Small-Growth Funds Gaining on Value Funds

With relatively few exceptions, stock mutual fund investors enjoyed another stellar quarter in the three months ended Sept. 30.

But exactly how well you did depended not just on the broad category of stocks that your fund owned, but on the specific niche that it targeted.

And those performance differences among niche categories could become more pronounced in the current quarter--which means it’s a good idea to have some sense of the niches your fund managers favor, if any.

Example: Many fund investors know that smaller stocks, in general, were the place to be last quarter. The average small-stock fund gained 16.6% in the quarter, according to fund-tracker Lipper Analytical Services in New York.

By contrast, growth-and-income funds, which target big, blue-chip stocks, gained 9% on average.

But within the small-stock fund universe, the funds that favor “growth” stocks--typically fast-growing, higher-risk issues--outperformed the funds that favor “value” stocks, which typically are less risky issues that sell for below-average price-to-earnings ratios.

Value issues had been the market’s favorites for much of this year in the small and mid-size stock sectors, as many investors who decided to bet on those sectors chose to play it relatively safe.

In the first nine months of the year the average small-value fund was up 30.3%, versus a 23.2% gain for the average small-growth fund, according to fund tracker Morningstar Inc. in Chicago.

But in the third quarter the average small-growth fund rose 17.7%, while the average small-value fund gained 14.9%.

“I think we’re in transition” from a market that favors value stocks to one that favors growth issues, said A. Michael Lipper, head of Lipper Analytical.

Some investment managers who parcel clients’ money among fund categories agree. Werner Keller, whose Sherman Oaks-based FundMinder manages about $1 billion for clients, says he added two small-growth funds--Berger Small-Company Growth and Kemper Small Cap Equity--to his main account mix in September.

But he also is keeping Pennsylvania Mutual, a small-value fund, in the mix. “Even though it feels like growth stocks are coming on, value is still doing very well too,” Keller said. He thinks that’s an indication that the small-stock move in general has a lot of life left in it, as those issues catch up after three years of lagging blue chips.

Sheldon Jacobs, editor of the No-Load Fund Investor newsletter in Irvington-on-Hudson, N.Y., also recommended that clients beef up their small-stock investments in the third quarter. But he is sticking with small-value funds, such as Neuberger & Berman Genesis.

His reasoning: If the market overall suffers a sharp decline--as it did in spring--high-priced growth stocks will again bear the brunt of it, while value stocks will suffer less.

Jacobs also says that, while the small-stock rally may continue in the near term, “I still think it’s a large-cap stock market in the long run.” Investors may have turned wary about some blue-chip issues because of short-term earnings concerns tied to the dollar’s strength overseas, Jacobs says, but he still believes that big companies are the primary beneficiaries of some major trends in the world, including booming global trade and low interest rates.

How can you tell your stock fund’s specific niche? If it isn’t obvious from the fund’s literature, call and ask. Most funds should at least be able to tell you the general size of the stocks they favor, and whether they employ a growth or value orientation--or, in the case of many funds, whether they favor neither, but rather buy a blend of growth and value.

Does the growth-versus-value debate matter in the long run? Morningstar data show that, over the last 10 years, growth-stock funds have beaten value-stock funds in all three niches (big stocks, mid-size stocks and smaller stocks).

The average annualized return on big-growth funds has been 13.4% over the last decade, versus 11.5% for big-value funds. Small-growth funds’ average was 13.5%, versus 11.6% for small value.

That performance split makes sense: If growth stocks are riskier, they should produce a higher return--albeit with more volatility--than value stocks over time.