When in Doubt Over Growth or Value, Try Blend

Growth stocks. Value stocks. Who needs the headache of trying to choose?

Performance data from recent years show that so-called blend mutual funds--which hold a mix of growth and value stocks--give investors what they would expect: returns that more or less split the difference between the two very different disciplines.

Large-stock blend funds, for example, produced an annualized return of 20.5% in the five years ending June 30, according to fund-tracker Morningstar Inc.

That was less than the 25% annualized return of large-growth-stock funds in the period, but well above the 14.9% return of large-value-stock funds.

The idea of simplifying a portfolio with a blend fund may be appealing to many investors today, given the intensified debate over which investing discipline--growth or value--will perform better in the near future.

“In most cases you might as well just buy a blend fund,” said John Rekenthaler, Morningstar’s director of research.

Growth funds typically target highly valued stocks of companies whose earnings are expected to grow rapidly.

Value funds, by contrast, tend to focus on beaten-down or unappreciated stocks priced at relatively low levels compared with earnings.

Blend funds, as the name implies, can mix stocks from both categories.

Though blend funds will probably never lead the pack, their approach can offer a relatively mellow ride. Case in point: Large-cap blend funds churned out an 8.8% return, on average, in the 12 months ended June 30.

By contrast, large-cap growth funds zoomed 27.3% while large-cap value funds sank 5.7%.

In the second quarter, when growth funds lost 5% to 6% on average, value funds held up far better. Result: Blend funds fell only about 2% on average.

“They help mute volatility in a market that makes strong gyrations,” said Morningstar senior analyst Christine Benz.

Yet even though blend funds can be ideal for investors looking to streamline their portfolios, they have at least two strikes against them: They’re hard to identify, in part because they can be a moving target as managers tilt their portfolios more in one direction or the other; and they’re considered bland.

To begin with, the Morningstar term “blend” hasn’t really caught on. Until the fund tracker developed its nine-part “style box” about 10 years ago, stock funds were generally thought of as small growth, small value, large growth or large value, according to Rekenthaler.

But many funds defied those labels, so Morningstar developed a style box in the fashion of a tick-tack-toe grid, going across from value to blend to growth, and top to bottom from large to medium to small stocks.

Investors looking for thorough diversification could pick something from each of the nine boxes, though even Morningstar says that might be overdoing it.

Morningstar categorizes blend funds as those whose holdings have average price-to-earnings and price-to-book-value ratios close to those of the blue-chip Standard & Poor’s 500 index. You could just buy the index fund, of course. But the idea of going with an actively managed blend fund is that the fund manager is trying to beat the index.

Aside from using Morningstar’s Web site (https://www.morningstar.com), how does one find an actively managed blend fund? The words “growth and income,” “blue chip” or “core” in the name of a large-cap fund can be a giveaway, Rekenthaler said. And generics, such as the Fidelity fund, tend to be blends.

Yet “style drift” can also make blend funds hard to spot. Morningstar’s portfolio analysis--and thus its labeling--can be dated, as funds are required to report their stock holdings only twice a year. A blend fund today might well be a growth fund or a value fund by year’s end, if the manager has that leeway.

And perhaps because blend “sounds wishy-washy,” as Rekenthaler put it, true blend funds rarely own up to it in their name. Salomon Smith Barney’s Large Cap Blend and Mid Cap Blend funds are among the exceptions.

A spokeswoman for one major fund company explained why two of the firm’s managers declined to be interviewed for this story: “We don’t want to be associated with an article that labels us as ‘blend.’ ”

Stigma or no, Benz said, true blend funds can make a solid portfolio foundation. She said new investors might buy a large-cap blend fund, then supplement it with a blend fund that targets small- or mid-cap stocks.

One appealing idea behind the blend-fund concept is that “you find a lot of great stock pickers here,” Benz said, as managers take advantage of good stocks wherever they find them.

She cites Howard Ward of Gabelli Growth and Larry Puglia of T. Rowe Price Blue Chip Growth. Those large-cap blend funds have returned an annualized 32.1% and 25.9%, respectively, over the last five years, beating the S&P; 500.

Blend fund shoppers should watch expense ratios, Benz said. They should be no higher than 1% for any blend fund and no higher than 0.75% for a large-cap blend fund, she said, “unless you’re getting something exceptional.”

Another caveat: Some blend funds have more of a “go-anywhere” philosophy than the growth-at-a-reasonable price philosophy that guides many of the funds, Benz said. CGM Mutual’s manager, G. Kenneth Heebner, for example, is known for a broad-ranging style with bold sector bets.

Though large-cap blend funds get the most interest, Rekenthaler said he likes “the smaller-cap end even better.” When an investing style tanks--like small-cap value in 1998 and ’99 or small-cap growth this spring--investors tend to bail before the eventual recovery.

“Psychologically, it can be hard to hang on, but small blend is often steady, doing a better job of retaining investors,” Rekenthaler said.

