Are These Value Managers in a Slump or a Coma?

Like Mozart flubbing "Chopsticks" or Michael Jordan missing a dunk, some of the fund world's most celebrated value managers look a bit silly right now.

Most value funds are sagging because there's little interest in value stocks such as financials and cyclicals in today's tech-obsessed market. But why are many legendary value funds and managers -- including former Morningstar Managers of the Year Bill Dutton ((SKSEX)Skyline Special Equities) and Don Yacktman ((YACKX)Yacktman fund) -- being dusted by other value funds?

The situation poses a difficult question for investors who may believe value funds are ready for a comeback: Which managers are simply far out of favor and which are in a tailspin?

What Happened These managers' sterling reputations don't jibe with their funds' performance over the past three years.
Fund	Manager	1-Yr. Return	Rank	3-Yr. Annualized Return	Rank
(SEQUX)Sequoia	William Ruane and Robert Goldfarb	-24.3%	311/311	8.9%	160/210
(OAKMX)Oakmark	Robert Sanborn	-25.4	471/471	-2.7	306/308
(YACKX)Yacktman	Don Yacktman	-24.3	470/471	-7	308/309
(SKSEX)Skyline Special Equities	William Dutton	-11.1	307/315	-.19	156/183
(LLPFX)Longleaf Partners	O. Mason Hawking, G. Staley Cates, and John Buford	-14.5	429/471	7.8	135/309
S&P 500	N/A	10.1	N/A	21.2	N/A
Source: Lipper, Data as of Feb. 17.

Obviously, these funds are in trouble to begin with because they're value funds in a growth market. Over the past year, the return of the average large-cap growth fund is beating large-cap-value counterpart 36% to just over 1%, according to Lipper. If you look at five-year returns, the spread is a smaller, but still significant, 10 percentage points.

Funds such as (SEQUX)Sequoia and Skyline Special Equities still have 10-year records that beat around 85% of their peers, so you know their style has worked in the past. Problem is, it's been out of favor for quite some time.

These managers are known as "deep value" investors who buy shares of solid but profoundly under-appreciated companies at ultra-cheap prices.

At the other extreme, there's relative value investing, in which a manager has more flexibility and can use different (i.e., less-strict) valuation measures. Some can simply declare that a stock is currently a value because its price will head north.

Deep-value managers remain in a deep hole compared to relative value peers who've boosted returns with pricey tech stocks.

"Deep value has just been destroyed, so the Yacktmans of the world have suffered," says Morningstar analyst Russ Kinnel.

No one knows that better than Don Yacktman, who admits he's been "creamed." He says the valuation spread between value and growth stocks is the widest it's been in 20 years -- he's been investing for 32.

But that's not necessarily the whole story. The deep-value (OAKLX)Oakmark Select fund returned a respectable (for value) 14.5% in 1999, though it's down 5.4% this year. And on the other side of the equation, Bill Miller, vaunted manager of (LMVTX)Legg Mason Value Trust and the king of relative value investing, is up only 6.9% over the past year and down more than 9% since Jan. 1.

No, a common thread among the fallen value giants is that they made outsize bets on falling stocks and sectors and stubbornly stuck to them.

Sequoia managers William Ruane and Robert Goldfarb have more than 90% of the fund invested in financials, an interest-rate-sensitive sector that's down 15% since Jan. 1. Nearly 30% of the fund is sunk into legendary value investor Warren Buffett's holding company, Berkshire Hathaway (BRK.A). The stock is down more than 37% over the past year through Friday's close.

On Jan. 31, Yacktman had a 17.5% bet on Dept. 56 (DFS), maker of collectible porcelain figures and miniature villages. He also had about 13% of the fund invested in embattled tobacco concern Philip Morris (MO). The stocks are down 54.9% and 51%, respectively, over the past 12 months through Friday's close.

Philip Morris was long the top holding of the Oakmark fund, and it still represented 5.2% of the fund's holdings as of Jan. 31.

O. Mason Hawkins and his colleagues at (LLPFX)Longleaf Partners have bet almost 15% of their fund on Waste Management (WMI), down a stunning 69% over the past year. (See a recent Dear Dagen column for more on Longleaf Partners and Waste Management.)

But these managers aren't giving up on their approach. Stubbornness is often the hallmark of a good value manager -- says Ed Rosenbaum, director of research for fund-tracker Lipper. "These are good managers whose style is just not working now," he says, adding that the worst thing they could do now is change their stripes, which would turn investors off even more than weak performance.

In the meantime, investors are hitting the exits anyway and that isn't helping matters. Collectively, these funds have assets of a little more than $10 billion. In 1999, more than $4 billion flowed out the door (roughly $3 billion from Oakmark alone), according to Boston fund consultant Financial Research.

Portfolio managers often have to sell stock to meet redemptions, and selling stocks that are falling can sink returns even further. "These funds are getting hit with redemptions, and that might not be something they've seen before," says Kinnel. Speaking hypothetically, "You've got to sell $5 million [in stock] per week. And if you want to buy something, you need to sell $10 million."

Given their current funk, it's not easy to figure out which, if any, you should choose.

Kinnel says choosing solid managers when they're out of favor can lead to great returns. How many investors remember, for instance, that several of last year's aggressive, small-cap darlings with triple-digit returns such as (VWEGX)Van Wagoner Emerging Growth sported double-digit losses just a couple of years ago?

But Kinnel cautions investors to steer clear of funds with longer-term weakness. Both Yacktman and (OAKMX)Oakmark are nearly dead-last among multi-cap value funds over the past five years, according to Lipper. Oakmark's underperformance is particularly distressing. The firm's managers select stocks from a companywide stock list, but Oakmark Select has chosen stocks from the same list and performed well.

No one can say when value investing will storm back into relevance or which of these managers will charge back to the top of the heap. Until then, you'll have to play value manager yourself, looking for a promising fund on the scrap heap. If you want a little help from us, take a look at our most recent Saturday Screen, where we pointed out some value funds that are worth a look.

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