Fund Times: Oakmark's Nygren Candid about Fund Struggles

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 disappointed us with their shareholder communication. Morgan Asset Management, advisor to  Regions Morgan Keegan Select High-Income , which is struggling due to its subprime exposure (as discussed in last week's column) placed the following manager commentary on its Web site, but only under the closed-end fund page and not on those of the open-end funds impacted. We think the firm owes investors a more detailed explanation of what's going on at the fund and how it hopes to deal with large losses, and the message needs to be easier to find on the Web site and on the appropriate pages. 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  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.

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 0.60% to 0.75%. The median expense ratio among no-load long/short funds is 1.95%.

Don't get too excited, though. Most average investors will not be able to gain access to this fund, which Vanguard says it decided to adopt to satisfy demand from institutional investors. Its investor shares will require a $250,000 minimum investment. Institutional investors have to commit $5 million to get in. All share classes of the fund also will charge a 2% redemption fee on shares sold within 30 days.

Laudus to Liquidate Other Long-Short Fund
Schwab's AXA Rosenberg Investment Management subadvised fund Laudus Rosenberg Global Long-Short Equity  will close to all on Aug. 27 and will liquidate assets and cease operations on Sept. 24, according to a recent regulatory filing. The fund's meager $16 million in assets will be returned to remaining shareholders at that point. The liquidation of the fund isn't surprising, given its inability to keep up with long-short category rivals over time, or for that matter, even beat the T-bill.

AllianceBernstein to Merge Several Fixed-Income Funds
AllianceBernstein recently announced in a regulatory filing its intention to merge AllianceBernstein U.S. Government  into AllianceBernstein Intermediate Bond (ABQUX); as well as to merge  AllianceBernstein Corporate Bond (CBFAX) and AllianceBernstein High Yield  into  AllianceBernstein Emerging Market Debt (AGDAX), should shareholders approve. Emerging Market Debt will then be renamed AllianceBernstein High Income Fund.

While there may be some investment research justifying these moves, we're skeptical of fund mergers that combine funds with radically different mandates. We think investors in each of these funds should think carefully about the role the legacy fund played in their portfolio, and whether the new resulting fund (should the mergers be approved) is still appropriate for them. For example, the U.S. Government fund is a high-quality portfolio of mostly Treasury and agency securities, holding very little credit risk, but the Intermediate Bond portfolio follows a multisector mandate that allows it to invest in corporate, emerging markets, and below investment-grade (up to 25%) debt, a clear departure for shareholders in the former fund.

Morgan Stanley Utilities Under New Management
Morgan Stanley announced the departure of Ed Gaylor and Steven Kreider from  Morgan Stanley Utilities , which will now be run solely by Mary Jane Maly, who has been with the offering since January 2006. The change is significant, as Gaylor was the fund's day-to-day manager and had been with the offering since 1988. Kreider had only recently been added to the fund management team and was in charge of the fixed-income portfolio, although he wasn't able to have much effect, because the fund hasn't held bonds recently. We'll see if Maly, who oversees all of Morgan Stanley sector funds, can turn this offering around.