MAY 2003

Lesson 302

Fund Investment Styles, Part II: Growth, Value & Blend

Types of Growth

Types of Value

Blend or Core

Growth, value and blend are three different fund investing styles. In Lesson 301, we discussed the significance of fund investing styles and how different data providers classify funds.

Rounding out our discussion of fund investment styles, in this lesson we'll explain the differences between growth, value and blend investing and the varying types of growth, value and blend funds.

Growth funds employ managers who look for companies with rising sales and earnings. These managers expect to profit when a company's share price increases along with its sales and earnings.

Fund managers using the value approach generally look for companies that are either undervalued by the market or have experienced problems and may be in a turn-around situation.

Funds characterized as blend or core funds have portfolios that exhibit some characteristics of growth and some of value. For example, a blend fund's average portfolio P/E ratios and earnings growth rates will be between that of growth funds and value funds, in most cases.

Growth and value are styles that will be in and out of favor with the market at various times. Patient investors should ride out the ups and downs associated with investing in different types of mutual funds.

Types of Growth

The growth style of investing covers a wide range of management and fund investing styles, including pure growth, growth and income, aggressive growth and growth index funds.

Pure or quality growth funds employ managers who invest in companies with rising sales and earnings expecting to profit from share price capital appreciation. These funds typically hold many companies familiar to NAIC stock investors.

Managers of growth and income funds usually invest in both growth and income stocks in an effort to provide investors with capital appreciation and some income. Income-producing stocks generate dividends and generally have slower growth rates than pure growth companies.

Aggressive growth funds invest in companies that exhibit potential for high growth. These companies may not have well-established track records. Aggressive growth funds are designed for more risk-tolerant investors and can be very volatile.

Many aggressive growth fund managers are willing to pay a high price for companies with fast-growing earnings or even for companies with potential rather than actual earnings.

Investors should be wary of this strategy. NAIC's proven philosophy involves investing in stocks with a track record of increasing sales and earnings during a five to 10-year period.

Growth index funds invest in line with market indexes that track growth stocks. These funds will deliver performance numbers very close to the market index, minus the fund's expenses.

Types of Value

The term "value" is used to describe a broad investment style that emphasizes a search for undervalued companies. Using various measurements, managers will decide which companies are most likely to see their full value recognized by the market in the future.

The portfolios of value funds usually sport lower average P/E ratios and price-to-book ratios than those of growth funds. The value designation covers a variety of differing investment approaches, including deep value, traditional value and relative value.

Managers of absolute or deep value funds adopt a strict methodology that focuses on a company's intrinsic worth. Once this valuation is computed, managers look for companies selling at less than their true worth.

Managers who follow this approach rarely compromise on what they will pay for a company. Some will seek out companies in beaten-down industries or companies that have had significant business setbacks.

In many cases, these managers find companies with prices that have fallen substantially below what the manager believes the company's business are worth.

The manager purchases such companies in the belief that the market will eventually recognize the company's true value and bid up the stock price.

The moderate value approach is also known as value with a growth twist. In this value sub-sector, managers are more willing to pay more for companies with very strong growth prospects.

These managers would be less likely to purchase companies with poor future prospects than deep value managers would.

Managers with this bent may compare a stock's price-to-earnings or price-to-book ratios to industry or overall market benchmarks in an effort to find undervalued opportunities.

In between "deep" value and "relative" value are traditional value funds. Managers of these types of funds would look for undervalued opportunities but wouldn't load up on contrarian-type companies or growth-oriented companies.

There are also value-oriented index funds that focus on value stocks of varying market capitalizations.

Blend or Core

Fund managers who choose a middle path between growth and value are said to follow a blend approach. Blend funds are also known as "core" funds because are appropriate as core holdings in an investor's portfolio. Managers of other funds with average P/E ratios and average portfolio earnings growth rates between value and growth may also be classified as blend funds.

Managers of blend funds may not stick to a particular investment style, but may select stocks that they believe will perform well in the future, regardless of whether they are steady growers or undervalued opportunities.

Blend funds can be found across market capitalizations in large, mid and small-cap funds. Some of the largest funds in the world are blend funds, including Fidelity Magellan and the Vanguard 500 Index fund.

These types of funds are also called "core" because many believe that they are core holdings for most investors. Because many investors like to diversify among value and growth funds, blend or core funds are attractive because they hold both types of companies.