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Growth or Value?

Now that growth is showing life, which do you choose? Your clients need both, no matter what the investing climate.

Never chase the hot dot. How many times have you reminded your clients about that basic investing truth? You, as a financial advisor, would never do that, of course. But one wonders. Consider mutual fund cash flows into large-cap growth and large-cap value funds over the last decade or so. Assets in large growth funds climbed 62 percent in 1999 as returns in that strategy soared. Meanwhile, assets in large-cap value funds dropped as that strategy lagged during the Great Bull Market. And once that trend began to reverse, investors dumped their growth funds in favor of value.

But, successful investors stick to their investing plans, rebalancing and tweaking as needed, of course. For the past nine months or so, growth funds have been showing signs of life, and, according to Morningstar, have outperformed value funds as a group. While your clients may still have bad memories about aggressive funds, you must remind them — well, some clients — that they should consider aggressive choices and that the right funds can provide important diversification and actually help them find the sweet spot on the efficient frontier. This could be an opportune moment to try some aggressive funds, says Pran Tiku, president of Peak Financial Management, a registered investment advisor in Waltham, Mass. Tiku is emphasizing funds like Bridgeway Aggressive Investors. “Growth funds have been out of favor for a long time, and now the aggressive portfolios could lead the next market cycle,” he says.

Handle With Care

Whenever you shop for aggressive funds, you need to exercise special care. To get maximum results, buy into the sector before it becomes red hot, then hold for at least several years. For additional protection, try a fund that has taken steps to avoid imploding at the bottom of the market.

Consider SunAmerica Focused Large Growth, a fund that combines strong returns with risk scores that are moderate for the large growth category. The fund dampens risk by diversifying, picking three subadvisors that each follows a somewhat different approach. “There are likely to be times when one of the managers is producing strong returns while the other two aren't doing as well,” says Steve Schoepke, vice president of research for SunAmerica.

The most aggressive manager in the SunAmerica fund is Dan Chung of Fred Alger Management. Chung looks for stocks with accelerating earnings, and will pay top prices to get them. Another subadvisor, Tom Marsico of Marsico Capital Management, takes a more moderate approach. Marsico picks stocks that seem likely to benefit from economic trends, like the increase in defense spending. A veteran growth manager, Marsico is eclectic, often buying unloved stocks that others might categorize as value names. The final manager in the group is Louis Navellier of Navellier & Associates, who looks for stocks with consistent growth. Navellier uses a quantitative system to learn which characteristics the market is currently favoring. Responding to the data, the portfolio sometimes focuses on moderately priced stocks, while on other occasions it holds stocks with premium prices.

Investors looking for a high-octane small-growth fund might prefer Oberweis Emerging Growth. In the difficult year of 2001, Oberweis was one of the few growth funds to stay in the black. The fund picks stocks that are increasing their sales and earnings at an annual rate of at least 30 percent. The average company in the portfolio is growing at about a 50 percent rate. Portfolio manager James Oberweis limits risk by only taking stocks that sell for half of his estimates of forward earnings growth. If a company is expected to increase its earnings by 40 percent this year, he will only pay a P/E of 20. In addition, Oberweis seeks solid businesses — not unproven high flyers. “We want companies with a proprietary advantage that would allow them to accelerate their rates of growth for some time,” he says.

A favorite holding is Ceradyne, a producer of ceramic products that are purchased by the U.S. military for body armor. Sales and earnings of the company have been growing at annual rates of more than 40 percent, but Oberweis says the stock trades at 17 times forward earnings estimates.

Not Just for Techies

While many aggressive funds place big bets on technology, Turner Midcap Growth tries to avoid trouble by staying broadly diversified. Portfolio manager Chris McHugh always holds assets in 10 market sectors and never overweights any industry. “If you try to make sector calls, you can have huge losses in a downturn,” he says.

Turner looks for improving companies that seem likely to meet or exceed Wall Street's earnings expectations. To get those promising stocks, the fund often pays P/Es of more than 40. That can be risky, but Turner compensates investors with strong bull-market results.

Hartford Growth Opportunities stands out as a growth fund that has beaten value competitors in recent years. Portfolio manager Michael Carmen has managed the feat by following a flexible style. The fund buys stocks of all sizes. Several years ago, the portfolio had big stakes in small-caps, which led the markets. Now Carmen figures that large stocks are about to lead, and he has 50 percent of assets there.

The fund seeks stocks that are showing signs of improving sales or earnings; Carmen likes to take positions before Wall Street has embraced them. A favorite holding is Network Appliance, a producer of data storage equipment. The company is increasing sales and earnings. But of the 28 sell-side analysts following the stock, 19 have ranked it an underperform or market performer. “We like to find stocks where the company is turning the corner, but Wall Street still gets it wrong,” says Neeti Ciolini, an investment specialist for Hartford.

One of the steadiest growth funds around is Legg Mason Partners Aggressive Growth. Portfolio manager Richie Freeman follows a slow-motion strategy. He buys small- and mid-cap stocks that are increasing their earnings by 20 percent or more — and then he rarely sells. The fund has a tiny annual turnover rate of about 2 percent. Freeman's goal is to hold his promising small stocks until they become behemoths. Often he succeeds.

Freeman is not shy about placing bets. Most of the fund's assets are in the 10 biggest holdings. The portfolio has big overweightings in health and media. Along with other Smith Barney funds, Legg Mason now owns this one. But Freeman is staying aboard, and that should ensure that shareholders will likely not see a change in strategy.

Aggressive Funds That Survived Hard Times
Fund Ticker Category 1-year Return 3-year Return 5-year Return % Rank 5-year Category Maximum Front Load
Hartford Growth Opportunities A HGOAX Mid Growth 27.0% 27.7% 5.1% 34% 5.50%
Oberweis Emerging Growth OBEGX Small Growth 17.2 29.2 9.5 20 0
Legg Mason Partners Aggressive Growth SHRAX Large Growth 21.2 21.8 3.0 14 5.00
SunAmerica Focused Large Cap SSFAX Large Growth 10.2 15.4 1.7 23 5.75
Turner Midcap TMGFX Mid Growth 21.2 26.6 3.4 56 0
Source: Morningstar. Data through 2/28/06.
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