Un amour renouvele?

Investors soon may find themselves back in the arms of an old flame – growth funds.

After a two-year love affair with investors, value-oriented mutual funds continue to outperform and outsell growth funds. But the makings of a rotation out of value and into growth may be in the works.

Many fund companies already are scrambling to bolster their growth lineups based on the prospect of such a shift, which may come late this year and last through the end of 2003.

There are key reasons for expecting a growth comeback:

* Value stocks are no longer particularly cheap.

* Many growth-stocks have fallen almost to value-stock price levels.

* Individual investors have a poor record in timing their purchases.

“The data suggest it’s time for growth to come back,” says Heidi Harrington, a senior vice president in charge of product development at Boston’s State Street Research and Management Co.

The most compelling piece of data is that value stocks are no longer cheap. They sell at roughly a 15% discount to the price-to-sales multiple of growth companies, according to their 12-month moving average. That means they are significantly more expensive than two years ago when that discount stood at 40%, according to Satya D. Pradhuman, chief small-cap strategist at Merrill Lynch & Co. Inc. in New York.

The sales multiple is used rather than the price-earnings ratio because many growth companies have no earnings.

“We are more likely to move toward a growth-at-a-reasonable-price kind of market as opposed to a pure-value market,” Mr. Pradhuman says.

Fund Flows

Then there are fund flows. Because investors chase performance, flows typically lag behind reality in the market by a year or so.

Investors had pumped $41.4 billion into value funds year-to-date through April 2, nearly double the $24.6 billion they put into such funds in the period a year earlier, reports Financial Research Corp. of Boston.

Growth funds, on the other hand, had bled $1.69 billion through April 2, close to the $1.65 billion they lost during the comparable period in 2001, according to FRC.

“We can look back in previous times this has happened and see that investors’ timing couldn’t have been worse,” says Christine Benz, an analyst at Morningstar Inc., the Chicago-based fund tracker. “It could point to a growth rebound being somewhere in the cards.”

Even Warren Isabelle, a well-known value investor, concedes that a growth rally probably is brewing. Many companies once viewed as the epitome of growth are now so badly beaten up that they are starting to attract value investors, he says.

At the end of March, nearly 18% of the $131 million in assets in his ICM/Isabelle Small Cap Value Fund were in technology companies. “Just because a company was traditionally in a growth universe doesn’t mean anything to me,” he says. “I will go anywhere there is value.

But Steve Oristaglio, deputy head of investments at Putnam Investments Inc. in Boston, isn’t convinced that there’s a lot of value in many growth companies. Even though his company recently launched a growth fund, he says he is skeptical that there will be a full-fledged rally.

“We like growth,” he says. “But we don’t think it offers any big advantages going forward. Valuations are not cheap across the board.”

Nevertheless, Putnam last week announced that it had hired Brian O’Toole, who ran U.S. growth equities at Citigroup Asset Management in Stamford, Conn., to lead a six-member large-cap-growth team responsible for $35 billion in assets. The team manages institutional and retail portfolios, including the $23 billion Putnam Voyager Fund and the $3 billion Putnam Growth Opportunities Fund.

Mr. O’Toole replaces Beth Cotner, who announced her retirement earlier this year. Putnam in March also quietly added another fund to its stable of growth funds, the $25.6 million Putnam Small Cap Growth Fund.

Meanwhile, T. Rowe Price Associates Inc. of Baltimore in May reopened the $4.8 billion New Horizons, a small-cap growth fund that had been closed to new investors since June 1996.

Pioneer Investment Management Inc. of Boston, owned by banking giant UniCredito Italiano SpA of Milan, filed plans with the Securities and Exchange Commission to open four new growth funds.

Also last month, Boston’s John Hancock Funds LLC bought the $124 million U.S. Global Leaders Growth Fund from Yeager Wood & Marshall of New York.

Any rebound, say experts, would likely be mild – at least compared with the last run-up, in 1999, when the average growth fund rose 55.3%.

The next rally, say experts, will probably be led by cyclical growth stocks, companies that are interest-rate sensitive and come with high revenue growth.

Companies such as Intel Corp. (INTC), The Home Depot Inc. (HD) and Harley-Davidson Inc. (HDI) are likely to fit the bill.

The big question, of course, is when exactly it will become safe to go back into the growth waters.

The average growth fund lost 20.82% in 2001, versus a 2.73% gain by the average value fund. Year to date through May 31, the average growth fund is down 10.68%, and value funds are up 1.75%, according to Lipper Inc. of New York.

“We are certainly not rushing in right now,” says Anthony Vargo, a financial adviser at Pittsburgh’s Legend Financial Advisors Inc., which oversees about $100 million in assets. “From a valuation standpoint, a lot of the large-cap growth companies still look pretty expensive.”