Are Value Funds Broken?

To the surprise of some investors, this historically sturdy strategy is getting pummeled.


Anyone who once thought of value investing as a low-risk way to ride out a bear market got a wake-up call this year. Value funds may have held up relatively well during the 2000-02 bear market, but their 2008 performance so far ranks at the bottom of Morningstar's categories of diversified stock funds.

Even more surprising to some, the kings of value--including Marty Whitman, Bill Miller, and the gang at Dodge & Cox--have fallen farther than most of their peers. Third Avenue Value, Legg Mason Value, and Dodge & Cox Stock have all lost more than half of their value this year (Miller's Legg Mason Value is down 62 percent!)

There are a couple of explanations for this. Miller, who awed the investing world by beating the S&P 500 for 15 consecutive years (1991 to 2005), may have lost his mojo. Keith Fitz-Gerald at Money Morning says he--along with the Dodge & Cox team--"simply underestimated the depth and severity of the challenges facing their investments. Adding insult to injury, they concentrated their investments in a relatively small number of core holdings they thought they 'knew.'

So piling into just a couple of holdings turned out to be disastrous, especially when they include companies like Lehman Bros. and Freddie Mac.

Whitman's is a case of low portfolio turnover, Fitz-Gerald says. Managers like him "simply don't sell all that often, preferring to ride out market gyrations, which they view as a mere nuisance. So their performance is likely to suffer in line with the markets. But that's not necessarily a bad thing."

And it's certainly not a bad thing to be a value investor right now. Why? Because when the market recovers, says Fitz-Gerald, "the deep-value choice available today will be some of the highest-performing investments for decades to come."