuine value managers so rare? Lettau et al. nominate a key cause.

It’s not just “mums and dads:” professional funds managers find it just as difficult, psychologically, to purchase unpopular (which are usually value) stocks – no matter how strong value’s historical outperformance of growth. Like retail “investors,” most of whom are actually speculators, so too the alleged experts: they’re too impatient to wait for value stocks to outperform.

John Meynard Keynes highlighted the tendency to prefer safe – that is, conformist – failure to risky, non-conformist success. In The General Theory of Employment, Interest, and Money (1936), he noted the strong preference of professionals, particularly investment professionals, to follow the crowd and protect their reputations rather than think independently: “worldly wisdom teaches that it is better for reputation to fail conventionally than to succeed unconventionally.”

What I observed in Why Value Investing Outperforms (29 April) is important to repeat here: at crucial junctures value investors must be contrarians, yet most people – including those whose job is allegedly to think and act independently – dread analysing and acting for themselves.

Value investors, on the other hand, embrace independent thoughts and deeds. They are, in Buffett’s phrase, “fearful when others are greedy and greedy when others are fearful.” Most people, however – including wannabee “value” managers – take the easy option and run with the consensus: they’re fearful when others are fearful and greedy when others are greedy.

It’s human nature: contrarians – and thus genuine value investors – can never comprise more than a miniscule minority of market participants.

Kent Daniel, a professor of finance at Columbia University whom WSJ cited, agrees: by the time a stock’s price-to-book ratio falls into the lowest quintile (20% of all stocks), it’s often suffered several years of poor performance. And if it’s lagged the market so long, it takes a rare degree of courage to buy it.

Why are there virtually no genuine value ETFs? After all, they typically benchmark a specific index; hence managerial discretion plays no role in their selection of stocks. But behavioural factors can influence an ETF’s composition in other ways – such as in the choice of the index to which it’s benchmarked.

According to Lettau et al., almost all of the supposedly value-oriented ETFs are benchmarked to subjective, vague or non-standard metrics of value. Non-value benchmarks, in turn, beget non-value portfolios, and non-value portfolios generally underperform.

#2 Very Few Who Claim They’re “Value Investors” Actually Are

Value investing is often – I’m tempted to say usually – misunderstood, misused or improperly applied. As a result, many “investors” (who, unwittingly or otherwise, are actually speculators) label themselves “value investors” when they’re actually pursuing something altogether different and comparatively risky.

Value investing, as championed by Graham and Buffett, isn’t a technique: it’s a philosophy which requires character and discipline – and particularly patience and relentless focus upon signal over noise.

The legitimate value investor cautiously estimates the extrinsic value of a business, and purchases its securities when its price is significantly lower than this estimate of value. The wannabee value investor, on the other hand, obsesses about companies’ current “story” – and discounts their long-term finances, earning power, cash flows, debt, etc.

True value investors regard themselves as part-owners of businesses. They’re comfortable holding a company for years and regardless of short-term market noise. The wannabee value investor regards stocks as short-term “plays” – and panics and sells when their prices keep falling.

Above all, the proper value investor thinks and acts independently of the crowd – and at suitable junctures defies it. She buys when others are fearful and sells when they’re greedy. The faux value investor, on the other hand, is easily swayed by market sentiment, trends and “hot stocks” – and lacks the discipline to hold boring, undervalued companies while glamorous “growth stocks” soar.

“Value investing” often becomes popular when speculators become anxious. During bull markets, spectators are exuberant – and thus shun the label “value investor.” During corrections and bear markets, however, they grasp the label in order to benefit from its association with safety and Buffett’s wisdom. However, it’s far easier to claim to be a value investor than to deliver the consistent, long-term returns which genuine value investors tend to achieve.

Value investing is ultimately a matter of character rather than merely of intellect. Yet try as they might, wannabees can’t fake temperament.

How, Then, to Identify a True Value Investor?

How, then, can you reap the benefits of value investing? DIY is one option; another is to locate one of the very few vehicles which invest in value stocks. To avoid choosing a “closet growth” fund, inspect a candidate’s history and holdings – and ignore its name and glossy marketing materials. Four activities are most important: 

1. Exclude anything whose track record is less than ten years. Of those which remain, compare results expressed as CAGRs (for details, see How you – and managed funds – overstate your returns, 17 October 2024).
2. Expressed as CAGRs, how has each candidate fared – in absolute terms and compared to a relevant benchmark – since its inception? During the Dot Com Bust, GFC, COVID-19 panic and in June 2022 and March 2026? If it hasn’t generally outperformed during downdraughts, crises, etc., remove it.
3. Inspect each candidate’s holdings. Are they (or were they when acquired) legitimate value stocks by some consistently-applied and reasonable standard? Or are they popular and expensive “growth” and tech stocks? If the latter, exclude it from your list of candidates.
4. How long, on average, does it hold securities? If the average is less than five years, remove it from consideration.

The end result of this rigorous process of culling will be a VERY short list!

Factor, Sector and Thematic ETFs are Addictive Poison

It’s ironic: John Bogle founded the passive “index” fund in the 1970s as a low-cost and low-risk – relative to a broadly-based index – means to encourage and facilitate long-term investing; over recent years, however, factor, sector and thematic (and particularly leveraged and inverse) ETFs, which are usually high-cost and high-risk, have become today’s principal tools for short-term speculation. 

Jason Zweig likens them to “high-price investment junk food.” I go further: they’re poison. It’s vital that you understand my analogy.

