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When bull ends, it's time for value funds to shine

There's an old chestnut about value investors that says they're never wrong, they're just early. Unfortunately for the professional ones, when you run a mutual fund that gets marked to market every day though, it doesn't really matter. If you're early, you're wrong, and if you're wrong, you get redeemed as investors chase performance like a dog chases a rolling Frisbee.

So it wasn't surprising to see some of the better long-term value funds doing poorly and being redeemed as the bull market in commodities wore on over the past year or two.

A lot of these managers either wouldn't touch oil, zinc, nickel and so on, or they underweighted them in favour of what they saw as solid companies trading at good prices while momentum players ignored them in favour of commodities.

But as the commodity bull run winds down, these value managers might be poised for a comeback. It happened before, in 2001/2002, as the tech wreck unwound. Value investors - those who stuck to their principles and weren't fired for it - picked up good stocks at unheard of prices and, eventually, inevitably, watched their fund's performance turn and run upward.

Value funds generally did quite well during that period compared with growth funds.

"Styles do go in and out of favour," says Morningstar analyst Mark Chow. "Look back to 2000, investors were still chasing performance, and that was a horrendous mistake."

So it might make sense to go shopping for funds that have good long-term track records but have fallen on hard times lately. There are some tricks involved here though.

The first is being able to read through the statistics. Statistics, as most of us know, have a way of misrepresenting the truth. They're usually used to tart up results, but in this case they can exaggerate troubles.

Let's take an example: the Chou RRSP fund, which is run by Francis Chou, a devout value maven. According to Morningstar, the fund's performance earns it a glowing mention in the fourth-quartile hall of shame, with a one-year loss of 25.5 per cent. You have to stretch the record back three years to find it in positive territory, and it's been dwelling in the damp fourth-quartile cellar for six years.

The trick here, though, is that the last devastating year affects all of these numbers, dragging them down. For instance, Morningstar has the 10-year track record at 8.5 per cent. But if you take out the last year, on the assumption that Mr. Chou's picks are not wrong but early, the nine-year return shoots up almost five percentage points to 13.1, which is quite good in both absolute and relative terms, and much closer to the long-term average.

Let's look at how the Chou RRSP Fund did the last time growth investing fell out of favour. In 1999, when investors were still chasing technology, the fund fell 6.7 per cent. The next year, when the Nasdaq market and tech shares like Nortel Networks peaked and started to plummet, the fund posted a return of 16.5 per cent. That was followed by returns of 17 and 32 per cent, and generally good returns until calendar 2007, when the fund lost almost a tenth of its value. And as mentioned, it's done worse since.

Said Mr. Chou in his latest annual letter to investors earlier this year: "The current environment reminds us of 1999 - stocks that were expensive became more expensive and stocks that were cheap became cheaper but eventually 'value will out.' "

Among other things, Mr. Chou has made big bets media stocks such as CanWest Global Communications and Torstar. The latter's shares are perking up and there's been talk of a CanWest takeover. Although we've singled out the Chou fund, it's only meant as an example. The same argument can be made of other funds as well.

So investors should look beyond the statistics, or at least adjust them to take into consideration the vagaries of the market. Cheap stocks do get cheaper if professional money managers dump them to pile into oil or copper in order to keep up with the index. But that doesn't make them bad investments.

Mr. Chow also cautions investors to look for managers who ply their trade consistently.

"You're looking for that quality manager who sticks to his discipline. To get a value manager to think in terms of growth is asking for trouble."

And finally, look a long way down the pike.

"Investors always say they want long-term investments but they often chase performance," Mr. Chow says.

Value investing done properly is the most rewarding style, not only in terms of returns but also in terms of safety. But it requires patience, fortitude and faith. If you're going to give your money to a value investor, plan on leaving it with him or her for the long term, or you might do yourself more harm than good.

Value funds rising from the ashes?

Quart Quart Quart Quart Quart
Beutel Goodman Cdbn. Equity- 1.4%3+8.8%3+9.9%4+10.7%4+13.5%3
Brandes International Equity- 19.2%3- 2.6%4+1.9%4+1.5%4+7.9%3
Brandes Sionna Cdn. Eq. cl A- 2.4%3--------
Chou RRSP- 25.5%4- 7.2%4- 2.5%4+1.3%4+3.6%4
CI Canadian Investment- 0.6%2+6.8%2+9.9%2+12.2%2+14.3%2
MacKenzie Cundill Value Ser. C- 17.6%3- 2.7%3+1.3%3+3.0%2+8.1%1
PH&N Overseas Equity A- 22.4%4- 2.6%4+1.2%4+1.3%4+5.5%4
Saxon Stock Investor Series- 3.5%3+7.5%4+9.7%4+10.3%4+13.1%4
Saxon World Grth. Investor Ser.- 21.0%3- 7.1%4- 2.8%4- 2.1%4+4.1%4
Trimark Fund SC- 19.1%4+1.0%2+2.9%2+1.5%3+5.0%3
Quart Quart Quart Quart Quart
Beutel Goodman Cdbn. Equity+10.9%3+10.2%3+10.8%1+10.2%2+8.8%2
Brandes International Equity----------
Brandes Sionna Cdn. Eq. cl A----------
Chou RRSP+4.8%4+8.2%2+10.1%2+8.5%2+8.5%3
CI Canadian Investment+11.1%2+10.9%1+11.3%1+11.5%1+9.8%1
MacKenzie Cundill Value Ser. C+5.6%1+4.1%1+6.3%1+7.3%1-
PH&N Overseas Equity A+1.3%4- 0.7%4---
Saxon Stock Investor Series+9.5%4+10.7%2+12.3%1+12.0%1+10.4%1
Saxon World Grth. Investor Ser.+2.0%4+3.1%3+3.2%2+3.4%4+3.6%4
Trimark Fund SC+2.5%2+3.2%1+4.2%1+4.9%1+5.2%1

© 2007 The Globe and Mail. All rights reserved.

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