Value stocks best bet to navigate choppy seas

Large-cap-value stocks stand out as the clear favorite in equities for the year ahead, according to financial advisers who took part in the 2011 InvestmentNews Industry Attitudes survey.

“Value stocks probably look most attractive, given the fact that at this point, we’ve beaten things up enough,” said Clinton Struthers, owner of Struthers Financial Services, a $100 million advisory firm.

However, he added, considering the amount of fear and uncertainty throughout the global economy, it has become increasingly difficult to forecast and evaluate the financial markets.

“I’m wondering how much of this [market turmoil] is real and how much of it is based on perception,” Mr. Struthers said.

VOTING FOR VALUE

According to this year’s survey, 71.2% of adviser respondents expect value stocks to outperform growth stocks over the next 12 months, up from 62.6% in last year’s survey.

And 52% of respondents believe large-cap stocks will lead the way, up from 35.5% last year. Mid-cap-stock leadership is anticipated by 28.9% of advisers, and small-caps were predicted next year’s strongest performers by 19.1% of respondents.

“We have a permanent overweight in value stocks because we believe there is a value factor in the markets,” said Harold Evensky, president and principal of Evensky & Katz LLC, a $700 million advisory firm.

“A reasonable economic recovery will favor value,” he added.

“We have been neutral on growth and value stocks, and I don’t see that necessarily changing anytime soon,” said Robert Schaefer, director of investment research at Oxford Financial Group Ltd., a $16 billion advisory firm.

“Right now, we don’t feel strongly about value over growth,” he added. “A lot of the growth stocks, particularly in the consumer sector, are looking more defensive.”

In many respects, the survey reflects the frustrations and uncertainty surrounding the global financial markets.

U.S. STOCKS OUTPERFORM

Year-to-date through last Tuesday, the S&P 500 was down 2.5%. The foreign large-cap-blend mutual fund category, as tracked by Morningstar Inc., was down 11.3%. The world market fund category was down 7.3%, and diversified emerging-markets funds were down an average of 17.7%.

When asked what percent of client portfolios are currently allocated to non-U.S. developed markets, 38.7% of survey respondents said between 11% and 20%, 23.8% said 21% to 30%, and 19% said 1% to 10%.

In terms of how those allocations to non-U.S. developed markets have changed over the past year, 46.9% of respondents said the allocations have not changed, while 28.3% of advisers said they have decreased client allocations in this area, and 24.8% said they have increased allocations.

LOOKING ABROAD

Based on the valuations he is seeing in the global markets, Mr. Schaefer said Oxford is likely to increase allocations to foreign markets in the year ahead.

“We’re currently neutral in overseas markets,” he said. “But you’ve seen some significant drops in some of those markets, and the valuations are looking quite compelling.”

The survey results showed that some of the bloom might be off the rose with regard to the recently hot emerging-markets category.

While 55.2% of the respondents said they allocate up to 10% of client portfolios to emerging markets, and 28% allocate between 11% and 20%, 6% are avoiding the emerging markets entirely.

“We’ve been waiting for the emerging markets to become more attractive, and they are getting there,” said Mr. Schaefer.

According to the survey, 53.2% of respondents did not alter their allocation to emerging markets over the past year, 28.3% increased their allocation, and 18.5% decreased the allocation.

“We have a permanent allocation of between 3% and 5% to emerging markets in our client portfolios,” said Mr. Evensky. “But on the developed side, we’ve just made somewhat of a reduction in our core allocation, down to 30%, from 45%.”

The catalyst for the dramatic change, he explained, is that Europe has become too risky.

“Given what’s happening in Europe, our belief is that it’s going to be at greater risk than the U.S. for the next several years,” he said.

Of course, all the global economic turmoil and market volatility has led to renewed adviser interest in alternative strategies.

UPPING THE ANTE

Over the past year, 42.1% of the respondents said their interest in absolute-return and alternative-investment strategies had increased, while just 5.3% said their interest had decreased; 52.6% said their interest in such strategies had remained the same.

“We’ve definitely expanded a bit in the area of alternative strategies,” said Mr. Struthers. “I’m getting a lot more clients coming to me with questions about alternatives.”

Of the seven alternative-strategy mutual fund categories tracked by Morningstar Inc., the market-neutral category had the only positive average return this year through last Tuesday, up 0.5%.

Bear market funds were down 6.2%, long-short equity was down 4.4% and the equity-precious-metals category was down 11.6%.

On the topic of interest rates and fixed income in general, the general consensus appears to be that it will all depend on the direction of the broader economy.

BALANCING ACT

“We’re dancing on a tightrope with rates right now, and I don’t see much of an increase coming, because I don’t see any inflationary pressure,” said Mr. Struthers.

Of the advisers surveyed, 55.1% said they expect interest rates to remain at near zero next year, but 35.2% said they expect a modest increase.

Based on statements made by Federal Reserve Board Chairman Ben S. Bernanke, the likelihood of a bump-up in the rate set by the Fed is unlikely, according to J. Brent Burns, president of Asset Dedication LLC, which builds fixed-income separate accounts.

“Bernanke told us what they are going to do with rates, so either he’s lying or he’s going to be forced to do something because of inflation,” Mr. Burns said. “The fact is, interest rates could stay low for the next decade.”

Email Jeff Benjamin at [email protected]