Many substances which are toxic in high doses can nonetheless be beneficial when they’re dispensed in small and strictly-controlled doses over limited periods of time. This principle, often summarised by the maxim “the dose makes the poison,” is the basis for a variety of medications – apparently including common treatments for heart disease, diabetes and chronic pain – derived from toxins.

It’s therefore conceivable that a very few factor, sector and thematic ETFs, administered in small and doses by competent people for limited periods, can occasionally play a legitimate and positive role in some investors’ portfolios.

However, as with toxins so too with such ETFs: risks (namely the high probability of abuse) will, for most people, greatly outweigh potential rewards. ETFs – particularly factor, sector and thematic ETFs – are the opioids of the financial world. The benefits of poisons exist; crucially, however, they presuppose competent administration and oversight, and small doses strictly time-limited consumption.

Poisons dispensed as medications become harmful when taken inappropriately, excessively or indefinitely; when abused, their risks rise exponentially.

That, I suspect, summarises most people’s use – that is, unwitting misuse – of ETFs. With few exceptions, they’ve become convenient and popular instruments of rank speculation. If their “investors” (who, inadvertently or not, are speculators) are lucky, they’ll experience mere disappointment; if they’re unlucky, they’ll suffer significant loss.

“Australia’s ETF market is set to hit $380b, up 400pc in six years,” The Australian Financial Review reported on 22 April. “Millennials and Gen Zs are piling into exchange-traded funds amid a volatile share market that has been rocked by the Iran war and interest rate rises.” According to State Street Global Advisors (see “Why ETFs are vogue despite recent turmoil,” The Australian, 30 April 2025), “65% of millennials in Australia had ETFs, higher than Generation X (44%) and Baby Boomers (31%).”

These figures bring to mind an old Wall Street joke: “in the beginning, the investor has the money and the hedge-fund manager has the experience. In the end, the hedge-fund manager has the money and the investor has the experience.”

In the years to come, I suspect that this gag will replace “hedge fund” with “factor, sector and thematic ETF” – and that Millennials and Gen Zs won’t be laughing (see also Don’t trust any “investor” under 30, 28 April 2025).

Conclusion: You Have Just Two Sensible Options

Despite its absurdly misleading title, “The $7 strategy that’s minting millionaires” (The Weekend Australian, 1-2 November 2025) imparts several crucial truths:

• “There are two broad types of (ETF) – passive (index) funds that track a particular index such as the S&P 500 or (S&P/ASX) 200, and active funds where investment managers choose particular stocks or themes.”
• For decades, comprehensive and rigorous research has consistently found that at least 80% of actively-managed funds – including actively-managed ETFs – underperform major indexes.
• “… the Warren Buffett maxim, ‘don’t invest in something you don’t understand,’ holds true for ETFs. (And) watch out buying ETFs that are rising rapidly. These are often higher-risk … and could fall just as rapidly.”
• “ETF providers are great at promoting fads …”
• “Look at the cost, look at the risk, and look at the track record, (don’t) just assume that all ETFs are equal and a safe, conservative and low-cost investment.”

“Life wasn’t meant to be easy,” said a protagonist in George Bernard Shaw’s play, Back to Methuselah, “but take courage: it can be delightful.” Many people often waste considerable time and energy resisting the obvious fact that life inevitably throws challenges and obstacles – and sometimes tragedies – into our paths. Accepting that difficulties and hardship are natural parts of the journey provides a strong incentive to cease what’s useless (complaining and fantasising) and commence what’s essential (learning and taking appropriate action). 

Squarely facing and bravely surmounting challenges, Shaw reminds us, is exactly what makes achievements so rewarding.

Speculators – which these days includes many advocates of ETFs – however, seek the “secrets” of financial markets; they also crave quick-fixes to difficulties and short-cuts to higher returns. They reject the basic truth that what’s worthwhile is seldom easy. As in theology, so too in investing: Gnosticism is rubbish. There are no secrets, and no easy paths, to solid long-term results. If you want to replicate (net of a small fee) the return of a major index such as the S&P 500 or S&P/ASX 200, you have only one alternative: a “vanilla” index fund. Since the early-1980s, their long-term results have been gratifying.

However, and as I demonstrated Figure 8 of Australian versus American equities: past, present and future (24 November 2025), there’s strong reason to expect that these results won’t continue indefinitely; if so, then index investors will eventually experience disappointment and perhaps appreciable loss.

Similarly, if you want solid long-term results – which over the past century have mostly exceeded major indexes’ – as well as the plausible likelihood (which is hardly a guarantee) that over the next 5-10 years this outperformance will resume, you have one and only one alternative: you must become a value investor.

You have, in effect, (1) a sensible and relatively simple option and (2) a justifiable and more complex one. Borrowing Benjamin Graham’s terminology, the first option suits the conservative investor; the second one suits the enterprising investor.

Value usually outperforms the S&P 500 Index; hence it’s the potentially more remunerative option. To reap the benefits of value investing, you must devote considerable time and effort to (a) learning and doing it yourself, and/or (b) locating one or more of the handful of value investors worthy of the name (as opposed to the very large number of impostors, opportunists and wannabees).

Emotionally it’s hard, but financially the rewards of value investing are significant. Being a momentum, growth and small cap speculator, on the other hand – as well as a holder of factor, sector and thematic ETFs – is socially easy because it’s popular.

But monetarily it’s ultimately costly because the odds are long: over the years, and compared to value investors and the Index, they’ll probably generate subpar – or worse – results.

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