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Value Funds See a Light at the End of the Tunnel

It may be too early to put new money in, but think twice about pulling money out.

This summer, investors will be able to do something they haven't been able to do in a decade -- buy shares in


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Windsor fund. The question I'm asking myself: Why would anyone want to?

Windsor, which made its debut when

Howdy Doody

was a hit TV show, has been closed to new investors since 1989. For much of that time, it's also been shut out of the market, return-wise. Last year, Windsor returned 0.9% compared with the

S&P 500's

28.6%. The fund has lagged the blue-chip benchmark six years out of the past nine. So it's not surprising that Windsor has seen $1.2 billion -- nearly 7% of assets -- fly out the door so far this year, according to money-flow tracker

Mutual Fund Trim Tabs

. It's also no surprise that Vanguard has decided to bring in new management blood.

But unless Windsor changes its style as well as its management, investors might not see all that much improvement. After all, Windsor's peers haven't been world-beaters either. The average value fund returned only 5.3% last year and a dismal 2.2% last quarter. No wonder the only value fund raking in big bucks these days is last year's all-star

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Legg Mason Value Trust -- you know, the "value" fund whose big winners were


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In fact, any portfolio manager committed to value stocks over the past five years has had a lot of explaining to do. Investors have made 283% on their money in growth stocks over the past five years, using the

S&P Barra Growth Index

as a measure. Value investors have had to make do with 163% during the same period, disappointing by this bull market's standards.

Believe it or not, beleaguered value stocks may be near a turning point, though first-quarter score cards show more value bashing overall. The S&P Barra Growth Index beat its value counterpart 6.9% to 2.9% for the three-month period. But during February and March, value stocks edged out growth, 0.81% to 0.73%.

Those numbers suggest that maybe it's not the time to give up on value funds if you already own them. I'm even beginning to hear from some experts that it's time to start nibbling if you don't. "Value is back in the game," says Edward Keon, head of quantitative research at

Prudential Securities

. Portfolio managers this year will have to make money by picking the right stocks, Keon says, not just by picking the right style.

Here are some trends in value's favor:

  • Interest-rate creep. Higher rates put pressure on price/earnings ratios, more of a negative for growth stocks than for value.
  • Higher earnings growth overall. Prudential is looking for 7% to 8% earnings growth in 1999 and 10%-plus in 2000. Value has a chance to compete in that kind of environment.
  • Rising commodity prices. Oil price hikes are translating into energy-stock gains, while firming steel prices could do the same for basic industry stocks.

Just don't expect anything too dramatic -- or too soon. Rates and commodity prices are fickle. And too much increase in either could sap the market overall, of course. Meanwhile, Prudential expects all the earnings growth this quarter to go to large-cap growth stocks, with no improvement in value until the second or third quarter. To anyone dusting off a value fund prospectus, Keon says, "It's a little early, but not terribly."

For investors with staying power, being a little early might not matter much. Long-term returns for growth and value funds are remarkably similar: For the 15 years ended in 1998, growth funds returned 13.8% a year while value funds returned 13.7%, according to



Don't misunderstand me; I don't advocate loading up on value funds. As anyone who has forecast otherwise in the past couple of years can attest, this is a market driven by growth and technology, and no one, least of all Prudential's Keon, would blame you for overweighting both.

But investors would do well to recall a strategy that has fallen out of favor in this narrow, '90s-style market. It's called diversification. What if the unthinkable happens and the tech stocks nosedive? Hey, it could happen. You'd want to own whatever was on the other side of the seesaw. That's most likely to be energy stocks or utilities, the industries that have had the lowest correlation with tech stocks over the past 15 years, says Keon.

Over the past six months, energy and tech stocks have had a negative correlation (-0.29), meaning they have truly moved in opposite directions.

Where better to get a good taste of energy and utility stocks than value funds, where the sectors account for 6.7% and 5.0% of assets, respectively, according to Morningstar? (Financials, the "best news" about value stocks, according to Keon, account for 21.4% of value fund assets.)

So while there might be better choices than Windsor


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Vanguard Growth & Income,

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Selected American and

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Kemper-Dreman High Return Equity have finished within the top half of their peer group for the past four years), investors may want to consider sampling some value funds now. With apologies to


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, I'll say, "Just hold your nose and do it."

Anne Kates Smith is a senior editor at U.S. News & World Report in Washington.