The death of value investing

By Tim Middleton

This is the second part of Tim Middleton's look into the collapse of financial funds and stocks. For part one, click here.

Boyar Value Fund (BOYAX) performed spectacularly during the previous bear market, beating the S&P 500 Index($INX) by 16 percentage points in 2000, 27 in 2001 and nearly 12 in 2002. But this time around it is getting creamed, down 25% in the 12 months that ended June 30.

What changed?

Well, during that 2000-02 cycle the financial sector was ebullient, beating the market nearly as much as fund manager Mark A. Boyar did. And Boyar is a huge fan of financials -- even now, when they are deep in the mud. They account for nearly 27% of Boyar Value assets.

"I've made so much money in this sector over the last 30 years," Boyar says. "It's no fun when they go down, but it gives you the opportunity to buy more of these things and make a lot more money (in the end)."

Boyar is hardly alone. Value and financials are joined at the hip. The average value mutual fund has two times as much invested in the group as the average fund on the opposite end of the spectrum, growth.

Academic research, including the Fama-French model that underlies modern portfolio theory, shows that value significantly outperforms over very long periods. Since its inception in 1998, Boyar Value has returned nearly twice as much as the S&P 500 Index despite the fund's recent underperformance.

True, all true. And artifacts from the Titanic are worth more now than when the ship sailed, but you wouldn't have wanted to be holding them in your hand in the meantime. And the chances are, you've got value debris of Titanic proportions in your portfolio.

Two of the 10 largest mutual funds and five of the largest 25 are value funds. Value did so well from 2000 through 2007 that it may by now dominate your 401(k) retirement nest egg, especially if you're drawn to top-performing funds.

But that was then. Now, whether you want to own this stuff depends on what your meaning of "long term" is. If you mean two decades or more, you ought to be buying value with both hands. But if your time horizon is any shorter, you ought to let it sink into its grave.

"Humans are conditioned animals," says Louis Navellier, the editor of the Blue Chip Growth investment newsletter. "Once they get stung, it takes time to forget. It's usually a seven- to eight-year cycle."

(Full disclosure: Navellier's newsletter and my own, ETF Insider, are published by InvestorPlace Media.)

The risk of value

It is beyond dispute that value outperforms over very long periods. It has to. These are the riskiest companies.

That might sound counterintuitive -- most people think of "growth" as hot stocks. But the opposite is true. True growth stocks are steady and predictable, like razor-blade manufacturers, able to generate rising revenue and earnings in every economic climate.

They are boring.

Value stocks, on the other hand, are cyclical, lurching from ecstatic highs to gut-wrenching lows. (Sound like the banking business lately?) Value managers buy them when they're out of favor and hold on until the next cyclical peak. The Fama-French model explains that this is why value outperforms: Risk takers have to be compensated more than risk avoiders.

The value-finance marriage*

			1-year performance
Capitalization	Value funds' holdings of financials	Growth funds' holdings of financials	Value funds	Growth funds
Small caps	23.3%	8.1%	- 19.8%	- 13.9%
Midcaps	21.4%	8.3%	- 16.8%	- 6.5%
Large caps	22.5%	8.9%	- 17.9%	- 6.0%
S&P 500 Index ($INX)	14.1%		- 13.1%

*As of June 30

Growth funds have much less exposure to financials than even the S&P 500 does, let alone value funds. And which type would you prefer to own in a recession? Growth, of course, because the economic winds are beating down value. And recessions result, of course, from cyclical swings in which excess inventory builds up in an important part of the economy.

Continued: Loving the unloved

 1 | 2 | next >