Returns of Value Managers Have Faded in Growth Funds' Shadow
By RICHARD A. OPPEL Jr. -- April 4, 1999
Think value investors have it tough these days?
Just ask William Nasgovitz, portfolio manager of
the Heartland
Value fund, whose own mother recently tried to pull her
money out of the fund.
"My mom wanted to buy Walgreen at 50 times earnings and
sell out of the value fund after making six times her
money," Nasgovitz said. "It's a great company, but it
isn't worth 50 times earnings."
He eventually persuaded his mother to stay put.
Recently, however, his son Will admitted to buying an
index fund. "Another little dagger," Nasgovitz said.
And there are many more. "Clients, consultants and
advisers are all tired of talking value," he said.
"They want action."
"Action" in this case really means one thing: big
growth companies and the funds that invest in them.
Value managers like Nasgovitz have long shunned what
they view as overvalued growth stocks like Pfizer or
Wal-Mart, trading at 40 times earnings or more.
Instead, they favor stocks with lower price-to-earnings
or other valuation ratios.
But that has lately brought grief for their
shareholders, as stocks relatively cheap by traditional
measures continue to be clobbered by the big growth
companies that have paced the enormous run-up in the
Standard & Poor's 500-stock index.
In fact, according to Morningstar Inc., large-cap
growth funds beat large-cap value funds by an average
of nearly 25 percentage points over the last 12 months,
the widest margin this generation. The trend held in
the first quarter of 1999, with large-cap growth funds
turning in an average return of 6.9 percent, versus 0.9
percent for comparable value funds. Mid-caps and small
caps, which have trailed the large caps over all, have
shown similar disjunction, with growth funds wildly
outperforming their value siblings.
As for Nasgovitz's small-cap value fund, it lost 8.3
percent in the last quarter, slightly less than the
average for its peer group.
The desperate straits of value managers have begun to
alter the investing landscape. While investors in the
funds are the most obvious sufferers, entire fund
organizations are being disrupted.
Some experts are questioning the accepted wisdom that
investors should hew closely to a specific investment
style. And the plight of the value manager is not
helped by the fact that no one seems sure why value
stocks have underperformed so much in the last four
years.
After being stalwart in their loyalty, longtime value
fund shareholders have begun to bolt: So far in 1999,
three-quarters of the funds with the largest investor
withdrawals have been value funds, according to AMG
Data Services, a company in Arcata, Calif., that tracks
mutual fund sales. Investors have pulled $10.3 billion
from those 15 funds this year, with the biggest net
withdrawal -- $1.2 billion -- coming from the
once-storied Vanguard Windsor.
Meanwhile, so far this year, a total of $9.6 billion
has poured into the two most popular growth funds, the
Janus 20 and the Vanguard Growth Index, together with
the Vanguard 500 Index.
The role of value funds -- especially those of the
large-cap variety -- as a mainstay of the individual
investor's portfolio has been diminishing. Just over a
year ago, investors had $2 invested in large-cap value
funds for every $1 in large growth funds, according to
Financial Research Corp., a data gatherer in Boston.
But that ratio has narrowed, to $2 in the value funds
for every $1.40 in the growth funds -- a result of
market gains, sales of value fund shares and purchases
of growth fund shares.
And the trend is accelerating. About 98 percent of new
money flowing into equity mutual funds this year has
gone to growth funds, according to J.P. Morgan
Securities.
Fund companies with a value bent are feeling investors'
pain. Shares of Franklin Resources, a big value and
international mutual fund manager, dropped 47.1 percent
in the last year as some of its best-known funds,
including the Mutual Series funds, lagged substantially
behind the market. (By comparison, shares of Kansas
City Southern Industries, which owns the red-hot Janus
funds, have jumped almost one-third over the last 12
months to near an all-time high, as its assets have
soared 60 percent.)
But as Nasgovitz can attest, it is the value managers
themselves who have borne the brunt of the storm.
Poor performance recently led the Vanguard Group's
chief executive, John J. Brennan, to hire stock-pickers
from Sanford C. Bernstein to take over part of the
Windsor fund portfolio run by the value manager Charles
Freeman, a longtime protege of the legendary Windsor
manager John Neff.
And last month Jean-Marie Eveillard, the value manager
at Societe Generale, saw the demise of a deal to sell
the company's asset management unit to Liberty
Financial after $2 billion in losses and investor
withdrawals from his company's mutual funds. "It has
been four years of basically crossing the desert," said
Eveillard, who owns 20 percent of the money management
unit. "If one was not in big growth stocks, one was
pretty much left with the crumbs."
For all the disruption, there is no consensus on what
has caused the gap between value and growth to be so
wide, or on when it will close.
Some managers think that with the advent of a new,
technology-driven economy -- where economic cycles are
far longer than they have been in the past -- it could
be many years before value stocks return to favor for
an appreciable period.
But more managers cite a combination of temporary
issues. Among the big factors over the last two years,
many say, were the economic crises in Asia, Russia and
Brazil that moved money managers to buy the big
technology and stable multinational consumer-goods
companies that proved, quarter after quarter, that they
could sustain profit growth even in rocky times.
