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Fund Times: Oakmark's Nygren Candid About Fund Struggles

Plus, news on Vanguard going neutral, various fund mergers, and more.

Morningstar Analysts, 08/27/2007

Some of the best mutual fund managers are often the most candid. Oakmark Select OAKLX manager Bill Nygren showed that with a special letter to shareholders in which he faced up to recent poor performance.

In his letter, dated Aug. 16, Nygren wrote: "The Oakmark Select Fund's performance since the end of the second quarter has been dreadful. Not only has the market declined significantly, but our Fund has fared meaningfully worse."

Part of this underperformance, he states, is due to the fund's longstanding position in Washington Mutual WM (nearly 14% of assets), which has suffered significant declines this year due to the fallout from subprime mortgage trouble. Nevertheless, Nygren argues that "Washington Mutual has taken on less risk in their loan portfolio than their peers have, as demonstrated by the strong credit ratings of their borrowers (FICO scores) and their lower loan-to-value ratios. Further, as a bank, Washington Mutual has much longer term funding than do pure mortgage originators. (and in the end) this difficult period should end up enhancing Washington Mutual's long-term earnings potential."

Nygren wrote that even if his analysis of this company's holdings is wrong, he and his team remain committed to their long-term, value-oriented investment style. He also said in an interview that he bought more shares of the fund during its travails.

In contrast, some fund shops recently have shown terrible shareholder communication. Morgan Asset Management, advisor to Regions Morgan Keegan Select High-Income MKHIX, which is struggling due to its subprime exposure has not placed any letters, market commentaries, or explanations of any kind on its Web site to better inform investors of the fund's trouble. We think the firm owes investors a frank and detailed explanation of what's going on at the fund, and how they hope to deal with large losses. Morgan and many others in the industry should take a lesson from Nygren.

Vanguard Is Going Neutral
The second-largest mutual fund family will try its hand at one of the fastest-growing investment trends: absolute return strategies. Such approaches come in many forms, but Vanguard is opting for the market-neutral route. The family has announced it will adopt the small, nearly 10-year-old Laudus Rosenberg U.S. Large/Mid Cap Long/Short Equity SSMNX and turn it into the Vanguard Market Neutral Fund, if shareholders approve in a November vote. The fund will try to deliver small consistent gains while minimizing the ups and downs that come with investing in the equity market.

Vanguard isn't just slapping its name one someone else's fund, though. It will manage part of the new offering. Jim Troyer of Vanguard's own quantitative equity group will share duties on the new fund with the Laudus Rosenberg fund's current managers from AXA Rosenberg. While AXA Rosenberg has been running market neutral and long-short strategies for years, this will be Vanguard's first foray into strategies that involve taking both long and short positions in stocks. Each advisor will use different quantitative models to buy favored stocks long and to short, or bet against, stocks that look unattractive. (Shorting technically involves selling borrowed shares in the hopes of buying them at a lower price and pocketing the difference.) Both teams will strive to keep the aggregate dollar amounts of their long and short positions roughly equal. The goal is to have the long positions rise more than the short positions and eke out a small, consistent gain that does not correlate with other asset classes. The fund aims to beat the 3-month U.S. Treasury Bill over time.PAGEBREAK

It's too early to tell how this combination will work, but it will have a lot to prove. Laudus Rosenberg U.S. Large/Mid Cap Long/Short has a decent record of meeting its objective. Though Vanguard has a lot of experience building and using quantitative models to buy stocks in funds like Vanguard Strategic Equity VSEQX, it has no public market neutral or long/short track record. Nevertheless, Vanguard offers much needed price competition to a pricey category. If Laudus Rosenberg shareholders (what few of them there are in this $21 million fund) approve they will get an immediate, dramatic expense reduction from 1.24% or 1.54% for institutional and investor share classes, respectively, to 0.6% to 0.75%. The median expense ratio among no-load long/short funds is 1.95%.

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