Talk about bad timing.
Just when value stocks outperformed growth stocks by the widest margin in seven years, pension funds moved assets out of value and into growth.
According to data from Greenwich Associates, Greenwich, Conn., the average pension fund had a 31.6% allocation to large-cap growth assets in 2000, up from 30.8% in 1999. In small-cap growth, allocations jumped to 8.8% from 6%.
At the same time, value equity allocations dropped. Pension funds had an average of 25.8% of their equity assets in large-cap value stocks last year, down from 32.3% in 1999. The allocation to small-cap value stocks dropped to an average of 6% from 6.2% in 1999.
This went against the grain of the market in 2000, as value handily outperformed growth. The median value equity separate account in the Pensions & Investments Performance Evaluation Report universe returned 12.7% in 2000, while the median growth equity account returned -7.2%.
Twenty-one percent of the pension funds surveyed terminated a value manager in 2000, up from 17% in 1999, the highest percentage in five years. Only 14% of pension funds terminated growth managers in 2000, down slightly from 15% in 1999.
"To the extent that that's an accurate reflection of the market in 2000, that's disappointing," said Stephen Holmes, president of Summit Strategies, a St. Louis-based consulting firm. "That tells me there were an awful lot of people looking into the rearview mirror."
Ted Disabato, president of consulting firm Disabato Associates, Chicago, thinks now is the time for growth shopping.
A year ago, it was hard to resist client enthusiasm for growth, he said, but now that clients' enthusiasm for the style has dimmed, Mr. Disabato is swimming upstream, trying to persuade them that it's time to increase those allocations.
"Things are on sale; it's the blue light special out there," he said. "Imagine if Wal-Mart had a sale where everything was 60% off. The parking lot would be filled."
Investors, however, often think just the opposite. "They fill the parking lot when prices are up 60%," he said. "Investors' enthusiasm takes a long time to get beat down. I think we're starting to see that now."
The role of consultants is to avoid making those mistakes, said Mr. Disabato, whose clients' interests have turned toward value and alternative investments, because they fear the market may run flat for an extended period of time.
Data from Mercer Manager Advisory Service, Louisville, Ky., shows that most of the growth placement activity of last year was in the first quarter, when that market still was charging ahead and value lagged. There were 55% more growth manager placements than value manager placements in that quarter.
Activity was relatively equal in the second and third quarters, but in the fourth quarter, the situation reversed, with 22% more value placements than growth placements, according to Mercer's Tracker database.
From deep to relative
Dev Clifford, researcher at Greenwich Associates, said many pension funds that terminated value managers had reached "the tail end of patience." But rather than shift assets into growth, pension funds fed up with years of lower returns from deep value managers fled for the middle ground of relative value and passively managed portfolios. "I would be surprised to see pension funds, rather sophisticated investors, replacing value managers with growth managers into the second and third year of an extremely hot growth market," he said. He was not surprised, however, to see a "healthy level" of terminations and replacements among value managers.
The higher average allocations to growth in 2000 were largely a result of organic growth of those portfolios, he said.
The $10.5 billion Kansas Public Employees' Retirement System, Topeka, traded one deep value manager for another last year when it terminated Brinson Partners, Chicago, in January for performance reasons and hired Wellington Management Co., Boston, to run the $325 million portfolio, said Scott Peppard, deputy chief investment officer.
Brandywine Asset Management Inc., Wilmington, Del., was among the value firms that lost accounts in 2000, said Alec Cutler, portfolio manager. Most of the defections were in the first half of the year, but the firm also saw terminations once value was solidly outperforming. That's because it sometimes takes pension plan boards a few meetings to make changes.
Mr. Cutler said some of the pension funds that terminated his portfolio went to passive accounts, opting instead for Russell 1000 Value index accounts.
But after a rough first quarter, the Brandywine large-cap value account had a strong year, returning 23.2%, according to PIPER, placing it in the second quartile. For the 10 years ended Dec. 31, it returned an annualized 18%, which is ahead of the median value manager return of 17.3% but behind the median growth return of 19.5%.
After a year of solid performance, the Brandywine large-cap value separate account is starting to be considered in more searches. "What goes around, comes around," Mr. Cutler said of the market fluctuations.
He believes the market is now in a sweet spot for value managers, and he sees value outperforming growth for an extended period.
He looks at the value cycle in four phases and believes the value market is in phase two. The first phase, which occurred last year, he called the "learning the lesson" phase, which was less about value's strength and more about growth sinking dramatically.
The second phase, which he believes is just under way, will see the markets stabilize with more steady outperformance by value managers, as valuations return to normal and the market makes more sense. He said this return to normalcy phase could last longer than usual - two to five years - because the preceding growth cycle was unusually long. "The harder the lesson, the longer the second phase."
Then phase three begins, said Mr. Cutler, when some sector starts to defy logic in terms of valuations. The irrationality tends to feed on itself and the market begins to narrow until the beginning of phase four, when the market is fueled by one or two high-flying sectors. This is the phase that value managers just crawled out from under last March.