The tipping point for much-maligned growth-focused mutual funds came at a tony Arizona resort in November last year.
Before an audience of about 300 financial advisers at the Westin Kierland Resort and Spa in Scottsdale, legendary investment guru Peter Cundill made a surprising pronouncement. The deep, deep value manager of more than $9-billion told the crowd that the best value in the market may be in growth stocks.
"I thought, 'Hey, that's great'," said attendee Philip Taller of Bluewater Investment Management Ltd. and manager of the $1.3-billion Mackenzie Universal Canadian Growth Fund.
"There's not a lot of value in value because value stocks have done so well," he said. "Value investors are telling us they are hard pressed to find value."
Mr. Cundill's observation represents a sea change in the outlook for the market. Growth-style investing, out of favour since the tech bubble burst in 2000, is poised for a comeback.
Growth managers aren't necessarily looking to buy a stock at a bargain price; they are looking to future share-price gains. In general, growth funds hold a stock for a shorter time and there is higher turnover within the portfolio.
"The companies that we are buying might have a great long-term growth profile, but there is something in the marketplace holding the stock price down," Mr. Taller said. "If you can convince yourself it's a temporary problem, then you have got a great confluence of factors. You've got growth at a really good price, the Holy Grail of what we are trying to achieve."
The 1990s were the decade for growth managers. The booming junior exploration market, coupled with intense interest in the Internet and technology plays, made speculative growth managers including Ian Ainsworth and Clas Olsson the toast of Bay Street. Growth-focused companies saw billions in net sales, a list that includes AIM Funds Management Inc., AGF Management Ltd. and Altamira Investment Services Inc. Top performers included the Dynamic Power Canadian Growth Fund and the Fidelity Canadian Growth Company Fund.
Everything changed in the spring of 2000. The Nasdaq Stock Market crashed, the Internet-fuelled tech bubble collapsed and growth stocks and funds have been behind the tool shed ever since. Value fund managers have made the most of the market, snapping up hidden gems at a discounted price.
Managers often have specific financial criteria that factors into the buying and selling of stock. The investment horizon is generally longer term in comparison to that of a growth fund.
Since 2002, the share prices of debt-heavy companies, resource firms and small-cap companies have served buy-and-hold value managers very well. Funds with a value mandate have excelled, among them the CI Canadian Investment Fund, the Dynamic Canadian Value Fund and the RBC O'Shaughnessy U.S. Value Fund.
Value guru Eric Sprott has spent this decade trouncing the competition. Since 2000, the $950-million Sprott Canadian Equity Fund has returned a stunning annual average of 32.4 per cent.
"We buy when things are better value, but when they are successful, they are considered growth stocks," Mr. Sprott said. "Things kind of morph . . . things that are deadbeat companies when you bought it, then, all of a sudden, after three years of 20-per-cent earnings growth, they are put into a different category."
Indeed, three consecutive years of double-digit gains have made three core categories regularly mined by growth managers an expensive proposition.
The S&P/TSX financial services, energy and materials indexes now account for 75 per cent of the value of the Toronto Stock Exchange. Such blue chip value stocks as Royal Bank of Canada, Suncor Energy Inc. and Canadian National Railway Co. trade at or near record share prices.
That shift in value supports the increasing sentiment that momentum-driven growth stocks may soon be back in vogue.
Investor interest in growth stocks and funds is on the rise, reports mutual fund giant Investors Group of Winnipeg.
"In the last couple of quarters, we've seen a resurgence or a renewed interest in the values of growth stocks," said A. Scott Penman, president and managing partner of I.G. Investment Management Ltd.
He predicts that in the near future, there may be less "disparity between growth and value" stocks when it comes to performance.
Growth fund managers argue that the economic outlook supports their investment thesis. Bluewater's Mr. Taller claims that interest rates and economic growth in Canada will be modest going forward. Companies with cash flow and earnings-growth rates that exceed the economy will enjoy accelerated share-price gains.
Mr. Taller's growth-stock picks include Cognos Inc., Canada's largest software company, and Biosite Inc., a U.S. clinical diagnostics company.
Stabilizing oil and commodity markets mean many Toronto Stock Exchange-listed companies will be hard-pressed to meet lofty profit expectations that call for an average growth rate of about 24 per cent in 2006, predicts Phillips Hager & North Investment Management Ltd. The Vancouver money manager says the bulk of TSX-listed companies will disappoint and report earnings gains this year in the high single digits.
"We really do think the timing to rotate from value to growth is now," said John Montalbano, president of PH&N.
"Growth-biased managers like ourselves are in a very favourable position for the next leg of the market," he said.
"In an environment where profit growth is decelerating and investor expectations are revising downward, it is one that is pretty ripe for emerging quality growth companies to outperform."
It's inevitable that market sentiment will shift, said Dan Hallett, an independent fund analyst based in Windsor, Ont.
"Look at the raw numbers . . . the nature of the market is cyclical," he said, adding that it might be time to revisit some of the growth-oriented funds that did well in the 1990s.
"If there's a manager you like that happens to be out of favour right now, it might be a good time to commit more money to the fund," Mr. Hallett said.
While the industry mulls the timing of growth's return, financial advisers preach diversity and urge clients not to fixate on a manager's investment style.
For example, Investment Planning Counsel Inc., a Mississauga company with about 550 financial advisers, recommends that prudent investors own a mix of value- and growth-focused funds.
"It's best to have one investment style offset another," said Chris Reynolds, IPC president. "It is very, very hard to predict whether growth or value . . . is going to outperform."
A fund manager's investing style is an important factor when building a portfolio, said Adrian Mastracci, a Vancouver financial adviser.
"But do I worry about it a lot? No," he said. "Over a five year window, I'll get mileage out of growth and value. Let's stick with quality and buying the right fund for the client.
"If I stick with that, I'm going to be more right that wrong."
© 2007 The Globe and Mail. All rights reserved.
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