Investing for value has outperfomed other investing styles for the last year, and, if history is any guide, could continue to do so well into 2005, according to a study by Merrill Lynch.

The reasons for the triumph of a more cautious approach are simple. The financial world is a grimmer place now than a year ago. The outlook for US economic growth has grown more cloudy, oil prices keep surging to record highs and political risks are looming. Even as corporate profits continue to be strong and bulls argue that the recent economic weakness is just an extended “soft spot”, investors are taking few chances.

Yet some observers believe growth will come back sooner rather than later. Jason Trennert, chief investment strategist at ISI Group believes the economy is sound, and says many of the strongest profits were produced by the most cyclical companies, including battered tech companies.

“It's too early to get too defensive and buy value, especially since its worked for so long.”

Nonetheless, investors have gravitated to safety.

Safety means companies with more stable cash flow and earnings, as well as cleaner balance sheets. If they pay dividends, so much the better. As Michael Mach, manager of the Eaton Vance Large-Cap Value Fund observed: “If people think the market is only going to be up in the single digits, and if Verizon gives a 4 per cent dividend, it means you get to start at the 40-yard line.”

So far this year, S&P 500 companies that pay a dividend have returned 3.4 per cent, including dividends. That compares with a loss of 9.4 per cent for their non-paying brethren.

Still, it is often hard for investors to work up much enthusiasm for such humble virtues. This is especially true in the wake of 2003's red-hot run powered by flashier fare. Many still remember that the tech-heavy Nasdaq, larded with low quality, speculative companies, soared 50 per cent. Even the large cap S&P 500 leapt 26.4 per cent.

But with all three major US stock indices in the red this year, stability starts to look awfully attractive. Mutual funds plying the value style have even managed to eke out small gains, according to fund tracker Morningstar.

Small-, mid- and large-cap value funds have racked up returns ranging from 0.6 per cent to 2.1 per cent so far this year. By comparison, investors in the average diversified stock fund are sitting with losses of 2.6 per cent.

That squares with new research from Richard Bernstein, Merrill Lynch's chief US strategist, whose statistical analysis indicates value emerged as the top investing style last month, after a year of dominance by the speculative style. (He requires a style to outperform for a 12-month period before declaring it dominant.)

Mr Bernstein found that over the last 18 years the speculative style dominated in three periods, including last year. The longest speculative period in the last 18 years was the recent tech bubble, running from about mid-1997 to the market crash in the spring of 2000.

Each time speculation has ruled, it has been followed by a return to sobriety. The cycle makes sense: after lower quality companies surge to full valuations, investors begin to look elsewhere for opportunities.

When value has ruled in the last 18 years, it has done so for at least 10 months, and beaten the S&P 500 by 14 per cent.

To determine which style is winning, Mr Bernstein creates and tracks model portfolios, rebalancing every month. His current value portfolio looks safer than the broader index - 54 per cent of it is ranked B+ or better by Standard & Poor's, compared with just 50.6 per cent of the broader index that can muster that grade.

Mr Bernstein's value portfolio is heavy on energy, financials and utilities. Energy has been a big part of value's success, as soaring crude prices have helped push the sector up 11.1 per cent this year, the best performance on the S&P 500. The parent index is down 1.9 per cent.

Financial services companies have spooked investors this year, as rates began to climb from four-decade lows. Traditional wisdom has held rising rates squeeze banks' margins, causing profits to slump. Although the broad S&P 500 financial group is roughly flat for the year, the bank sector has climbed 3.6 per cent, as investors focus more on the cushion banks' lucrative fee income provides.

Bill Fries, portfolio manager of the Thornburg Value Fund, likes financials, citing Bank of New York in particular. He says BoNY benefits from higher short-term rates because it maintains large liquid balances it collects interest on overnight.

In spite of a 5.2 per cent gain for S&P 500 utility stocks this year, they are the most unloved sector by US mutual fund managers. But that is a plus, because it signifies much more money that could come into the sector to push prices higher. Mr Mach is a utilities fan.

“Utilities have seen the light and cut back on capital spending. They've got lots of cash flow, which frees them up to raise dividends,” he said. David Dreman, a value maven, said his discipline will continue to outperform because the fallout from the bursting of the tech bubble is not over. He cited the hefty 113 price-to-earnings multiple for internet darling Yahoo, and the 78 p/e multiple for online auction site eBay. The S&P 500 p/e is 19. “There's been a change here and this might continue for a while because historically, a lot of these tech stocks are still very very high.”