Lighten up on large-cap growth stocks

September 20, 1999

Lighten up on largecap growth stocks

Lighten up on large-cap growth stocks

Investment Consult

Do it for now, at least. There are better US investments--evenamong big companies.

By Lewis J. Altfest, PhD, CFA, CFP

Over the past several years, large-company growth stocks have been ona tear, beating small companies' average total return by double-digit margins.This trend became even more pronounced last year, after certain overseasmarkets began to roil: Investors flocked to the comfort of familiar namesand steady earnings.

But favoring large-cap growth stocks makes less sense now than it didthen. In March, Asia's economy began to come out of its doldrums. We'vealso seen encouraging signs in cyclical stocks--those representing industriessuch as housing and automobiles, which tend to react swiftly to the economy'sups and downs. Moreover, small and medium-size companies have started tooutperform large-cap growth stocks. Large-cap value stocks--those whoselow prices don't reflect what's believed to be the true value of the companiesthat issue them--also are registering better results.

Does this mean you should take all your money out of large-company growthstocks and funnel it into other categories? No. Keep a percentage in thesecompanies, so your portfolio remains properly diversified. In my June column,I recommended that investors 40 or older keep 10 percent of their portfoliosin large-cap growth stocks and 15 percent in large-cap value. Generally,that's not a bad long-term allocation. But to take greater advantage ofvalue stocks' resurgence, you and your financial adviser might decide torejigger your large-cap holdings to create a 2-to-1 value-to-growth ratio.

I understand that this advice might be hard to take. When I recentlyadvised a middle-aged obstetrician to lighten up on large-cap growth stocks,he couldn't bring himself to do so. Because those stocks had done so well,he paid little attention to my warning that many of them are selling athigh prices relative to their earnings--and that a broad market declinewould cause those perched the highest to take the worst tumble.

Sometime during the coming months, the obstetrician may wish he'd takenmy advice. Expectations for large-cap growth stocks are so high these daysthat even a profitable company could see its stock price stagnate or drop.

Soaring prices based on rapid earnings growth are especially difficultto sustain. Each year, several large-cap growth companies descend from investorheaven because earnings didn't meet lofty expectations. Cadence Design Systems,Coca-Cola, and Compaq Computer are just a few recent examples. Anyone whohad a substantial stake in one or more of those companies probably feltlike a cliff diver who missed the water.

Last year, investors whose portfolios were heavily weighted toward large-capvalue stocks could relate to that feeling. The typical large-cap value mutualfund severely underperformed the Standard & Poor's 500 Stock Index in1998. But that's because most such funds held fewer assets in technologystocks relative to the index, and they generally had heavier weightingsin utilities and industrials, sectors in which growth was sluggish. I believethat when tech stocks dip and investors start searching for reasonably pricedequities, large-cap value funds will outperform large-cap growth funds.

Two no-loads you should consider are Vanguard Windsor II Fund (800-662-7447)and Neuberger Berman Partners Fund (800-877-9700).

Vanguard Windsor II--whose assets have more than tripled since 1995,to $34 billion--now ranks among the biggest mutual funds. Nevertheless,the portfolio managers are still finding good places to invest all thatmoney: The fund's five-year average annualized return is 22.6 percent, achievedwith less risk than the S&P 500 exposes investors to. That's evidencedby Vanguard Windsor II's below-average risk rating and the current portfolio'saverage price-earnings ratio (price divided by earnings): 22.8 vs 36.0 forthe S&P 500. Despite that significantly higher risk, the S&P 500returned only 3.6 percentage points more during the same five-year span.

Your total return gets a boost from the fund's low turnover rate, whichhelps reduce capital gains taxes, and from Vanguard's cut-to-the-bone ap-proachon expenses. Windsor II's expense ratio is a mere 0.4 percent; the averagefor the large-cap value category is 1.3 percent.

Neuberger Berman Partners, a 31-year-old fund with $3 billion in assets,had an underwhelming 6.3 percent return in 1998. Despite that, the fund'sfive-year annualized return of 20.5 percent is only slightly less than thatof Vanguard Windsor II. A new portfolio co-manager--S. Basu Mullick, a vicepresident of Neuberger Asset Management--was named last December. I cameaway impressed after meeting Mullick, and I expect him to inject new ideasand build upon the fund's strong long-term track record. Among the fund'scurrent value holdings are Bank One, Cigna, General Motors, and GTE, allof which have P-Es one-third lower than that of the typical S&P 500stock.

The author, a fee-only Certified Financial Planner, is president ofL.J. Altfest & Co. (www.altfest.com),a financial and investment advisory firm in New York City. This column appearsevery other issue. If you have a comment, or a topic you'd like to see coveredhere, please submit it to Investment Consult, Medical Economics magazine,5 Paragon Drive, Montvale, NJ 07645-1472. You may also send a fax to 201-722-2688or e-mail to meinvestment@medec.com

All data in this column are through July.

Lewis Altfest. Lighten up on large-cap growth stocks. Medical Economics 1999;18:45.