Just a Few Mutual Fund Thoughts for Volatile 2009 Markets
Most managed mutual funds fall into one of two philosophical camps: value or growth.
Typically, Value managers are the bargain shoppers of the stock market. If they don't think a stock is cheap enough, they don't buy. What makes a stock cheap? This is where picking funds can get confusing because every value investor has a slightly different way of assessing bargains.
Growth investors buy shares of corporations whose profits are rising faster than those of others in the industry or the market as a whole. Some growth managers look at rising cash flow, the amount of money a business generates minus the cash it spends, because cash flow is thought to be less vulnerable to accounting manipulation.
Growth stock investors often pay high prices for stocks of companies they believe will continue to boost profits. Sometimes, as in the tech bubble, the belief isn't justified.
Value investors often buy beaten-down stocks that seem cheap. But as the financial services meltdown has shown, depressed shares can get more depressed. For that reason, value managers tend to be long-term investors.
Returns of Value and Growth Stocks
Now to the so what question? Who cares whether a stock, fund or portfolio is value, growth or a blend? As always, we have to look to the past. History tells us that a value fund has greater risk, but with that risk, comes higher returns. One analysis shows that from 1979 to 2003, annualized returns for value stocks was 14.5%, compared to just 12.5% for growth. Because of this, some suggest that a portfolio designed for the long term, say at least 10 years and preferably 15 or 20, have more invested in value funds than growth funds.
However, Two Styles Are Better than One
Given this parity in long-term results, the choice of which style to hold in a portfolio may seem unimportant. But to an investor concerned about volatility—the ups and downs in performance—there’s more to consider. Growth and value stocks historically have been cyclical, trading leadership (display below). Those swings in performance are not only hard to endure emotionally, they can also adversely affect a portfolio’s long-term returns.
Growth and value are highly cyclical
Active value and growth managers have likewise tended to outperform at different times: The premiums of active value and growth managers had a negative 0.21 correlation to each other from 1981 through 2003. But that very cyclicality can be turned to advantage. Since the two styles are successful at different times, combining them in one portfolio can create a buffer against dramatic swings, reducing volatility and the subsequent drag on returns.
Getting the kind of diversity that different styles offer when combined may be the safest play in volatile markets such as those we see continuing in 2009.
