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July 31, 2002

Value Vanquishes the Bear

By Kathryn M. Welling

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Laurence B. Siegel, director of investment policy research at the Ford Foundation, has great investment instincts. But he knows too much to follow them blindly, preferring instead to temper instinct with disciplines developed over a lifetime of experience in delving deeply into the best investment research available. Especially the quantitative stuff. A good bit of which Larry, back when he served as managing director of Ibbotson Associates, which he helped to establish in 1979, did much to put on the map.

But Larry isn't a head-in-the-clouds intellectual, either - something he can prove equally by quoting early rap song lyrics or by pointing to his service as chairman of the investment committee of the Trust for Civil Society in Central and Eastern Europe. He is, in short, precisely the sort of fellow you'd expect to keep his head - and maintain a long-term perspective - even amid volatile markets. Which is exactly what he's doing. -KMW

The markets seem to have gone wacky, Larry. Is this part of a process that means value-oriented strategies had their day, and growth stocks are about to revive? You did, after all, pen (along with John Alexander) that very well-timed piece on "The Future of Value Investing" that appeared in Invesco's first quarter 2000 report - when almost everyone believed value stocks were death.

Value strategies have performed so well since March 2000 that their expected return, relative to the overall market, is much more modest than it was back then. But I still think value stocks have more attractive valuations, and more "visibility" in the sense of earnings that are believable and predictable. And value is a better strategy overall, although a well-constructed portfolio has growth as well as value components.

What do you mean, value is a better strategy?

Value stocks are already priced to include the possibility of a disaster. If the disaster doesn't occur - and there will be many more non-disasters than disasters - you eventually get a capital gain as the market figures out the true worth of the company's assets. So the active value manager only has to figure out which companies are most likely to collapse. Growth stocks are much better companies. However, they are typically priced for high rates of long-term growth that are only rarely realized. If there is an earnings disappointment - and for most growth stocks, there eventually will be - the price will fall. To beat a growth benchmark, the manager has to figure out which of many companies are going to have the competitive edge that enables them to become the next Microsoft or Wal-Mart. That's too hard.

Let's talk a bit about the "science" of money management. The problem is that many portfolio managers seem to have forgotten the essence of investment risk: Loss of capital, or purchasing power. You're a quant -