Value managers tend to like financials, and many have been shunning commodity-related stocks, which they think are overpriced. That has led to miserable results. Here’s my advice. By Steven Goldberg, Contributing Columnist July 8, 2008 Value investing, usually the most rewarding way to invest, has fallen on hard times. As a result, some value managers with outstanding long-term records are looking like fools.Look at what’s happened to some of the most renowned value funds over the past 12 months—a period during which Standard & Poor’s 500-stock index has lost 15%. Dodge & Cox Stock (symbol DODGX) has fallen 24%, Longleaf Partners (LLPFX) is down 21%, Longleaf Small-Cap (LLSCX) has lost 22%, Muhlenkamp (MUHLX) is off 30%, Oakmark (OAKMX) has lost 21%, Oakmark Select (OAKLX) has plummeted 31%, T. Rowe Price Equity Income (PRFDX) is down 19%, Vanguard Windsor (VWNDX) has plunged 28% and younger brother Vanguard Windsor II (VWNFX) has fallen 22%. Then there’s Bill Miller’s Legg Mason Value (LMVTX). After a record 15 consecutive years of beating the S&P 500, the controversial value manager is in the midst of his third straight wretched year. Over the past 12 months, his fund has lost 38%. (See "Is Bill Miller Toast?") What’s behind the disaster in value investing? Bargain hunters typically own a lot of financial stocks, which historically sell at relatively low prices. What’s more, these investors tend to shun commodities stocks unless the sector has done badly for quite some time. Value investors normally sell shares of commodity companies, which are notoriously cyclical, after they’ve had a significant run-up. Advertisement Value investing and momentum investing—that is, buying what’s been going up—are polar opposites. And for quite a spell now, what’s been cheap has continued to get cheaper (particularly financials) and what’s been going up—namely stocks tied to energy and industrial materials—has kept rising. Numerous academic studies have shown that over the long haul, investing in value stocks is usually more profitable than buying stocks of growth companies—those that are firing on all cylinders but whose stocks command high price-earnings ratios and are expensive on the basis of other measures. But the traditional value approach has proven disastrous over the past year. True, the entire stock market is in a funk—it officially reached bear-market territory (a decline of at least 20%) in early July—but value stocks have been the primary culprit. Year over year through July 3, Morningstar’s index of value stocks has plunged 25%, while its comparable index of growth stocks has fallen just 8%. What’s an investor to do? I’ve been recommending for a long time that investors put the lion’s share of their money in stocks of large growth companies. My favorite funds remain Vanguard Primecap Core (VPCCX) and Marsico Growth (MGRIX), which have each shed 9% over the past year. Advertisement Growth companies remain almost as cheap as value companies by most measures—an incredibly rare occurrence. Plus, large, growth companies have the muscle to survive hard times—and to perform better than other stocks during periods of inflation. (Morningstar’s large-company index has lost 14% over the past 12 months, while its small-company index has dropped 21%.) But that doesn’t mean you want to sell all your value funds. Over the long haul, most of these funds will do just fine. But value managers tend to buy early—when stocks are still falling. That’s why you find poor-performing stocks such as Wachovia in Dodge & Cox Stock and General Motors in Longleaf Partners. Which funds should you hold on to? All of my favorites have outstanding long-term records. They are Dodge & Cox Stock, Longleaf Partners and Longleaf Small-Cap (which is closed to new investors). I also think Muhlenkamp will bounce back, and T. Rowe Price Equity Income remains a fine choice for conservative investors. Legg Mason Opportunity (LMOPX), Bill Miller’s smaller and more nimble fund, still makes sense in small doses, although my commitment to this high-fee fund is beginning to waver as its price continues to plummet. Steven T. Goldberg (bio) is an investment adviser and freelance writer.