Growth stocks were driven up further, they say, by what
is sometimes called "closet indexing" -- the purchase
of the largest-capitalization stocks in, say, the S&P
by active fund managers. Some managers moved into these
big growth stocks simply because they grew tired of
missing out on the market's momentum.
The rush to Internet stocks also played a role in
helping growth funds, some said, while day traders --
the ultimate momentum players -- became market movers
in their own right.
Low interest rates, meanwhile, allowed bullish analysts
and investors to justify ever-increasing P/E multiples.
Plummeting commodity prices, driven lower by waning
Asian demand, socked energy and natural resources
companies, core holdings of many value portfolios.
Avoiding commodity companies was the biggest reason
that the $31 billion Vanguard Windsor II fund beat so
many other value funds last year, said the fund's
manager, James Barrow. "The metals and heavy chemicals
and things like that, those stocks were just terrible
last year," said Barrow, whose fund rose 16.4 percent
in 1998 but still trailed the average large-cap growth
fund by nearly 20 percentage points. Last quarter, it
rose 2.1 percent.
Managers have been feeling increased pressure from fund
companies and 401(k) clients to stick with an investing
style, be it large-cap growth, small-cap value or
whatever, no matter what the market might do. Now, some
value managers have rethought the way they appraise the
value-growth distinction.
Of course, some have long been flexible. "It boxes you
in," said Charles Royce, who manages $2.3 billion in
value-oriented portfolios at Royce Funds, referring to
the tendency to pigeonhole managers into narrow
classifications. "It's defining what kind of stocks you
buy, as opposed to what you think is the most
interesting opportunity."
"We buy growth stocks when they're depressed, but we're
a value manager," Royce added. "If the style police
were looking over our shoulder, they would probably
raise that issue."
Investors are less likely to do so: His funds have
generally lost less money in the last year than the
average small-cap value fund.
Barrow, the Vanguard manager, does not criticize value
managers who are riding high on some high-valuation
stocks, like William Miller of Legg Mason Value Trust,
a large-cap fund that rose 49.9 percent in the last
year on the back of high P/E stocks like Dell Computer
and America Online. "I'd rather have his numbers, and
try to explain away his idea of value, than have mine,"
Barrow said.
Few people, of course, predict the death of value
equities, which have outperformed growth stocks for
long periods in the past.
Jeremy J. Siegel, a professor of finance at the Wharton
School of the University of Pennsylvania, has noted
that from 1962 to 1989, stocks with the lowest P/E
ratios performed far better as a group than stocks with
the highest. And studies by Eugene Fama, a University
of Chicago finance professor, have shown that over long
periods, stocks with lower price-to-book ratios
outperform those with higher ratios.
But this does not mean that value investors will feel
better anytime soon.
The divergence between growth and value could continue,
said George Sauter, manager of the $78 billion Vanguard
500 Index fund. "Just because valuations would point
more to value stocks and small-cap stocks doesn't
necessarily mean performance has to shift there," he
added.
Sauter predicted that value stocks would eventually
make a comeback but warned that investors should not
base their decisions on when that will happen.
Stock-picking "is child's play next to trying to call
value and growth cycles," he said.
Value fund investors may have to swallow one last
bitter pill anyway. While many investors think that the
relatively low price-earnings and price-book ratios of
value stocks provide a cushion during market
corrections, that has not been true lately. Large-cap
value and growth stocks fell about the same amount
during the October 1997 selloff, while value stocks
actually declined slightly more than growth stocks
during the correction last summer.
Few value managers dare to predict when their
turnaround might come, but they say that higher
inflation or a strengthening economy would be strong
catalysts. Some of them say, optimistically perhaps,
that the recent 37 percent jump in oil-service stocks
could be a harbinger. And others say growth stocks
could underperform value stocks if the Internet bubble
popped or if technology companies' growth abated after
worries over the Year 2000 computer bug passed.
A turn could come soon, Douglas Cliggott, U.S. equity
strategist at J.P. Morgan, has argued. His research
indicates that the last time stocks had such high
valuations -- measured by comparing bond yields with
the average P/E ratio of the S&P 500 -- was about seven
years ago, when value stocks began a two-year period of
sharp outperformance over growth stocks. Moreover, he
thinks value stocks will be spurred by an upturn in
global economic growth in the coming year.
And Eveillard of Societe Generale said things were so
out of whack that companies might take matters into
their own hands. He predicted that a wave of corporate
arbitrage -- in which large growth companies buy
smaller value companies by trading their own richly
valued stock for the lower-valued shares -- might soon
wash through the markets. The big companies could add
to their per-share earnings even while paying huge
premiums.
"As always, when a strong trend has been in place for a
few years, there is no lack of people who rationalize
why what has been true will continue to be true -- in
other words, that value, and particularly small value,
will never come back," Eveillard said. "If I thought
so, I would retire."
c.1999 N.Y. Times News Service
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