If you haven't shifted some of your clients' into a value fund by now, shame on you. Those relics of the Old Economy are back in vogue.
Growth funds have dominated the market for the past 10 years ended in 1999. But in the latter half of 2000, rising oil prices, high-profile earnings disappointments, and election-year uncertainties, drove investors to defensive investments. Value funds provide a cushion against changing economic times and market conditions. Of course, there's no telling how long the ride will last. The third quarter offered stark evidence that there are rarely any sure bets.
Growth -oriented technology stocks fell from grace, ranking as the worst- performing sector in the third quarter. 'Technologies' downturn benefited active managers, who on average are underweight in this sector versus the indexes,' says Brad Lawson, senior research analyst at Frank Russell Co., the Tacoma, Wash., firm that computes the Russell 2000 and other indexes. 'It was a strong quarter for managers who focus on valuations,' he adds.
Among small-cap stocks, the Russell 3000 Value Index outperformed the Russell 3000 Growth Index in six of the first nine months in 2000 - particularly in the third quarter, when the value index reported a 5.7% gain to the growth index's 5.2% loss. Meanwhile, the Russell 2000 Growth Index (11.1%) trounced the Russell 2000 Value Index (5.6% loss) during the same time frame.
Value funds belong in a balanced portfolio. But that doesn't mean you should advise clients to dump growth funds, which could rebound when market conditions change. However, there are good reasons to allocate significant assets to value funds. Short-term market swings aside, value funds tend to produce slightly better returns than growth funds - without the added volatility. During the 72-year period from 1928 through 1999, the average annual return of value stocks was 13.3%, vs. 10.2% for growth stocks, a Chicago-based financial research firm.
To pick a winning value fund for your clients, choose a disciplined manager. A good value manager must have the steely resolve to buy beaten-down stocks due for a rebound - and to maintain courage if the investments don't pay off immediately.
Using a database provided by Morningstar, the Chicago-based research firm, we screened for value funds makes them good bets for your clients.
Lord Abbett Mid-Cap Value (LAVLX)
This 17-year-old fund, with approximately $600 million in assets in three share classes, is the most diversified and traditional of the three funds in our screen. Co- managers Edward K. von der Linde and Howard Hansen focus on companies with a potential catalyst. 'We're not strictly mechanical in using a price-to-book or low P/E strategy,' Hansen says. 'Usually, situations we invest in will have these characteristics, but we will not buy unless the catalyst for change is present. We search for absolute values. We don't play the relative game,' he adds.
The managers focus on companies with market capitalizations ranging from $1 billion to $10 billion. To minimize risk, no single stock may represent more than 5% of the fund's total assets.
'They've got a very clear investment process. It involves some proprietary models for screening and some in-depth fundamental research,' notes Philip Edwards, director of managed fund services at New York-based Standard & Poors. The fund is one of 10 select funds in S&P's mid-cap value style sector.
The portfolio typically holds from 50 to 70 stocks diversified across most economic sectors. Last year the fund benefited from its exposure to the utility, energy, and healthcare sectors, which held reasonably steady against the market's turbulence. Tech stocks were notably absent. 'While we were light in technology coming into (2000), we eliminated our exposure in the first quarter of last year,' Hansen says.
Through Oct. 31, the fund posted a 19.4% five-year average annual return for its Class A shares, handily outdistancing most of its peers. Year-to-date through mid-November, the fund was up 35.9%.
Third Avenue Value (TAVFX)
This $1.9-billion fund managed by Marty Whitman delivered a 19.56% annualized return through Oct. 31, outperforming the S&P 500 and the Russell 2000 Value Index during this period. Year-to-date, through mid-November, it was up 19%.
Whitman, who also manages the Third Avenue Small Cap Value fund, is a deep value manager, though not a bottom fisher, he says. 'We buy when stocks have dropped, but we don't try to pick bottoms,' he adds.
Whitman's mantra is 'safe and cheap' -- in that order. To qualify as 'safe,' a company must have competent management, an understandable business, and an exceptionally strong balance sheet. 'Cheap exists when we pay no more than 50% for what we think the common stock would be worth if the business were a private company or takeover candidate,' Whitman says. Many of his holdings actually are acquired - Whitman estimates there are three to five takeovers a quarter.
Whitman's intense analysis makes for a fairly concentrated portfolio. In fact, his 10 largest holdings, with a median market cap of $1.4 billion, comprise about 40% of the approximately 105-stock portfolio.
'They've got a very stable management team,' says Russ Kinnel, a senior analyst at Morningstar. 'Their analysis is very rigorous and very different. They're looking for companies that don't have to have that many things go right, and they'll still be okay.'
Weitz Value (WVALX)
Wally Weitz, manager of this $2.9-billion fund, has carefully avoided jumping into high-tech stocks. Thus, his Omaha, Neb.-based fund hardly suffered during the year's volatile second and third quarters.
'We almost never own tech,' says Weitz, who believes that technology becomes outdated so quickly that it's difficult to identify the companies that will sustain long-term growth.
Weitz, who also manages the Weitz Partners Value Fund, has a disciplined, bottom-up approach. 'We try to understand what a rational, informed investor would pay for the whole business, and to buy shares at a significant discount to that business value,' he says.
The fund's portfolio holds about 75 stocks at any given time. Of these, the top 10 holdings typically account for 35% to 45% of the fund's assets.
Although he's often classified as a mid-cap manager, Weitz considers companies of all sizes. The fund concentrated on the banking, telecommunications, and financial services sectors in recent years. 'We have no preconceived sector preferences, but when the best bargains happen to cluster in three or four areas, then we're willing to have a portfolio concentrated in those areas,' Weitz says.
This makes short-term performance more volatile, and the fund sometimes seems out of step with the general market on both the upside and downside. 'We try to avoid the risk of permanent loss of capital, but we do not try to avoid short-term volatility,' Weitz cautions.
The fund's long-term track record is one of the category's best. It returned an average 20.8% annually for the 10-year period through Oct. 31, vs. 19.4% for the S&P 500. Year-to-date through October 2000, the fund was up 9.1%.