Talk about a tease. The spring rally in value stocks melted as quickly as an April snowshower, and 1999 is shaping up to be another disappointment for value investors.
Growth investing is on track to beat value for the sixth consecutive year, and the ninth time in 11 years, with the Standard & Poor's Barra Large Cap Growth Index up 14.51% through October, compared with a 9.28% gain for the S&P Barra Large Cap Value Index.
That gap spells more grief for value investors and more redemptions for beleaguered value money managers who were giddy with hope in the second quarter, when the value index (up 10.80%) raced ahead of the growth index (up 3.83%) thanks to optimism about the global economy.
These investors need reassurance soon, as over the past 20 years growth stocks have outperformed value stocks 20.3% to 17.2% on a compound annual basis, according to calculations by James Floyd, a senior analyst at the Minneapolis-based institutional research firm Leuthold Group.
Value stocks -- loosely defined as those with a low price-to-earnings ratio relative to the average for the market -- tend to outperform growth stocks during periods of rapid expansion because of their cyclical nature. They are concentrated in the industrial, basic materials, energy and financial services sectors.
But things turned ugly again in the third quarter, with interest rate jitters rattling financial stocks and earnings disappointments by stocks -- from Mattel to Lockheed Martin -- favored by value managers. The value index plunged 9.23%, while the growth index dropped only 3.49%.
"Until performance returns, we are unlikely to see any real meaningful flows (into value funds)," says Dave W. Haywood, director of research at Boston-based Financial Research Corp. "Investors in mutual funds certainly chase performance."
$100 BILLION DIFFERENCE
Indeed, value funds continue to experience hefty redemptions. Investors yanked $28.9 billion out of value funds through September, while a whopping $70.4 billion flowed into growth funds, according to FRC.
"Shareholders continue to throw huge amounts of money at the funds that have done well in the near term," says Robert J. Sanborn, manager of the $5 billion Oakmark Fund.
His large-cap value fund, however, isn't one of them. It has suffered outflows of $2.3 billion through September.
Things in the value camp may get worse before they get better.
Some experts say it will take a recession and/or bear market to humble individual investors who are responsible for the run-up in big growth stocks like Microsoft Corp., Intel Corp. and Cisco Systems.
"You are going to have to throw some real fear into the hearts of growth investors," says Leuthold's Mr. Floyd.
"It will take a recession or bear market to get people to think about risk and return, and not just return."
He says value stocks would benefit in such an environment because the market would ultimately rise in anticipation of renewed economic growth.
"The public needs to lose a little more of their overconfidence to convince people that value investing is OK," he adds.
That may take some "well-publicized growth blowups," says Larry Sondicke, senior vice president of Franklin Mutual Advisers, the Short Hills, N.J.-based value shop that runs the Mutual Series funds. It is a subsidiary of Franklin Resources Inc. in San Mateo, Calif.
According to FRC, investors have yanked $6 billion from the Mutual Series funds this year, with the largest outflows from Mutual Shares and Mutual Beacon, mid-cap value funds that were up 6.14% and 8%, respectively, through September. The S&P Barra Mid-Cap Value Index was down 4.62% for the same period.
"We've had some outflows, but nothing that we've had any difficulty managing through," says Mr. Sondicke, co-manager of the $8 billion Mutual Shares and $4.5 billion Mutual Beacon.
The funds, he says, are performing well this year despite the value slump, thanks in part to some "special situation" holdings.
Chicago-based Telephone and Data Systems, for instance, has risen about 39% to $111 per share since mid-September, when it announced plans to merge one of its subsidiaries with a publicly traded wireless telephone company in a stock-swap deal.
"We know value is a style that works. We are sticking to our knitting. The weakness creates opportunities to buy meaningful positions that we couldn't own at these prices," he adds.
Post-earthquake traUMA
Still, when value finally comes back into vogue, the landscape will have shifted dramatically.
Some value managers have already lost considerable market share. Some have branched out into growth investing in an effort to round out their offerings. And some have latched onto pricey tech stocks in an effort to keep pace with the market.
"You have a lot of people who have left the value universe and have moved to 'New Value,'" says Franklin's Mr. Sondicke, referring to managers who have snapped up high-flying tech stocks. "Some may believe that the world has changed and that value needs to change with it."
Among the fund shops with a value bent that have slipped in ranking during the past year are newly public Neuberger Berman, which dropped to No. 50 from No. 42; Pioneer Group, which fell to No. 34 from No. 33; and Oakmark funds, which has dropped out of the top 50 altogether, according to FRC.
It's easy to see why Neuberger has slipped. This year, its funds have had outflows of $3.2 billion, twice the amount for all of last year. Most of this year's redemptions have come from its flagship Guardian large-cap value fund, which was down 3.25% through September.
"The pendulum has become pretty stretched in favor of large-cap growth to the exclusion of other parts of the market," says Michael Kassen, chief investment officer of New York-based Neuberger.
But "extremes tend not to stay so extreme," he says, adding that next year is likely to be marked by "synchronized global (economic) expansion," which bodes well for value stocks.
"In that environment, a lot more companies will have the prospect of pretty good earnings," explains Mr. Kassen.
Nonetheless, Neuberger has hedged its bets. During the last couple of years, it has brought in a cadre of investment management talent in an effort to boost performance and added growth funds. It continues to expand its growth lineup, with plans to roll out a large-cap growth fund by yearend.
"People buy mutual funds looking through the rear view mirror. As performance improves, we will move back into our traditional position of net inflows as opposed to outflows," says Jeffrey B. Lane, Neuberger's president and chief executive officer.
