Value-oriented managers get back in the game

After a four-year run by growth managers, value managers came bouncing back in the third quarter, according to a new study of managed-equity accounts held by institutions.

While value managers didn’t take over the rankings, they accounted for seven of the 15 top-performing accounts as measured by the latest Performance Evaluation Report in Pensions & Investments, a sister publication of InvestmentNews.

“The most important thing in the third quarter is not what we bought but what we didn’t,” says James Gipson, president of Pacific Financial Research Inc. in Beverly Hills, Calif.

“We didn’t have the portfolio loaded with small tech stocks that we don’t understand, and did not have some of the larger tech companies that are more understandable but are priced very highly,” says Mr. Gipson, whose 95+ strategy topped the rankings with a 20.6% return in the third quarter.

In comparison, the median Piper managed-account manager returned 3.4% while the Standard & Poor’s 500 stock index fell 1%.

Forced to stray

Pacific Financial’s strategy required “very little brainpower” but did require the willpower to resist the temptation to stray from the manager’s investment philosophy, he says.

“Until a few months ago, there was a large temptation to get on the bandwagon.”

Neil Eigen, managing director and partner in charge of value investing at New York-based J.&W. Seligman & Co. Inc., tells a similar story.

“More than anything else, we stuck to our guns” and didn’t invest in tech stocks, he says. Seligman’s large-cap value strategy turned in a 17.9% performance in the third quarter.

Most of Seligman’s third-quarter performance can be attributed to bets in financial and health-care stocks. Bank and insurance stocks such as the Bank of New York Co. Inc., Allstate Corp., the St. Paul Cos. Inc. and Summit Bancorp proved to be winners for the manager.

Similarly, financial stocks such as Fannie Mae and Freddie Mac, and health-care stocks such as Tenet Healthcare Corp. and HCA fared well.

The Healthcare Co. produced good returns for Pacific Financial in both its top-ranked 95+ Equity and 14th-ranked Unconventional Value strategies. (The 95+ equity strategy is at least 95% invested in equities, while the latter approach has a higher cash component.)

Other winners included tobacco giant Philip Morris Cos. Inc. – reversing an earlier stock market drubbing – and real-estate investment trusts, which enjoyed “great balance sheets, high yields and cheap prices,” Mr. Gipson says.

Reits included Equity Residential Properties Trust, Equity Office Properties Trust and AvalonBay Communities Inc.

Paul Houk, senior portfolio manager at New York-based SG Cowen Asset Management Inc., says the bubble in technology stocks ended March 10 when the Nasdaq peaked.

“When the party’s over, you find out there’s no there there,” he says, paraphrasing Gertrude Stein.

Tech stock value

“It would not surprise me at all if, over the next five years,” tech stocks become the next value stocks.

He cites the example of what happened to the Nifty Fifty stocks in the early to mid-1970s.

Mr. Houk, whose core to value mid-cap portfolio ranked second among equity managers, with a 20.6% third-quarter return, benefited from overweightings in energy, utility, insurance and managed-care stocks.

Strong performers included energy companies Anadarko Petroleum Corp. and Devon Energy; utility Constellation Energy Group Inc.; insurance companies UnumProvident Corp. and W.R. Berkley Corp.; and health-care firms Foundation Health Systems Inc. and Mid Atlantic Medical Services Inc.

Mr. Houk says he creates an upside and downside range for each stock, using different ratios for the type of stock. For example, he uses price-to-earnings for a generic drug company stock and price-to-book for a bank stock.

Growth stock managers did not fall off a cliff during the quarter but certainly did not enjoy the spectacular returns of recent years.

While the median managed-account value manager returned 6.1% in the third quarter, with fairly uniform returns across capitalization sizes, the median growth stock manager return was a meager 1.1% – weighed down by a -0.2% median return for large-cap growth managers.

For longer periods, however, growth stock managers remained far ahead. For the one- and three-year periods, the median growth stock manager returned 34.4% and 21.6% annually, respectively, while the median value manager returned 15.3% and 7.2%. (All returns for periods of more than one year are compound annualized.)

Top managers

The quarter’s top growth-stock managers included:

* Denver Investment Advisors, with a 20.1% return for its small-cap strategy.

* Provident Investment Counsel, returning 19.5% for a mid-cap approach.

* American Express Asset Management, returning 18.8% for its Growth Spectrum I small-cap strategy.

But some growth managers took it on the chin: Invista Capital Management ranked last for the quarter with its small-cap growth equity strategy, returning -17.7%; Sands Capital Management’s large-cap quality growth style returned -10.8%; and Fuller & Thaler Asset Management’s small/mid-cap growth strategy returned -10.3%.

For longer periods of time, Driehaus Capital Management, a Chicago-based growth stock manager, continued its domination of the rankings. For example, its small-cap recovery growth strategy ranked first for the one-year period ended Sept. 30, turning in a spectacular 243% performance.

Driehaus’ mid-cap growth and small-cap growth portfolios returned 132.8% and 107.6% during that period, ranking eighth and 11th, respectively.

For the three-year period ended Sept. 30, Driehaus’ mid-cap style was top-ranked, with a compound annualized 66.5% return, while the small-cap recovery strategy ranked fifth, at 58.4%, and the small-cap growth portfolio was eighth, at 56.6%.

In comparison, the median managed-account manager returned a relatively modest 22% during the 12-month period. The S&P 500 returned even less, providing a meager 13.3% return, though the Russell 3000 growth index provided a 23.9% return.

For the three-year period ended Sept. 30, the median manager returned 14.8% compared with 16.4% for the S&P 500.

Growth managers completely took over the top rankings for the one-, three- and five-year periods.

Other top performers for the one-year period included:

* Winslow Management Co., a Boston-based manager that buys stock in environmentally responsible companies. The group returned 197.4% for its small-cap to mid-cap emerging-growth strategy.

* Kopp Investment Advisors in Edina, Minn., returning 161.2% with its emerging-growth style.

* Duncan-Hurst Capital Management Inc. in San Diego, returning 148.4% with its micro-cap growth portfolios.

Top-performing commingled-fund managers consisted of a range of styles last quarter, led by sector, growth and large-cap-value funds.

Barclays Global Investors’ intermediate utilities fund returned a leading 23.8%, while Neenah, Wis.-based Associated Bank’s regional bank fund ranked third at 19.2%.

Meanwhile Provident Investment Counsel’s mid-cap growth fund returned 19.5%, and American Express’ Growth Spectrum I Fund returned 18.8%.

Rounding out the top five was Santa Monica-based Dimensional Fund Advisors Inc.’s large-cap value strategy at 15.4%.

For the one-year period, growth managers again prevailed, led by Driehaus Capital’s small-cap recovery growth fund, returning 254.2%.

It was followed by Provident’s mid-cap fund at 127.6%, and Massachusetts Mutual Life’s small/mid-cap growth fund, returning 118.9%.