BUSINESSWEEK ONLINE : NOVEMBER 20, 2000 ISSUE
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Value Funds: The Old Economy's Old Reliables
A great way to hedge and a proven long-term winner

Does your mutual-fund portfolio contain a mix of the past few years' winners? Then it's probably filled with names such as Janus Twenty ( JAVLX), Amerindo Technology ( ATAHX), and Munder NetNet ( MNNAX). But with tech, telecom, and the whole Internet sector--the mainstay of those funds--on the ropes this year, the former superstars are bleeding red ink.

That's why you should consider long-neglected ''value'' funds, which hunt for bargain-priced stocks. Value players typically focus on unglamorous Old Economy industries such as banking, manufacturing, energy, and utilities. But a new breed seeks bargains in pricier sectors, including technology, as well. After six years of spotty performance, value funds are on the upswing. Since the tech-heavy Nasdaq index peaked on Mar. 10, value funds are up 14.6%, vs. a 13.2% decline for growth funds, as of Nov. 3.

Unfortunately, many fund investors are merely watching value's comeback. Over the past two years, investors have yanked $128 billion out of value funds--or about 20% of the assets in value funds now. Between withdrawals and portfolio losses, value funds now account for only 13% of fund assets, down from 20% in 1997, according to Financial Research Corp. With many investors' portfolios skewed toward growth funds, ''a little rebalancing would be appropriate,'' says Philip Edwards, managing director at Standard & Poor's, which, like BUSINESS WEEK, is a division of The McGraw-Hill Companies.

Even if technology snaps back, it makes sense to own some value funds. For one thing, value and growth stocks don't move in lockstep, so exposure to both styles provides a safety net when one is out of favor. Indeed, in October, value funds offered investors refuge from a falling market, gaining 1.5% even as the average domestic equity fund lost 2.7%.

SHIFTING DEFINITION. Moreover, although growth stocks have dominated since 1993, value investing remains the better long-term performer. Over the last 70 years, value stocks clocked a 13.4% average annual return, vs. 10.2% for growth stocks, according to Ibbotson Associates. Still, because it's difficult to predict which kind will do better at any one time, it's important to invest in both camps.

How much of your portfolio should be in value depends on how much risk you want to take. Value funds appeal to conservative types because they are less volatile than funds that buy growth stocks, which are prone to big price swings. Even New Economy zealots should use value to temper the gyrations in tech-heavy funds. ''All of our clients, even the most aggressive, have something in value,'' says Ronald Roge, a financial advisor in Bohemia, N.Y.

Convinced you want to invest in value funds? Be forewarned: Fund managers don't all see value the same way. ''Don't assume that because something is called a value fund it's going to be what you expect,'' warns Chris Traulsen, a senior analyst at Morningstar.

When conceived in the 1930s, value investing meant buying stocks that sell for less than the value of a company's tangible assets, such as its property, plants, and equipment. Typically, this yields portfolios heavy in manufacturing and natural-resource stocks. Examples are the Franklin Large Cap Value and Babson Value funds ( BVALX).

Later, investors such as Warren Buffett added a new twist. They recognized that intangible assets--such as famous brand names and unassailable franchises--that don't show up on balance sheets can have value, too. Buffett bought consumer companies such as Coca-Cola ( KO), which was not cheap by traditional value measures. Gabelli Blue Chip Value ( GABBX) also invests in this manner.

The newest generation of value investors embraces the New Economy. They estimate future cash flows--a metric more common to growth managers. And if they think something is undervalued, they'll buy it--even if it's a technology stock selling at prices that would make traditional value buyers cringe. The champion of this new approach, Legg Mason Value Trust ( LMVTX), has made plays on America Online ( AOL), Dell Computer ( DELL), and Amazon.com ( AMZN). Not only did it blow away its value peers but it has beaten the Standard & Poor's 500-stock index for nine straight years. Some other funds that take this road: Selected American ( SLASX) and Excelsior Value & Restructuring ( UMBIX).

X-RAY VISION. Although most value funds don't fall neatly into one camp, a quick way to figure out where a fund stands is to look at how expensive and tech-heavy it is compared with its peers. Take the Oakmark Select Fund ( OAKLX). Although 16% in technology, the fund still looks cheap, since its price-to-earnings ratio of 17.4 is 22% below that for mid-cap value funds. Its price-to-book-value ratio of 3 is also well below the category's average of 4.1.

In contrast, PBHG Focused Value ( PBFVX) looks expensive. At 29.1 and 5.5, its p-e and p-b ratios are above the averages for large-cap value funds of 25.3 and 5.4. It's no wonder, since 32% of the fund's assets are in technology, as opposed to 14.4% for the category.

Make sure to check both a fund's p-e and p-b ratios. Since many beaten-down companies post losses, ratios that take only earnings into account are not always reliable. As a final check, read a prospect's annual report. It contains a snapshot of its holdings on a specific date, as well as an overview of its investment philosophy.

Which type of value fund makes sense for you? It depends on what else is in your portfolio. One way to figure out what percent of your assets are in value vs. growth is to plug your holdings into the Portfolio X-Ray feature at Morningstar.com for a breakdown.

If you are heavily skewed toward growth, a traditional value fund--likely to be one with low p-e's--is the better choice. The new value funds, with higher p-e's, own a fair amount of tech stocks and may duplicate more than they help diversify your portfolio. Indeed, since the Nasdaq peak, the most expensive third of value funds (measured by p-e and p-b ratios) have trailed the cheapest third.

New value funds can play a role in a portfolio, offering a middle ground between shoot-for-the-moon growth funds and bottom-feeding value players. But if you really need to offset a tech-heavy portfolio, nothing does it like an old-fashioned value fund.

By ANNE TERGESEN

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