Tech rush knocks down nonbelievers

Mutual Funds

Value managers who refused to go with flow lose lofty rankings

June 04, 2000|By Scott Cooley | Scott Cooley,MORNINGSTAR.COM

The fates, which were once so kind to value purists, have not recently smiled upon some of the discipline's most revered fund managers.

In the second half of 1997, a Barron's magazine manager ranking, entitled "Simply the Best," found Oakmark Fund's Robert Sanborn in the top spot. By early 2000, after two years of abysmal returns, he was out of a job.

Two years ago, Bill Dutton's Skyline Special Equities boasted the best 10-year record of any offering in the category. After a double-digit 1999 loss and amid many redemptions, Skyline merged two other funds into Special Equities.

And just a couple years back, David Dreman was the toast of Wall Street. In 1999, his flagship Kemper-Dreman High Return Equity shed 13 percent of its value and a significant part of its shareholder base.

Against this backdrop, some value managers have managed not only to survive but also to thrive. Bill Miller's Legg Mason Value Trust has beaten the S&P 500 index for nine years running. Chris Davis has steered Selected American to peer-beating returns for five years in a row. Third Avenue Value manager Marty Whitman has also continued to generate excellent returns.

What separates the consistently good managers from those who recently haven't made the grade? Put simply, the less successful managers made some big bets, and they did not pay off.

Unless you have been living under a rock, you know that, until recently, technology stocks have been on fire. One factor that took a huge toll on Sanborn, Dreman and Dutton was an almost total lack of technology. Among the three, Dutton is the biggest tech bull, with a 3 percent stake.

Given that technology accounts for more than 30 percent of the overall stock market, that amounts to a huge sector bet.

Value purists are understandably queasy about many tech firms' lofty price/earnings ratios. But look at it this way: By shunning technology, they're avoiding the risk of owning overvalued, high-P/E stocks, but instead they're taking on the risk of betting on the wrong sector.

A growth fund that places 60 percent of assets in tech stocks arguably isn't making a larger sector bet than a value fund with nothing in the sector - both are 30 percentage points away from the market norm.

There have been many opportunities to buy tech on sale. During 1998, when Dreman and Sanborn were buying Philip Morris, one of Davis' favorite tech stocks, IBM actually traded at a discount to the tobacco firm (relative to operating earnings). HP, Texas Instruments and Intel, among others, also have been priced at discounts to the broader market at times.

Chip stocks were dirt cheap in the wake of the 1997 Asian economic crisis. Whitman scooped them up, and Dutton did not. Miller started buying Dell Computer and America Online before they became market darlings, and then - unlike most value managers - was wise enough to hang on for the ride.

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