The Growth vs. Value Debate Is Raging Again

As painful as it might sound, it still pays to look beyond the bleeding and see how some fund categories are performing during these tough times. Investors who have done that have noticed one dramatic shift amongst all those return numbers. After turning in a sweet average return of 14% last year — nine points ahead of the S&P 500 — growth funds have fallen off a cliff in 2008. The average growth fund has lost 10.8% year to date, two percentage points worse than the broad market.

That poor performance has once again ignited an age-old debate in the mutual-fund industry: Which is the better bet, growth or value? The hype in 2007 was that growth offerings were finally ready to take a leading role in the industry after years of trailing their value counterparts. Many advisors repositioned their clients to account for that change. However, it looks like growth's time in the spotlight was short-lived. Now, those same pros are trying to determine if this is just a short-term blip or a long-term indication of things to come. Guessing wrong could cost their portfolios a bundle.

Showing a bias toward growth or value says a lot about what type of an investor you are. Value investors tend to be patient and focus on the long term. They typically buy beaten-down stocks that are trading at a price/earnings ratio below that of the broad market. Growth investors, though, are more aggressive risk-takers. They favor stocks that have super-charged earnings estimates and ones that are trading at high multiples. They may shell out more money, but fans of growth stocks argue that the potential payday is worth the added expense.

Your investing time horizon also plays a part in which camp you fall into. Academic research has shown that value tends to outperform growth over the long term. So, if you are looking out 20 years or more, value seems to be the smart play. Of course, there are five-year spurts where growth has broken through. (The tech boom is an example.) And history also shows that growth stocks tend to do well when the market takes a downturn. For example, health-care companies, a growth bellwether, do well regardless because cash-strapped consumers still need to spend money on medical care. Naturally, investors flock to the stocks posting good earnings when everything else is tanking.

But all that isn't holding true this time around for growth funds. What's different? To start, there are the billions of dollars of write-downs on bad mortgages that have impacted financial-services firms — and may still do so well into this year. High commodity prices have hit consumers not only at the gas pump but at the checkout line, too. Investors have gotten whacked by wave after wave of bad news. That's created a lot of skepticism when it comes to earnings estimates for '08. Investors just don't believe the numbers. Since growth stocks are dependent on their earnings projections they have been at the receiving end of a lot of selling.

"When investors are defensive they buy value," says Joel Larsen, a principal at Larsen Financial Strategies Group in Davis, Calif. "When they are optimistic they are willing to buy growth. They have to be optimistic."

Tobias Levkovich, chief U.S. equity strategist at Citigroup, puts it more bluntly when it comes to the 16% earnings growth projections being pushed by his Wall Street counterparts. "We think no one believes those projections within the investment community," he said in a Feb. 19 report. It doesn't help growth's cause when even stalwarts like Google (GOOG) start to experience slowing profits.

So where does that leave this debate? We usually don't dwell on such short-term trends. However, in this case we think this is one trend that has not only clipped your portfolio the last two months but will continue to do so for the rest of this year and probably into 2009, too.

There are a couple of options to consider. You could hedge your bets by holding an equal helping of two well-run actively managed value and growth offerings that complement your core index holdings. We used the SmartMoney.com fund screener to find no-load funds in each category that were low cost and had track records over the last 10 years that put them in the top 25% of their peer groups. Good growth offerings include T. Rowe Price Growth (PRGFX) and Marsico Growth (MGRIX). Top value funds include Dodge & Cox Stock (DODGX).

Another idea is to buy what's out of favor. Mario Yngerto, a financial planner with Genesis Wealth Management in Plano, Texas, likes to avoid timing the market by using a simple annual rebalancing tactic. Once a year he takes profits when one style outperforms and automatically buys the one that lagged. Currently, he owns both styles of funds, but is leaning in favor of value. "Nobody can dispute the fact that value has consistently done better than growth over time," he says. However, he does recognize growth has its days. The only problem is figuring out when that time has arrived. "No one can look in the future and tell me which year growth will do better."

Of course, you could always just avoid the whole debate by purchasing a broad offering like the Vanguard Total Stock Market Index fund (VTSMX). This fund owns 3,565 stocks that span both the growth and value universes in addition to every range of market capitalization. The fund charges a measly $15 for every $10,000 invested. You may miss out on big growth runs at some point, but the cheap fees and broad exposure will give you decent returns — and help you sleep at night.