How to Find the Right Balance and Avoid Manias
Should you invest in growth funds or value funds in uncertain times? Fortunately, you don’t have to choose one over the other. Managing your portfolio can be a matter of shifting the emphasis as you participate in growth and value funds as well as blended funds:
Emphasize growth funds when economic growth is slowing.
Emphasize value funds when the economy begins to accelerate. These periods are usually accompanied by a steep yield curve, when short-term interest rates are much lower than long-term rates. Banks are a large component of the value sector, so a steep yield curve usually precedes higher bank profits.
How do you approach the value-growth question and protect yourself from manias? Here are some guidelines:
When purchasing either kind of fund, examine how well the current portfolio manager navigated debacles of the past. Keep in mind, however, that past performance doesn’t guarantee future results.
Don’t believe the hype. Exercise common sense. Investment management is a closed world, and managers feed off one another. When an investment theme looks extreme, head for the exits; if it looks too good to be true, it probably is.
Read a mutual fund’s annual and semiannual reports to get a sense of the fund management’s thinking. Watch out for language that echoes some of the more hyperbolic language used by the talking heads on the business news channels.
Examine a fund’s holdings for style drift. In the late 1990s, value managers suffered because their funds were dramatically underperforming their growth counterparts. In desperation, value managers added growth stocks to improve performance. Unfortunately, many did this at the market peak, which caused their value funds to decline like a growth fund in the following bear market. Value funds that remained true to their style performed much better in the bear market of 2000 to 2002.