Among small blends, he and Benz like T. Rowe Price Small Cap. Among mid-cap blends, Rekenthaler likes Gabelli Value and Vanguard Mid Capitalization Index, which follows the S&P; 400. Among large blends, he likes Vanguard 500 Index, which mimics the S&P; 500, and TIAA-CREF Growth & Income, an index-active hybrid.

Active fund managers have constructed winning blend portfolios using various recipes. A sampling:

* Paul Blaustein, manager of Whitehall Growth fund, will pay up for a good stock. “I don’t think growth and value are antithetical,” he said. “Value doesn’t simply mean a low price-to-book ratio. A low P/B more likely just means it’s a bad business.”

He said he looks for companies with a proprietary edge and robust profit growth. He avoids slow-growth sectors such as utilities, focusing instead on technology, health care and consumer stocks, which may be why his portfolio’s average P/E and P/B ratios are a bit higher than the S&P; 500.

The fund’s returns top the large-cap blend group for the last one-, three-, and five-year periods, according to Morningstar.

Chip component maker Altera (ticker symbol: ALTR) exemplifies his stock-picking philosophy, Blaustein said. Though it sells for more than 40 times his estimate of earnings per share for 2001, the valuation is justified by the company’s high return on capital, profit margins and growth rate, he said.

Blaustein’s stock-picking skews toward bargain-hunting on occasion, as long as he likes the company long-term. “We bought Bristol-Myers Squibb (BMY) when regulators delayed approval of one of its new drugs and it was temporarily depressed,” he said. “This company generates a lot of proprietary products.”

* Mark Greenberg of Invesco Leisure does not take a leisurely approach to portfolio management.

He spends a week and half each month on the road, talking to company managers, customers and competitors. To keep tabs on key holding Gemstar-TV Guide International (GMST), he talks to cable operators, e-mails and phones management regularly and visits Circuit City and Best Buy to see how the products are selling.

Though he looks for companies growing earnings or cash flow by double digits annually and then applies a valuation screen, he said stock picking requires the finesse to see beyond the numbers.

“We look closely at the accounting to see if they are making their earnings targets honestly or dishonestly,” Greenberg said.

Sector funds like Greenberg’s--which focuses on the entertainment and leisure industries--are more volatile than diversified blend funds. Invesco Leisure’s three-year annualized return of 34.1% is best of the mid-cap blend funds, Morningstar says, but the fund lost 6% in this year’s first half, despite holding such value names as casino firm Harrah’s Entertainment.

* “Our spin is the dual approach” of active management and indexing, said Carlton Martin, manager of TIAA-CREF Growth & Income. His portfolio can swing back and forth, with the active and passive elements ranging between 80% and 20% at any time, depending on how his team views the market. During market sell-offs, Martin hunts for bargains, but when the market seems fully valued, he leans toward the index approach.

Like many blend managers, Martin looks for good companies and then sees whether those stocks pass a proprietary valuation screen. “We don’t have to swing at every pitch,” he said.

The young fund, whose 0.43% expense ratio is closer to passive than active, has beaten the S&P; 500 in 1998 (its first full year), 1999 and so far this year.

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Times staff writer Josh Friedman can be reached at josh.friedman@latimes.com.

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Market-Beating Large-Cap Blend Funds

The Times screened fund tracker Morningstar’s database for actively managed, no-load large-cap “blend” funds rated four or five stars by Morningstar. The screen also required that the funds have below-average expense ratios and one- and five-year returns higher than the Standard & Poor’s 500 index. Here are the large-cap blend funds that made the screen, ranked by five-year annualized return.

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Annualized return: Assets Fund 1-year 5-year (millions) Whitehall Growth 51.7% 32.5% $144 Vanguard Primecap 44.1 29.8 23,338 T. Rowe Price Blue Chip Growth 20.3 25.9 7,075 AARP Capital Growth 24.9 25.4 2,479 Vanguard Morgan Growth 24.9 25.3 5,856 SSGA Growth & Income 14.6 25.2 455 Rainier Core Equity 19.6 25.0 917 Buffalo USA Global 38.7 24.9 51 Columbia Common Stock 21.8 24.9 1,005 T. Rowe Price Growth Stock 26.2 24.5 5,668 State Street Research Inv. 17.7 24.2 1,182 S&P; 500 index 9.3 24.0

Fund 800-phone Whitehall Growth 994-2533 Vanguard Primecap 662-7447 T. Rowe Price Blue Chip Growth 638-5660 AARP Capital Growth 322-2282 Vanguard Morgan Growth 662-7447 SSGA Growth & Income 647-7327 Rainier Core Equity 248-6314 Buffalo USA Global 492-8332 Columbia Common Stock 547-1707 T. Rowe Price Growth Stock 638-5660 State Street Research Inv. 882-0052 S&P; 500 index

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Note: All data through Friday

Sources: Morningstar Inc., Times research

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How ‘Blend’ Fund Returns Stack Up

Here is a look at average annualized returns for nine categories of stock funds, for the three years ended June 30. By far, growth-stock funds were the place to be in the period. But investors who opted for a middle ground of “blend” funds, which can own both growth and value stocks, came out far ahead of those who stuck with pure value funds.

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Source: Morningstar