Growth funds may gain in tilt versus value

For more than three years now, value mutual funds have outperformed growth funds in their perpetual stock-market contest.

But growth, some experts say, may be nearing a renaissance, as the economy gradually turns around. "It's definitely time to start buying growth stocks," says Peggy Farley, head of Ascent/Meredith Asset Management, in New York.

Growth vs. value is probably the longest-lasting dichotomy within the mutual-fund industry. Growth funds traditionally contain firms such as Coca Cola and McDonald's whose earnings and revenues are expected to rise rapidly. On the other side, value funds hold firms whose assets are selling for less than their intrinsic value. Such firms, including Washington Mutual, Cigna, and Berkshire Hathaway, tend to have low price-to-earnings or price-to-book ratios. (The latter compares stock prices with the value of a firm's total assets.)

But lately, growth funds appear to be loading up on a good number of value stocks to boost returns. Meantime, not to be outdone, some value managers are dipping into growth stocks.

Confusing? Yes.

What is certain is that investors are chasing performance. Current investor dollars "are pouring into value funds," says Avi Nachmany, director of research for information firm Strategic Insight in New York.

In March, some $40 billion flowed into stock mutual funds, the second-best month ever for the fund industry. "Some $15 billion of those dollars went into value funds," says Mr. Nachmany. Only "several hundred million dollars" went into growth funds on a net basis. "Investors are saying, 'I'm more confident about the stock market and the economy than in the past year or so, but I'm going to put my money into what has worked in the past.' "

The lopsided groundswell to value makes some investment managers such as Ms. Farley nervous. "It is definitely time to be a little contrarian," she says, remembering the huge amounts of money that flowed into technology stocks in the late 1990s – and then disappeared seemingly overnight.

Farley, for her part, looks for "inexpensively priced" growth companies. She likes Applied Materials; Adtram, a maker of high-speed digital products; and Medtronic, a medical-device maker. Among sectors, she sees potential gains in technology (computer and chip-makers, semiconductors); heathcare, and, to a lesser extent, biotechnology.

"Investors should own both value and growth shares," says Sheldon Jacobs, who publishes the No-Load Fund Investor, a newsletter in Ardsley, N.Y. While value remains on top, Mr. Jacobs believes that a turnaround to growth cannot be discounted if the economy suddenly springs to life. "When we do get a new bull market, growth will do better than value," he says.

Jacobs says that, if he were to choose by style, he would have 60 percent of current assets in value, and 40 percent in growth – and then flip flop the numbers as the economy swings into full-scale growth.

Meantime, some value managers are adding growth shares to their portfolios – both to be ready for a possible shift in investing style, and because of the attractive share prices among many growth stocks.

"We are looking at some technology [growth] companies that may have some potential," says Richard Rosen, co-manager of the J.&W. Seligman Large Cap Value Fund, as well as Seligman's Small Cap Value Fund.

Among traditional growth-oriented firms he is looking at: IBM and Apple Computer. (He currently holds some IBM shares.)

One factor that may give a slight boost to growth funds in the months ahead (at least, in the eyes of investors) involves the nation's best-known fund-ratings system. Morningstar plans to change its popular star-coded rating system starting July 1. Currently, only five growth funds receive the highest- ranked five-star ratings, compared with 43 value funds.

By contrast, 168 growth funds have one-star ratings, compared with only 10 value funds.

No doubt the higher returns of value companies in the past several years have led to the higher ratings, as well as the fact that so many value funds are fairly new, which helps rev up their short-term gains.

But the new ratings system, according to Russ Kinnel, who heads up equity research for Morningstar, is more finely calibrated and should cast a better light on growth. It will compare each fund with its category peers rather than the entire fund universe. The end result, he says, will be to "more effectively" determine if a fund manager is actually adding gains to his portfolio.