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These Former Colleagues Are in a Value League of Their Own

Michael Price and his proteges have gone in different directions. Do great minds still think alike?

Bridget B. Hughes, 10/05/2010

It's been almost 10 years since famed value investor Michael Price left his chairman post at Mutual Series, five years after selling it to Franklin Templeton in late 1996. And it has been even longer since he stepped down from his day-to-day portfolio-management duties. But his influence remains strong. Since his departure, portfolio managers and analysts he trained and worked with have become prominent in their own right. They have followed different paths, albeit many along the same general investment road.

Some, such as Peter Langerman, remain at Mutual Series. Langerman runs Mutual Shares TESIX, among other funds. Others have launched their own mutual funds, pledging to follow the same time-tested value philosophy they learned from Price and, directly or indirectly, from his teacher, the late Max Heine. In fact, several ex-Mutual Series managers now offer mutual funds. David Winters launched Wintergreen WGRNX in late 2005 after leaving Mutual Series several months earlier. David Marcus, who worked at Mutual Series until 2000 and subsequently worked with a family's personal investments and businesses, started Evermore European Value EVEAX and Evermore Global Value EVGBX at the end of 2009. Finally, Chuck Lahr and Anne Gudefin, at Mutual Series for nearly seven years and 10 years, respectively, left in late 2009 to start up PIMCO EqS Pathfinder PATHX, which launched in April 2010.

With a handful of investment outfits plying the same strategy, including Price's own MFP Investors, LLC, investors can glean some insight from examining their portfolios, which are disclosed quarterly. (Although such disclosures can be made with as much as a 60-day lag, these investors are all long-term-oriented, often holding on to companies for multiyear periods.) How similar are the portfolios? Do they show the Price influence? Are there stocks or areas the managers all agree on?

The Rules
Let's first examine just what this uncommon strategy entails. Perhaps the most important aspect of the strategy is its one guiding principle: Don't lose money. Assessing each investment's downside is critical in all three legs of the strategy, as well as in portfolio construction. Another distinguishing characteristic is its indifference to index weightings. Sure, the funds all aim to produce index-beating returns over the long haul, but the managers are agnostic when it comes to how similar to or different from the index they look.

The portfolios can be wide-ranging and involve a variety of tools, including options and other derivatives, but primarily focus on three main areas.

One, the managers all look for stocks trading at discounts to their intrinsic value, which can be estimated by the managers in a variety of ways. Cash flow is key, as, generally, are strong balance sheets, and the managers favor corporate managements that use their capital wisely, which often means returning it to shareholders in the form of dividends or share buybacks. The funds can end up holding on to stocks in this camp for many years.

Two, the funds engage in merger-arbitrage strategies. That involves buying a company that is the target of an acquisition in an attempt to capture the spread between the current market price and the (higher) deal price. Because acquisitors generally see their share price decline after making acquisitions, this strategy can also involve shorting the stock of the acquisitor. Depending on the companies involved and how quickly deals close, this can be a shorter-term tactic.

Three, the managers look for distressed-debt opportunities, which can take a variety of forms. In its most intensive form, they might buy the bonds of a company going through bankruptcy, be appointed by the courts to the creditors' committee, work with that company's creditors to secure favorable financing, and end up swapping their bonds for stock in the new, better-capitalized company. As with merger-arb opportunities, supply ebbs and flows. Distressed debt isn't usually a big piece of the funds.

Meeting of the Minds, for the Most Part
Of the hundreds of companies that the five investment houses owned (as of June 30), surprisingly not one company passes everyone's tests.

That said, there are companies owned by four of the five. (Mutual Shares was our chosen representative portfolio from Mutual Series, and Evermore Global Value was our pick from Evermore.) And there are other similarities among the funds.

Four of the five managers own value-club favorite Berkshire Hathaway BRK.A in a greater than 1% weight. (Marcus is the exception.) Remember the preference for good capital allocators? But Winters is currently the most enthused: Wintergreen had more than 7% of assets in Berkshire Hathaway at midyear. Winters says that Berkshire is a complicated company on which few spend the time really "doing the work," and he thinks it's undervalued.PAGEBREAK

Bank of America BAC makes the grade for four of the five, with Winters on the sidelines this time. It shouldn't be a surprise that this stock attracted interest from this crew. In looking for huge margins of safety (that is, a big gap between the market price and the managers' assessment of intrinsic value) and with experience investing in distressed areas, these investors often end up picking through rubble. Between late 2007 and early 2009, Bank of America's shares dropped more than 90%, as many questioned whether or not the company could survive in the wake of a serious financial crisis. But these managers appreciated Bank of America's strong franchise and knew banking wasn't going away. Especially as the company strengthened its capital structure and shareholder dilution became less of an issue, they have gained more confidence in the stock.

Indeed, financials have long been important to Price and company. In part, their sometimes complicated businesses and financials, as well as the risk associated with leverage, meant discounts could be found. All of the funds have double-digit exposures to financial stocks, including banks as well as insurance companies.

Price in particular has been active in the distressed parts of financials. In fact, his top holding now is West Coast Bancorp WCBO, which takes up more than 4.5% of his portfolio's invested assets. That firm recently recapitalized its balance sheet, and Price participated. Mutual Series also recently bought West Coast Bancorp, though it's a much smaller position--less than 25 basis points in Mutual Shares. Price's portfolio is peppered with other financial re-orgs, including his number-two holding Symetra Financial SYA, as well as CIT Group CIT, which both Mutual Shares and Evermore Global Value also own. (Mutual Series owns Symetra in its financial-services fund but not in the more diversified Mutual Shares.)

One other surprise on the portfolio-overlap front: Price doesn't currently own any tobacco companies, though he has in the recent past. That's noteworthy because tobacco has been an integral part of both Mutual Shares and Wintergreen for at least the past five years. PIMCO EqS Pathfinder also likes these companies--it has more than 10% of assets in tobacco firms--while Evermore Global Value has a 4% position in Philip Morris International PM (which the other three also own). Mutual Series, though, has recently been trimming its tobacco stake. Tobacco firms tend to generate steady, prodigious cash flow, offer a reliable dividend, and often buy back shares--three attractive characteristics for these managers.

One final similarity are the funds' cash stakes. Price's regulatory disclosures include only his invested assets, so it's unclear how much his portfolio currently has in cash. But all of the others have cash stakes ranging from 10% to 14% of assets, as of the end of June. Cash is a residual of what investment opportunities the managers are finding, but a proclivity to pounce when opportunity strikes means the managers generally keep some cash at the ready. That said, for the two funds that have some history, Mutual Shares and Wintergreen, around 10% of assets in cash is on the low side of their historical ranges.

Alive and Well
Despite the fact that there is not one stock held by all--and remember, this is just a snapshot at one point in time--there are enough similarities to Price's approach to conclude that the Price strategy is alive and well in mutual funds. Mutual Shares seems closest, with a broad portfolio of stocks as well as a smattering of distressed-debt investments (though they don't amount to a large portion of the portfolio). Both Wintergreen and Evermore Global Value are different in their portfolio construction--they are both much more compact, with a smaller number of names, and have much more invested overseas--but the stocks they buy fit the strategy.

It's too early to compare the performances of the small group, considering that PIMCO EqS Pathfinder and Evermore Global Value are so new. Plus, Price's total return isn't available to the public. But Mutual Shares and Wintergreen have behaved similarly, generally holding up reasonably well in down markets and providing a smoother ride for shareholders overall than most funds do. What's clear, though, is that investors now have several avenues to take to invest in a distinctive, time-tested value approach.

Bridget B. Hughes, CFA, is an associate director of fund analysis with Morningstar.

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