Investors See Shifts as Managers Think Outside Funds’ ‘Style Box’
The bear market of 2001 has been making for some strange bedfellows in the world of actively managed stock mutual funds.
Consider:
* Brian Rogers, the “value”-oriented manager of T. Rowe Price Equity Income and T. Rowe Price Value, has recently been buying classic “growth” tech stocks such as Hewlett-Packard Co. and Microsoft Corp.--even though the shares still sell for price-to-earnings ratios above what many value managers would regard as cheap.
* Meanwhile, Bramwell Growth fund manager Elizabeth Bramwell has been looking at stocks that pay above-average dividend yields--a market sector usually reserved for hard-core value managers.
For fund investors, portfolio shifts like these raise an important question: Is your fund manager buying stocks that don’t seem to fit your expectations for the portfolio?
In mutual fund parlance, it’s called style drift when a fund heads away from the investment style that investors believe the fund has committed to follow.
“There are people who just don’t care what their managers are buying, so long as it makes money,” said Philip Edwards, head of fund research at Standard & Poor’s Corp. “But there are a fair number--an increasing number--of people who care about asset allocation.”
After all, you may have bought a fund specifically to gain exposure to growth stocks such as tech and telecom shares as part of your overall diversification strategy. Even though those sectors have crashed, you may be sticking with the fund because you expect to ride any long-term rebound in those stocks.
But if the manager dumps tech for, say, financial stocks, you may miss out if tech rockets.
How prevalent is fund style drift? Fund tracker Morningstar Inc.’s database shows that 18% of the stock funds classified as either “value” or “growth” recently held portfolios that did not meet Morningstar’s technical definition of those categories. That’s up from 15% last September.
Yet there are many ways to judge what is a value stock and what is a growth stock. And that’s a big part of the problem in assessing whether a fund has indeed gone into style drift.
To categorize a fund as either growth or value, Morningstar weighs the average price-to-earnings and price-to-book-value ratios of a fund’s holdings relative to stocks that Morningstar tracks in its proprietary database.
Those funds with portfolios that have higher P/E and P/B ratios than Morningstar’s universe averages are generally classified as growth funds. Those with lower P/Es and P/Bs are typically considered value funds.
To an individual fund manager, however, whether a stock rates a growth or value designation can be a personal judgment call.
“I think the reason some value portfolios have been buying tech is that that’s where the relative weakness has been,” said T. Rowe Price’s Rogers. “I don’t think this is any pattern of style drift.”
Fund managers can easily defend value designations for stocks by arguing that the market is underestimating a firm’s future earnings growth or current assets.
Many tech shares, for example, now are priced at 20 to 30 times 2002 earnings estimates--on par with P/Es of many non-tech shares. Yet analysts, on average, still expect tech firms to grow faster than companies in other sectors in the long run. In theory, that could mean tech stocks are value plays now.
Other value formulas also can be used. Bill Miller, manager of Legg Mason Value Fund, was buying shares of Amazon.com and America Online in the late 1990s, arguing they were cheap relative to other Internet stocks.
Rogers, whose Equity-Income fund has more than doubled its technology exposure to around 7% of total assets, equates his move to what some value managers did in 1993 and early ’94 with drug stocks.
Drug shares plunged in 1992 and early 1993 on fears that the Clinton administration would push through drug price controls.
“People focusing on style consistency asked back then, ‘How could you have an equity-income fund loading up on growth stocks like Pfizer or Merck?’ ” Rogers said. But those were the stocks that were being undervalued at the time relative to their long-term prospects, he said. And their rebound in 1994 helped value funds beat growth funds that year, he said.
On the flip side today are growth fund managers like Bramwell who are seeking growth in sectors once considered exclusively value plays.
“Some people can’t believe I’m looking at utilities,” said Bramwell, whose rather conservative approach to growth investing has helped her limit losses in her fund this year.
“But look at Duke Energy,” she said, referring to the electric and gas company. The company’s earnings are expected to grow 10% in 2002, and the stock also provides a 2.4% return via its dividend yield.
People who question whether her fund should be investing in utilities “don’t know what growth means,” she said. “We’re looking for companies with visible earnings growth ahead, and I think the utilities and oil-services areas fit that description.”
Many of her fellow growth managers agree. Although tech sector earnings have slowed from torrid rates of recent years, earnings growth rates are rising in some traditional value sectors such as energy and financial services, growth managers say.
Last fall, the Denver-based Marsico Funds began trimming their tech stake and moving money into financials, drugs and other sectors. A year ago, the Marsico Growth & Income Fund had nearly 40% of assets in tech shares. But recently, financial and industrial stocks were the two biggest sector weightings in the fund.
“We felt that the long-term investment potential was higher in these groups than in the tech area, which we felt was fraught with risk to earnings and [P/E] multiples,” said Jim Hillary, senior analyst for the fund.
Many fund investors may be happy with such portfolio shifts--if they pay off.
And many fund industry analysts say that fund managers ought to have greater flexibility in managing a portfolio, and not feel confined to a “style box.”
“While we think you have to look at the overall asset allocation [of a fund] . . . there is probably more opportunity in some cases to add value by giving talented managers enough room to buy their best ideas,” said Steve Savage, editor of the No-Load Fund Analyst newsletter.
Still, the potential for significant portfolio shifts in a troubled stock market, as managers try to find a winning formula, can cause problems for investors who bought a fund for a specific style reason, or for a specific type of stock.
The bottom line: Keeping a closer eye on your fund’s holdings is important in this market, experts say.
It’s easy enough to read your fund’s bylaws, and check out information on its Web site, to see how much flexibility your manager has in structuring the portfolio, and to view the fund’s biggest stock and sector bets.
Likewise, at https://www.morningstar.com you can see if your fund’s style box designation matches what you intended when you bought it.
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What’s Value, What’s Growth?
The plunge in tech stocks over the last year, while many non-tech shares have rallied, has pulled down price-to-earnings ratios in the tech sector while lifting other sectors’ P/Es. Meanwhile, analysts’ estimates of earnings growth rates for the next five years have declined for some tech firms, risen for other sectors. Here’s a look at some stock P/Es based on analysts’ estimates of earnings per share for 2002. Also shown are estimated annualized five-year growth rates and each stock’s current dividend yield.
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Tech Stocks
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Share Est. Est. 5-yr. Div. Company price 2002 P/E growth rate* yld. Hewlett-Packard $30.96 20 13% 1.0% IBM 112.00 20 14% 0.5 Micron Technology 43.35 24 20% - AOL Time Warner 47.60 31 32% -
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Non-Tech Stocks
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Share Est. Est. 5-yr. Div. Company price 2002 P/E growth rate* yld. Duke Energy 46.00 17 11% 2.4% Gillette 25.90 22 11% 2.5 Pfizer 41.00 26 22% 1.1 Enron 61.65 29 17% 0.8
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Sources: Bloomberg News, Zacks Investment Research, IBES International
