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Richard Pzena and Kunal Kapoor

Standing firm against falling returns and assets, Richard Pzena stockpiles beaten-up financials. His is a conviction few share.

Morningstar Advisor, 06/17/2008

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To say that Richard Pzena has been put through the wringer may be an understatement. While many of his peers won't touch beaten-up financial stocks, Pzena has steadfastly added to the likes of Freddie Mac FRE, Fannie Mae FNM, Citigroup C, Bank of America BAC, and others in the past six months.

But as the myriad headlines have made abundantly clear, that simply hasn't been the right thing to do. Not yet, anyway. The John Hancock Classic Value Fund PZFVX, which Pzena manages, fell more than 14% in 2007 and was down double digits for a brief period in early 2008 again. Pzena Investment Management PZN, which went public in 2007, has seen assets under management decline from a high of more than $30 billion to less than $25 billion recently. Meanwhile, the firm's stock fell from more than $20 to less than $10, before bouncing back modestly.

It's enough to make most investors pack it in, but Pzena is sticking to his guns, convinced that others are massively overreacting to the problems facing many financial companies. He is convinced that stock prices for many notable financials already reflect some very negative news, so his firm recently went as far as to launch a financials-only portfolio for institutional accounts.

Such conviction has served Pzena well in the past, and he's certainly expecting the same again. In fact, he isn't shy about comparing his current malaise to what he went through during the Internet heyday. This time, however, the company he's keeping is more modest, with many notable value managers positioned quite differently. Why is he standing firm? To find out, we visited him on March 6 at his New York offices. Kunal Kapoor is president and chief investment officer of Morningstar Investment Services.

Kunal Kapoor: You've said that you look for good businesses experiencing temporary problems that should be earning more than what they're currently earning. What are some things that you look for to determine whether you think the firm can correct its issues and move forward?

Richard Pzena: First, is it a good business? A good business is a business where you can identify one or more reasons why it should, in the long run, earn a good return on its invested capital base. It could be anything: a competitive cost structure, physical assets or location, a customer base that's difficult for a competitor to unseat, a brand or a franchise or a technology--something that makes us think that even if the current management fails in its efforts to restore the earnings back to normal, someone else is going to want to try.

Then, we have to make a judgment, and this is the hardest part, because the judgment is, will the management's plan likely cause the earnings to rebound? Obviously, we buy before we know if the plan's going to work. So it's a judgment. We're making an assessment.

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