The Plight of the Value Investor

(page 2 of 2)

"This is a Bill Miller problem and not a value problem," says Adam Bold, chief investment officer of the Mutual Fund Store.

Still, the same problems that have tripped up Miller in the past couple years have hurt a wide range of value investors. Repeatedly, investors hunting for bargains have purchased financial stocks, only to see the shares' value plummet even further. It was a classic "value trap," says Matt Kaufler, manager of Touchstone Value Opportunities Fund (CCEVX).

Allure of Financials

Many value managers are saying, "These are the best valuations on financials I have ever seen in my whole life," Bold says. Even if you acknowledge the problems facing banks and other financial firms, the sector seems priced for "absolute disaster," an unlikely outcome, he says.

Miller's holdings include JPMorgan Chase (JPM), down 5.5% this year; and insurers Aetna (AET), off 31%; American International Group (AIG), down 54%, and UnitedHealth Group (UNH), which has fallen 51% this year.

In his recent letter to investors, Miller said he was "quite aware of our mistakes, both of commission and omission," but he also argued for some optimism about the financial sector. "It is obvious the credit crisis will end, and it is obvious the housing crisis will end, and that credit markets will function satisfactorily and house prices will stop going down and then start moving higher," he wrote.

Is Value Passé?

If Miller and other value investors appear out of step with the times, it may be because of this hopefulness. Value investing is fundamentally an optimistic philosophy, believing, as Miller puts it, that "stock prices will be higher in the future than they are now."

But stocks are trading below not only their recent records, but also their values in early 2000—meaning that stocks as a class have been a lousy investment for the entire decade so far. Meanwhile, home values are falling, commodity prices have risen, and inflation worries are heating up.

In such a pessimistic environment, many may wonder if the value philosophy still works. In the past month alone, investors have pulled more than $1 billion from large cap value funds, a larger percentage than outflows from growth or blend funds, according to TrimTabs Investment Research.

Patience Required

But value managers claim to see gloomy times like this as a great opportunity. "We tend to be pretty active when the environment is ugly," Intrepid's Travis says. For investors obsessed with the fundamental value of stocks, a market correction can offer shares at long-term bargains.

For the time being, however, a persistent downturn could mean more mediocre returns for Miller and value funds in general. "With value, sometimes you have to be more patient," Bold says. It can take a while before Wall Street comes around to a value investor's point of view on stocks that have been overlooked, or in some cases decimated, by the market, he says.

It's inevitable that rough periods hit investors who make bold bets that differ from the market's conventional wisdom, says Karen Dolan, director of fund analysis at Morningstar. "The more important thing is, 'How do they do over the long term?'" she adds.

Bruised But Not Beaten

For Miller, the question may be more specific, relating to his abilities as a manager. Is the magic gone?

Miller still has the confidence of Morningstar's fund analysts. Miller seems to have learned some lessons, but he and his associates are "not panicking and veering from their successful long-term strategy," Morningstar's Carlson wrote after a visit with Miller and his staff. "We wouldn't be surprised to see the fund go from worst to first again."

But Miller has his doubters, to say the least. Miller's losses are so large, and his underperformance so persistent—stretching back to 2006"that it's past time to give him the benefit of the doubt, Bold says. "Enough's enough."

Kaufler, however, defends his fellow value manager. "I would not count him out," he says. "I know some people are starting to write his epitaph. I would not be one of them."

Steverman is a reporter for BusinessWeek's Investing channel.