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Two Top Managers Put on the Gloves

These fund managers are demanding better behavior from the companies they own.

Bridget B. Hughes, 06/09/2009

As an investor, you entrust your money to others--such as corporate managements and boards of directors--and expect them be good stewards of your capital. You expect them to run the business in a thoughtful and responsible manner, ultimately resulting in a profitable experience for you and other shareholders.

Sometimes that delegation is a beautiful thing. After all, those closest to the operations of a business can be keen practitioners with the interests of shareholders (a category that often includes themselves) at heart. As Wintergreen Fund WGRNX manager David Winters said at the annual Morningstar Investment Conference last week, "People matter."

But what happens when they surprise you, and not in a good way? Or you find yourself disagreeing more and more with their tactics? Most mutual fund managers and other investors simply sell the stocks or bonds and walk away. It's a viable approach and often the easiest and most painless way to go.

But mutual funds can be such big stockholders that they are often in a good position to demand better behavior from the companies that they own. And as two mutual fund managers recently showed, more-daunting tactics are not unheard of. It's too soon to tell whether or not their maneuvers will translate into higher returns for the funds that they lead, but we appreciate how engaged the managers are in these instances.

Third Avenue Sues MBIA Corp.
Third Avenue Value TAVFX manager Marty Whitman made a bold investment in MBIA Incorporated MBI when seemingly few others would. A shareholder of MBIA's common stock for more than 10 years, Whitman participated in that firm's January 2008 capital raise by buying bonds of subsidiary MBIA Corporation, after mark-to-market accounting on its underlying portfolio had taken a big toll on the company's capital base.

At that point, Whitman wrote about the fund's investments in MBIA and MBIA Corporation's surplus notes as a distressed situation--something with which he has had success over the years. Although Whitman recognized the problems within MBIA, he thought the capital infusion would help rectify the situation, and he had long been attracted to the firm's municipal-insurance operations--a good, steady, profitable business.

Whitman's opinion of the firm changed quickly after what he calls a "plain-vanilla fraudulent transfer" on the part of MBIA Corporation on Feb. 18, 2009, and, following the lead of several hedge fund investors, Third Avenue sued. In Third Avenue's view (according to Third Avenue's April 6, 2009, complaint), MBIA Corporation "moved all of the healthy, income generating U.S. public finance insurance business, $2.1 billion in cash, and another $2.9 billion in unearned premiums to MBIA Illinois, while purporting to leave behind and "ring fence" in MBIA Corp. all of the "toxic" structured finance bond insurance and credit derivative business." Third Avenue wants MBIA to either rescind the transfer or to otherwise compensate the funds. Since Third Avenue's suit, a sizable group of banks, including JP Morgan and Morgan Stanley, have filed a similar complaint.

Whitman's portfolio-management practices don't normally include lawsuits, but he does note that the distressed-investing world is a "confrontational business." And although lawsuits against one's own portfolio holdings aren't common, they have occurred. Legendary value investor Jean-Marie Eveillard, for example, once sued one of his larger holdings.

It will take some time before the case is settled or decided. If Third Avenue wins, MBIA picks up the legal bill. If it loses, Whitman doesn't expect any legal expenses incurred by the fund to be material. However the case turns out, it does not change our opinion of this Fund Analyst Pick; Whitman has long been an eclectic and principled investor, and we have confidence in the long-term appeal of Third Avenue Value.

Wintergreen Advisers Publicly Challenges Consolidated-Tomoka Land
We've seen shareholder proposals at the company level before, and while some of them get a lot of attention, many of them aren't approved. We've also had enough conversations with mutual fund portfolio managers to know that they rarely rock the boat when it comes to questioning corporate managements--at least not in public. In the case of Wintergreen (shareholder) and Consolidated-Tomoka Land CTO, however, their fight was much more vocal and visible.

Wintergreen Advisers, which advises Wintergreen Fund, owns more than 25% of Consolidated-Tomoka, so it (rightfully) has the ear of management. But according to Wintergreen fund manager David Winters, the money manager's suggestions and questions tended to fall on deaf ears, and Consolidated-Tomoka continued to behave in a way that was disagreeable to Winters.

Winters thus decided to take a more active approach. In the months preceding Consolidated-Tomoka's May 19, 2009, company meeting--by which time shareholders were to elect members to the board of directors--Wintergreen sent repeated solicitations to other shareholders putting forth his case, attempting to persuade voters. Wintergreen nominated several directors to the fund board, some of which would be pitted against incumbent directors; it also made three shareholder proposals, including one that would separate the CEO and chairman of the board posts.

Winters' efforts didn't go unnoticed, and the two parties subsequently engaged in a rapid-fire back-and-forth. Each laid out its reasonings for other shareholders to see things its way; each tried to dismiss the arguments of the other in a forceful way. Of course, each accused the other of acting in its own self-interests. Wintergreen created a fantastic graphic illustrating what it saw as conflicts of interests among existing board members. Consolidated-Tomoka quickly attempted to discredit the document.

Shortly after the shareholder meeting (and votes), Wintergreen could declare victory. Although not all of its nominated directors were elected, several were, and the 25% shareowner is now represented by three of the 11 (27%) directors. Its three shareholder proposals were also passed.

Although Wintergreen won its battle against Consolidated-Tomoka, which today represents less than 2.5% of Wintergreen Fund's assets, it remains to be seen whether the win will translate into better results for Consolidated-Tomoka and for Wintergreen Fund. As with Third Avenue Value, however, we remain confident in Winters' varied portfolio-management techniques for the long run.

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

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