Suddenly, The Password Is `Value'Jeffrey M. Laderman
Some 18 months ago, Robert Martorelli watched in amazement as recession-wary mutual-fund managers flocked to supergrowth stocks such as Amgen, The Gap, and Home Depot that could prosper in a sick economy. "We saw incredible values as people threw away stocks that didn't have earnings momentum," says Martorelli, who runs the $240 million Merrill Lynch Phoenix Fund, which invests in unloved and unwanted companies. So, he selected investments "for the upturn"--and waited. The fund logged a respectable 37% total return in 1991. But that was far behind funds that had loaded up with high-octane growth stocks.
Now, with the economic recovery in hand, Martorelli's patience is paying off. His fund was up 18.69% for the first quarter (through Mar. 27), the best growth fund and fifth-best of some 1,200 equity funds tracked by Morningstar Inc. Now, it's Martorelli and his unglamorous stocks, such as Anacomp, National Semiconductor, and Navistar International, that are looking snazzy.
The eclipse of growth stocks by economically sensitive or "value" stocks was the most dramatic shift in a market that, on the surface, looked placid. The Dow was up about 2%, the Standard & Poor's 500-stock index down 2.8%. The average U.S. diversified equity fund neither made nor lost money. That may disappoint those who piled a record $14.2 billion into equity funds in the first two months--a figure that could easily reach $20 billion when March sales are tallied. Investors tend to buy last year's winners, and those who picked 1991's hot growth funds were more disappointed.
The move away from high-growth stocks was evident in the largest funds: Twentieth Century Select Investors, a growth-stock fund, slid 7.29% during the quarter. By contrast, the Windsor Fund, which makes big bets on cyclical companies, delivered a 4.52% return (table). Even more graphic evidence: The quarter's top-performing fund specialized in one of the U.S.'s most cyclical industries. Fidelity Select Automotive Fund (table) jumped nearly 25% on the rally in auto stocks. The fund's assets under management exploded, too, going from $2.4 million at yearend to $82 million by the end of March.
ILL HEALTH. Health care funds, previously regarded as the prescription for investment success, took the worst drubbing--an average loss of 10.77% for the quarter. Oppenheimer Global Bio-Tech, which soared 121.1% last year to become the best-performing fund of all, dropped 13.82%. Fidelity's Biotechnology, Health Care, and Medical Delivery sector funds, all among last year's top 20, have taken ill, too. They're taking up the rear along with the long-suffering Japanese and precious-metals funds.
Compared with the health care funds, the diversified growth-stock funds that led the charge last year just have the sniffles. Of 1991's top 10 growth funds, six are in the red so far this year. Still, the worst of the lot, the Janus Twenty Fund, was down just 7.94% in 1992--hardly a serious stumble after last year's 63.9% climb.
Not all of last year's leaders were dethroned. Financial specialty funds, for instance, are still riding high. In 1991, financial-services companies rallied mightily as interest rates dropped dramatically. Although interest rates are creeping up this year, the financial funds are still eking out gains. That's because investors now figure that banks and thrifts, heavily represented in these funds, have the worst of their losses behind them. Strength in the financial sector is also bolstering more diversified funds with major holdings in financial companies. "Finance stocks are important for us," says Heiko Thieme, manager of the American Heritage Fund, one of the few 1991 leaders that is still leading. His fund reaped about a third of its 16.67% return from financial stocks.
Small-company funds, whirlwinds in 1991, are still making gains. But among funds that invest in small stocks, there was a changing of the guard, too. Again, high-growth has been giving way to value issues with rock-solid fundamentals.
A typical example: Last year's red-hot Montgomery Small Cap Fund, which built a stellar 98.7% return with shrewd investments in high-growth emerging companies, is off 5%. Now the leading small-company fund is the more sober Heartland Value Fund, up 19.74%. Like Merrill Lynch Phoenix, Heartland kept pace with its peer group last year, but it really broke away from the pack in January. Like Phoenix, it invests in companies with good fundamentals that are out of favor with investors. They include companies in prosaic businesses, such as auto parts and small-town banking, which are cheap by most investment yardsticks. Says Heartland portfolio manager William Nasgovitz: "We never buy a stock with a p-e greater than 10."
ILLIQUID. Not surprisingly, other top-performing funds--Pioneer Capital Growth, Babson Enterprise, and Skyline Special Equities--also practice small-cap value strategies. Even more telling is that two top funds, Colonial Small Stock Index, up 16.09%, and the DFA U.S. 9-10 Small Company Fund, up 13.89%, are index funds that buy the smallest-capitalization stocks. Last year, they underperformed the average small-company fund; this year, they're beating all but two. The reason is that most small-cap managers shoot for fast-growing, leading-edge companies. The indexes, on the other hand, include the hundreds of mundane small companies that are more dependent on the economy for growth. It is those stocks, longtime laggards, that are now on the make.
While managers who buy Philip Morris Cos. and Exxon Corp. can deploy dollars easily, it's harder for those who invest in small-company stocks. Information about the companies is hard to find, and the stocks are often illiquid. That's why the Fidelity Low-Priced Stock Fund, which went from $200 million in assets to $800 million in just seven weeks, shut its doors on Mar. 9. "We need time to put that money to work," said Neal Litvack, senior vice-president at Fidelity. Other small-company funds that closed during the quarter include Montgomery Small Cap and Babson Enterprise.
Although the first-quarter performance derby was clearly won by the cyclical, or value-stock, players, the growth-stock portfolio managers have not cried "uncle." The case for health care stocks, for instance, is based on an aging population and new medical technologies, not on the economy. Should the recovery prove weak, investors could dump the economically sensitive stocks and return to reliable growth stocks--and the growth funds that soared in recent years will resume their flight.
Investors should get an idea of which way the winds are blowing when companies report first-quarter profits in coming weeks. If the cyclicals are still not up to speed, the value funds' newfound celebrity status may be short-lived.