These are heady days for deep-value funds

They do very well as relative-value investors suffer

Dollars & Sense

March 24, 2002|By Scott Cooley | Scott Cooley,MORNINGSTAR.COM

This is a good time to be a deep-value fund.

With the market favoring companies with genuine, current profits, funds with purer takes on value investing have done relatively well over the past year. For example, Dodge & Cox Stock and American Funds Washington Mutual Investors, which both prefer financials and industrial cyclicals over technology issues, have performed extremely well during the past 12 months.

Both posted gains in the 12 months that ended Feb. 28. Dodge & Cox Stock has benefited from gains on decidedly old-economy companies such as Bank One and Union Pacific, while Bank of America and International Paper are among stocks giving a boost to American Funds Washington Mutual Investors.

As much as value funds have thrived, relative-value investors have suffered.

Value offerings that devote an above-average percentage of assets to technology stocks, including Selected American Shares and Legg Mason Value, have stumbled, posting large losses over the past year.

Tyco International's accounting woes have hurt Selected American early this year. Meanwhile, Legg Mason Value's Bill Miller has a great track record, but he has misfired on a number of telecom picks and a few tech stocks.

The past few years also serve as a good reminder that even longer-term trailing returns can be heavily influenced by one or two extreme years of good or bad performance.

A couple of years ago, relative-value investors' long-term returns trumped those deeper-value funds. The champs of a few years ago have become this year's chumps, and at some point, the market will shift gears again and favor faster-growing companies. Therefore, we advise investors to think long and hard before selling a relative-value fund such as Legg Mason Value. We think a lot of these funds will bounce back strongly in a more-favorable market environment.

Legg Mason Value Prime: With more in tech and telecom than his typical rival, Bill Miller trailed the peer group last year, and he's off to a terrible start this year. But he did beat the S&P 500 index last year, for the 11th year in a row, thanks to the strength of old-economy stocks such as Waste Management.

Miller did a lot of his shopping last year in the beaten-down tech and telecom arenas, and the performance of those picks will go a long way toward determining whether he beats the index for a 12th straight year. Although those issues have faltered this year, we're not worried: Miller's record over the past decade is nearly unparalleled.

Vanguard Growth & Income: The key for this fund is how it's faring vs. the S&P 500, because it is an enhanced-index fund. As a result, its sector weights are tied to those of the S&P 500 index, and its calendar-year returns track it fairly closely.

Thus, it fills the same niche in a portfolio as a large-blend fund. Over time, management's computerized stock-picking models have added to returns by focusing on companies with attractive valuations and strong earnings momentum.

Selected American: Chris Davis and Ken Feinberg look for great companies whose stocks are temporarily depressed. They didn't fare well last year: American Express faltered badly and the fund's tech stocks took it on the chin. And last year's year-end top holding, Tyco International, has gotten pummeled, as investors wonder whether its complex accounting will make it the next Enron.

Dodge & Cox Stock: Management typically looks for companies that have good growth prospects but are cheap on traditional measures such as P/Es. It then holds them for the long haul, which has meant it has paid out small capital-gains distributions in most years.

American Funds Washington Mutual A: This fund offers just about everything a value fund should: good long-term returns, little downside risk, high tax efficiency and a low expense ratio.

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