The differences within the sometimes-tricky "growth" style of investing seem to be, well, growing. That's because many of the man-agers and fund families investing money today cannot agree on where and how one finds the best growth stocks. The traditional rules about what constitutes growth no longer seem to apply, according to managers and industry observers.
"In the old days, it was simple-growth meant price/earnings. But everything changed in the 1990s, and today, many people are confused about what is growth," says Dr. Gerald Perritt, an academic and a fund manager.
"Many growth funds have just become too frothy. Their P/Es have become unrealistic," declares Mark Spangler, an advisor in Seattle.
Growth has become "a big tent" that is incorporating many different styles, says Don Phillips, a managing director at Morningstar. The fund rating service is working on a new system for classifying the differences among growth funds. In the meantime, advisors grapple with growth styles that are very different-so different that the most volatile of these funds have been among the biggest losers over the last 18 months.
Spangler withdrew client money from growth funds in 1999, when many started running with average P/E ratios in the 30s, 40s and higher. "That, to me, was a clear sign that many of these funds are just too risky," he adds. Spangler holds that there is no pure growth strategy; almost every fund is some mix of growth and value. Sometimes he is short, or long, on growth or value.
Even after the 70% freefall in the Nasdaq over the past two years, growth today can mean mostly technology companies. It can mean a mix of companies, Perritt complains, yet all can be classified in the same category. "There's too much information out there and a lot of it confusing. I blame Morningstar, and I blame financial publications," he says.
Some growth funds today are run like closet tech funds-examples are some of the high-flying Putnam funds. It is a growth shop with funds such as Putnam OTC Emerging Growth, which has had up to 85% of its assets in technology (but recently cut back to 42% tech), and Putnam Voyager, with some 30% in technology. Emerging Growth lost 46.6% last year, following a 51% loss in 2000. Voyager dropped 23% last year and 18% in the previous year. The same charge could be levelled at Janus and many growth-oriented families.
A Putnam spokesman said loss controls would be put in place. "Putnam has sought to have better-balanced positions across various sectors of the economy," he adds. Putnam also has sacked a number of managers over the last year.
Not all growth-fund families have as pressing a need for more damage control. They have been able to muddle through the last year and a half. Growth entries such as T. Rowe Price Mid-Cap Growth have cut back on technology, especially over the last year and a half, a disastrous period for the growth category. T. Rowe Price Mid-Cap Growth recently had a 17% tech weighting and has spread the bulk of the fund into other areas, such as financials, services and health.
The problem, some fund observers say, is that there are different degrees of growth. What is growth investing anyway? "Growth investors," claims a publication of T. Rowe Price, "focus on stocks of companies that will grow faster than the rate of inflation." But how one finds these companies-and how much one aims to exceed the rate of inflation and what risks one takes to attain that goal-are some of the great current controversies surrounding growth investing.
"Some growth funds have been easing up over the past year and a half on technology. Others are sticking to their guns and continue to overweight portfolios with a large share of technology, believing these continue to be the fastest-growing areas," Phillips says, and the disparity is causing confusion.
"Some of these fund managers are gunslingers, and some follow more traditional methods of finding growth," says Brad Lawson, senior research analyst with Frank Russell Co. in Tacoma, Wash. "The styles, even though they are supposed to be the same, can be very different."
To find answers, Morningstar is going to institute a new system of measuring funds that will look at gradations of growth, Phillips says. He concedes there is much confusion about growth; that simply measuring a growth-fund portfolio by the traditional indexes-price to earnings and price to book value-is not enough. "We are going to go beyond P/E and P/B and measure degrees of growth. Obviously, the differences within this group are becoming greater," he adds.
Morningstar's new classification still will look at multiple ratios, but it will also factor in variables that describe a company or fund's intrinsic growth characteristics, not just the market's interpretation of promise for growth as measured by P/E and P/B ratios.
These variables include projected earnings, historical earnings growth, sales growth, cash flow growth and book value growth. The new methodology will also measure how quickly a growth fund retrenches in a bear market by analyzing changes in its ratio of cash to equities.
A new sector classification will attempt to spotlight differences among fund strategies. "There are many nuances to growth investing. There are also a lot of growth funds that operate in value territory. These are the kind of things we want to show," Phillips adds.
The ability of advisors and investors to understand this debate is critical. Misunderstanding can destroy a portfolio as advisors place investor assets in funds that are more risky than they imagined. "Some growth managers are going to follow an aggressive growth strategy, they are going to follow a momentum investment style that follows the hot sector," explains Robert Smith, manager of T. Rowe Price Growth Stock Fund.
Smith has gone for the less risky growth strategy and only carried a 17% tech weighting. He also has a significant stake in health care and financial stocks. Consequently, he was slightly ahead in 2000 when his fund rose 0.2%, and only down 9.7% last year, when large growth lost 23.6% and the S&P lost 11.8%. It was a good year for growth managers who stayed away from "gunslinging." Smith's performance last year and in 2000 meant his fund beat about 80% of the funds in his category.
Within the growth philosophy, there are different degrees of growth, Phillips says.
Indeed, many advisors stressing growth have seen their portfolios crack up recently as the category has gone through hard times. Over the past three years of tremendous and terrible performances, the controversy over what constitutes growth probably never has been more intense.
For an example, consider Fidelity OTC and ABN AMRO/Montag & Caldwell, both of which are growth funds. Morningstar classifies them in the same category. But that is where the similarity ends. Although they have had similar performance over the last three years, these two funds pursued very different strategies. Fidelity OTC has overweighted technology-it recently had 70% of the portfolio in tech-ABN AMRO has bought technology carefully and has only a 14% tech component. It also has diversified into health stocks as well as financials in its attempt to find growing companies.
The performance of these two growth funds has been radically different and yet similar. Fidelity OTC's buy-tech-at-any-price philosophy excelled in 1999 with a return of 72.5%. But in the next two years, the numbers were dreadful and it lost most of its gains, yet still finished the three years through the end of last year ahead by 1%.
ABN AMRO badly trailed Fidelity OTC in 1999. It was up only 22.5% in a year when many growth funds were returning 100% or more. But it was only down 7.3% in 2000 and minus 13% last year. Its three-year number was virtually unchanged. These radically different performances are not surprising. ABN AMRO's beta, a measurement of risk, is 0.79-while Fidelity OTC's is a very high 1.73. The average growth fund has a beta of about 1.25.
Before investing, Lawson and Perritt say, check a few important indicators: beta, standard deviation, alpha and even the traditional price/earnings and price/book ratios. They also say that the degree of a fund's diversification still is the key component in finding a gunslinger. Check how the performance was achieved. What's in a word? Today, in the sometimes gimmicky, take-a-big-gamble world of growth investing, what's in the word "growth" is confusion.