The Value Line Enigma

On Wednesday, we discussed the highly touted CAN SLIM strategy. However, it's a story we've heard before. The following is an excerpt from my book What Wall Street Doesn't Want You to Know about another publication purported to have astonishing returns: the Value Line Investment Survey.
The Value Line Investment Survey has an incredible track record. Value Line touts its market-beating track record in advertisements hawking their services. Even Fischer Black, one of the fathers of the EMH, once stated that Value Line's results were a big exception. Black concluded: "almost all Wall Street firms would improve performance if they fired all but one of their security analysts, and then provided the remaining analyst with the Value Line Service."

A logical conclusion would seem to be that if anyone could beat the market using Value Line's advice and strategy it would be Value Line itself. To test this hypothesis an investor could compare the performance of Value Line's funds with the performance of comparable benchmarks in the form of Dimensional Fund Advisors (DFA) passively managed asset class funds. The Value Line fund, classified as a large-cap growth fund by Morningstar, returned 17.14% per annum over the 15-year period ending June 30, 1999. Value Line also runs the Value Line Leveraged Growth fund, also a large-cap growth fund. It returned 18.47% per annum for the same period. The DFA Large Company Fund, an S & P 500 Index fund, outperformed both, returning 19.06% per annum. Value Line also runs the Value Line Special Situations Fund, a small-cap growth fund. Its return for the same 15-year period was 12.08% per annum. This compares to the returns of the two DFA small-cap funds of 12.52% per annum (DFA 6-10 fund) and 12.39% per annum (DFA 9-10 fund). The DFA 6-10 fund basically buys all the stocks that are ranked by market capitalization in the bottom half of all stocks (deciles 6-10). The 9-10 fund buys the smallest 20% (deciles 9 and 10). Value Line has a newer fund, the Value Line Small-Cap Growth Fund. Its 5-year performance for the period ending April 30, 1999 was 14.81% per annum. This compares to the returns of 15.81% (6-10 fund) and 15.71% (9-10) for the two DFA funds. In all cases the Value Line funds underperformed their proper benchmarks.

Investors should also consider that these return figures are all pretax. Since the Value Line funds are actively managed and the DFA funds are passively managed, for taxable accounts the underperformance of the Value Line funds would in all likelihood have looked even worse. The greater turnover of actively managed funds results in greater capital gains being realized and greater taxes having to be paid.

What accounts for the underperformance? First, a publication's recommendations carry none of the operating expenses of a mutual fund. Neither do they incur transaction costs in the form of commissions, bid/offer spreads, and market impact costs (a mutual fund buying or selling large blocks of stocks will likely drive the price against itself, increasing the transaction's cost). Another explanation is that the funds might not have exactly followed Value Line's own recommendations. And, of course, publications pay no taxes. It is worth noting that Hulbert estimated that if an investor followed Value Line's stock picks, buying only stocks rated 1 and selling any that were subsequently downgraded to 2 or lower, the investor would have experienced a turnover rate of about 200% per annum. The implication for investors is that they would never have earned the returns implied by the recommendations and advertised by Value Line since the recommendations carry no transactions costs or taxes (200% turnover will generate substantial expenses and taxes).

My book was published in 2000, so I have updated the data (all returns are for the 10-year period ending June 30):

• The Value Line Fund (VLIFX) has lost 5.9 percent per year, while the MSCI US Midcap 450 Index returned 3.2 percent per year. The fund has done so poorly it carries Morningstar's one-star rating and now has less than $100 million of assets.
• The Value Line Leveraged Growth Fund is now Value Line Larger Companies Fund (VALLX). It lost 4.1 percent per year, while the S&P 500 lost 1.6 percent a year.
• The Value Line Special Situations Fund is now Value Line Premier Growth Fund (VALSX). It gained 0.3 percent per year, while the MSCI US Midcap 450 Index returned 3.2 percent per year.
• The Value Line Small-Cap Growth Fund is now Value Line Emerging Opportunities Fund (VLEOX). It returned 2.6 percent per year, underperforming the MSCI US Midcap 450 Index by 0.6 percent per year.