Success may diminish value stock funds' appeal
Prosperity poses a ticklish problem for everyone who practices the art known as value investing.
Value investors, in their perennial quest for overlooked bargains in stocks and other markets, thrive on obscurity and disfavor. The more success they enjoy, the farther they may find themselves from their natural habitat. And they have had an unusual run of success lately.
After trouncing their growth-fund rivals for five straight years since the end of the 1990s, value stock mutual funds have done it again in the first half of 2005. The competition isn't even close.
One standard-bearer of value investing, the Vanguard Value Index Fund, showed a 3 percent year-to-date gain through the middle of last week, while its opposite number, the Vanguard Growth Index Fund, was up 0.2 percent.
Last year, according to Bloomberg data, the Value Index fund gained 15.3 percent, more than doubling Growth's 7.2 percent payoff. Over the last five years, Value has gained 3.5 percent a year while Growth has sustained a 7 percent annualized loss.
This comes as sweet vindication for the value crowd, with memories still fresh of a period in exile during the growth-led bull market of the 1990s. In 1998, the Growth Index fund rose 42.1 percent, almost tripling Value's 14.6 percent gain. In 1999, Growth was up 28.8 percent, Value 12.6 percent.
So why isn't everybody in Valueville smiling? Something in the very nature of value investing doesn't love the spotlight.
As gains increase among any group of stocks chosen by value criteria, they naturally tend to lose their attraction for value investors.
Five years ago, says William Nygren, manager of the $6.7 billion Oakmark Fund, opportunities abounded among ''grossly undervalued companies that have failed to attract investor attention." While a smattering of technology stocks and other growth favorites commanded price-earnings multiples of 50 times earnings or more, many other more mundane stocks languished.
Since then, Nygren writes in a recent website commentary, ''the range of [price to earnings] has narrowed so much that we believe the better values today are generally the superior businesses. Values across industries and market capitalizations appear much more rational, meaning it will be harder for stock pickers to add as much value over the next five years."
Nygren says he thinks a value manager can do well shifting his sights from the bargain basement to looking for above-average firms trading at average prices. Other value managers take a darker view.
''We are fearful of the investment environment," writes manager Robert Rodriguez in a letter to shareholders of the $1.8 billion FPA Capital Fund, which at last report had more than a third of its assets in cash.
Investors are ''searching for higher returns in a low-return world," Rodriguez says. ''They are moving out on the risk curve, whether they realize it or not."
Because of this, Rodriguez says, he is especially bearish on a favorite industry among many value investors, financial services. While bank, insurance and other financial-services stocks recently made up more than 20 percent of the Standard & Poor's 500 Index, Rodriguez says he had only 2.1 percent of FPA Capital's money in that sector.
Growth-stock partisans say all this may bode well for a comeback on their side of the market. This hope was neatly expressed in the title of a panel last week at Morningstar Inc.'s annual mutual-fund conference in Chicago: ''Is growth the new value?"
To some value investors, such questions miss the point. In absolute, rather than relative, terms, they say values today are just plain scarce.
''Unrealistic requirements for business growth or investment returns are driving strategies that are perverse in today's low-return environment," Rodriguez says. ''This is one of those times when it requires a great deal of patience, discipline, and conviction to maintain a contrarian position."
Chet Currier is a columnist for Bloomberg News. 
