- The Washington Times - Wednesday, March 3, 2004

For investors trying to decide whether to put more money in value funds or growth funds, the current market offers little guidance, although recent returns show value might have a slight edge.

Throughout last year, growth funds had a modest advantage, as they often do in strong markets. Since the start of 2004, however, value funds have outpaced them, according to research firm Lipper Inc. The largest difference can be seen in the large-cap area, where value funds have had a return of 3.5 percent since Jan. 1, while growth funds gained only 2.36 percent.

With the market’s short-term outlook uncertain, most financial professionals recommend that investors continue to hold a mix of both styles. If you’re looking to make small adjustments around the edges of your portfolio, however, it’s usually best to do it in a way that runs counter to marketplace trends, said Emily Hall, senior mutual fund analyst with Morningstar Inc.

“You don’t necessarily want to run up your growth exposure after growth has had a huge run, like now, because you might be getting in at higher price levels,” Ms. Hall said. “You don’t want to chase past performance.”

For a novice investor, the words “value” and “growth” might hold equal appeal, but they can have vastly different meanings on Wall Street. Often a matter of debate, choosing a strategy frequently boils down to personal preference.

Value investors are bargain shoppers. They seek out underpriced companies with strong fundamentals that have temporarily fallen out of favor. Value funds tend to be less volatile because they focus more on safety than growth, often investing in more mature companies that pay dividends.

When professional investors explore growth stocks, they’re usually looking for companies with great potential that will give returns in the form of future earnings appreciation. Growth managers are always on the lookout for the next big thing, and often invest in rapidly expanding young companies, making their funds more volatile. To them, the steady, plodding performance of value stocks seems dull.

Yet academic research has shown consistently that value investing produces better returns over time — up to 7 percent a year on average, said Lubos Pastor, a finance professor at the University of Chicago Graduate School of Business. This “value premium” seems to support the theories of famous investors such as Warren Buffett and his mentor, Benjamin Graham, but academics are still trying to understand why the strategy has such an edge.

Two theories offer explanations of why value outpaces growth, Mr. Pastor said. One is that investors become irrationally optimistic about growth stocks, overreacting to good news only to realize their mistakes when returns diminish later. The other possibility is less intuitive: Some researchers have suggested that the seemingly staid value stocks are actually a riskier investment overall.

The risks associated with growth investing are usually firm-specific, and can be offset by holding a larger number of companies so the successes and failures average out, Mr. Pastor said. But recent research argues that value investing poses different and potentially greater risks that cannot be countered by diversification. Some researchers suggest this is because value companies as a group may be more susceptible to market downturns.

“This is one of the most interesting questions in empirical research,” Mr. Pastor said. “If you do not believe it’s true that value stocks are riskier than growth stocks, then you should buy value. If you believe it is true, and various studies suggest it’s not clear, you should be indifferent. It all depends on your perception.”

Followers of either belief can possess almost-religious intensity, but sometimes the lines between value and growth blur. Because money managers conform to these strategies to varying degrees, you should never assume anything about a fund just because it has the word “value” or “growth” in its name.

Rather than subscribe to either, Sheldon Jacobs, editor and publisher of the No-Load Fund Investor, prefers funds that blend value and growth strategies.

“If you think about it, if you’re in a fund with a certain style, you’re guaranteed to be a laggard at some point,” Jacobs said. “Whereas if you bought a fund that is not style-specific in theory, the management could go wherever the leadership of the market goes.”

No matter what approach a fund takes, you should always look closely to see how its holdings fit in with the rest of your portfolio. Focus on what kind of risks you’re willing to take, and how much volatility you can stomach.

“The small investor should go with their gut. I ask my clients, can you sleep at night with this choice? What can go wrong? Well, things could go south. How far south? Well, if you’re in growth, to zero,” said Peter Calfee of Calfee Financial Advisors Inc. in Cleveland, who also prefers a blended approach. “The everyday investor needs to have balance.”


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