Growth funds doing well
Here’s something to think about as you rebalance your mutual fund portfolio at the end of the year: Growth stocks, largely out of favor for the last several years, outperformed value stocks in November and maybe positioned for a comeback in 2006.
Professional investors and fund managers have been finding attractive opportunities in growth for months now; in fact, growth has been performing well relative to value since May, said Stephen Wood, portfolio strategist with Russell Investment Group. This could signal a shift in the longer-term investment cycle.
“In the past five years, value has done OK, but the real story is that growth has been getting clobbered,” Wood said. Now that it’s started to take off, he added, “We don’t think growth will roll over and go belly up. Once a style comes into favor, it tends to stay there for years. You just had the fifth year of a value cycle. Do you get a sixth year? You could. But I’m not convinced we’ll see it.”
When financial professionals speak of growth investing, they usually are referring to stocks with strong earnings and revenue growth, or growth potential. This strategy differs from value investing, a style favored by bargain hunters like Warren Buffett, which seeks profits by accumulating shares of companies that are underpriced by fundamental measures. The theory behind value investing is that stocks like this won’t stay unloved forever.
In November, good performance among tech stocks helped the broad-market Russell 3000 Growth Index post a 4.4 percent gain, compared to a 3.4 percent advance for the corresponding Value Index. The Value Index still holds the lead for the year, but its advantage has narrowed to less than a percentage point: It was up 6.34 percent for the first 11 months of 2005, compared with a 5.49 percent rise for the Growth Index.
This doesn’t mean you should dramatically realign your holdings. But if your portfolio is overweight in value funds and stocks, it is probably a good time to reassess your exposure to growth. Fund flows suggest our tolerance for risk is already on the rise. According to TrimTabs Investment Research, of the $2 billion that poured into domestic equity funds the week ended Dec. 7, more than a third went into aggressive growth.
Another potential influence on the outlook for growth is monetary policy. The Federal Reserve appears likely to continue to raise interest rates into the new year, which could have a dampening effect on the economy in 2006. That doesn’t necessarily signal a bad year for value, but it could mean the characteristics of growth stocks will be more prized.
The key for small investors is to rebalance every year in a disciplined manner. For example, over the last five years you might have sold the shares of value funds that did well and bought shares of underperforming growth funds. In the short term, this might seem counterintuitive. Why buy a loser? But over the long term, you’d have the advantage of accumulating shares of growth funds cheaply. You’d automatically buy low and sell high.
You don’t have to take on a lot of risk to get exposure to growth. You can have a footprint in it through a blend fund that invests in both types of stocks. The main thing is to not let your emotions dictate your allocation, or your rebalancing decisions, said Wood.
“The human mind likes to stick with things that have done well recently, it’s less painful,” he said. “It’s human nature to have short-term memory dominate your analysis. The battle for investors is to screen out how they’re feeling.”