Nygren is out ...

Late last month, I finally sold Bill Nygren's Oakmark Select Fund (OAKLX). The most important reasons for doing so are:
(a) I was running a loss on the fund and did not see any point in not realizing that loss at the end of the year. After all, I needed something to offset capital gains from other transactions.
(b) The fund was due to make distributions - and this was almost 10% per share. No point in paying capital gains on a fund where I was running a loss.

So I sold the fund and will consider buying it again next year. Morningstar continues to pump up OAKLX, and its performance over the last 10 years is nearly twice as good as the S&P 500. So why the "maybe" - here are the main reservations against buying OAKLX:

(a) It has a concentrated portfolio of 25 or so stocks - that is fine, but its very skewed in its weighting. The biggest holding, Washington Mutual, is more than 13% of the portfolio and has been absolutely crushed this year's subprime debacle. Even as I type this, it is down about 8% after announcing severe dividend and job cuts. WaMu has been the single biggest reason that OAKLX is under performing the S&P 500 by almost 15 percentage points! Some say the bottom has been reached for the financial stocks - who can tell? Value pick or value trap? In addition to WaMu's situation, it would be good if Nygren didn't overload so much on a single stock.

(b) Absolutely no energy exposure - this is fine, since I have a pretty large exposure to the energy sector through other funds. But the fact that Nygren didn't see any "value" plays there seems strange.

Here are a few snippets about Nygren/WaMu/OAKLX from old-timers on the Morningstar forums

I don't think Nygren can unwind his OAKLX position without inevitable carnage in the stock, WAMU's intrinsic woes not withstanding. Even if WAMU was going up and Nygren started selling, people will notice and follow him out the door putting downward pressure on the stock.

Admittedly Nygren is in a tough spot. Regardless of how revered a manager is, excuses made normally circle around, "held on to housing stocks too long" (Muhlenkamp), or "did not invest in energy stocks" (Miller? and perhaps Nygren as well?). But with Nygren, he is insisting that WAMU is excellent value. Dunno what Nygren's average cost is for WAMU in OAKLX. But I have to believe he has been buying it for some time and his value must be lower than his cost. Wonder how he keeps shareholders from exiting his fund. [note - Ron Muhlenkamp of MUHLX and Bill Miller of LMVTX]

Here is one more:

Concentrated funds is a problem for a jackass manager simply investing in the top 20 stocks at any given point of time. Now if you give the same manager the mandate to invest in 50 stocks, he'll still do bad, because he is not really doing money managing. Managers like these are the usual suspects, Robert Loest, Kevin Landis, Van Wagoner, etc. These managers suck without necessarily having concentrated folios. I don't think I will say that about Bill Nygren and Muhlenkamp belong to the above category. I mean I can have 5% of portfolio in each stock and that gives me 20 stocks. Those who invest in stocks themselves instead of funds - how many stocks do you think they own?
The problem is with implementation. Clearly there is something to be said about having conviction in your ideas. So I presume maybe Nygren started with a 5% position for WAMU in OAKLX and he let his winner run eventually hitting 15%. The point is, when you stop and say enough is enough. The problem with this implementation is less with Nygren holding 15%. I mean if WAMU was 50% YTD, we would all be fawning over Nygren. The problem then IMO is that you cannot run a concentrated fund AND have too many assets. Because then, the games up. You cannot compensate when the market moves against you. (Therefore my move from OAKLX to OAKWX, not that it necessarily helps too much even though WAMU is 5% of assets here instead of 15%)
Let's look at CGMFX portfolio. I see 22 stocks with top holding of 7%. A tad high perhaps. Regardless, the difference is that Heebner is allowed to hedge his fund. Nygren doesn't - not that he wants too. Concentrated + Large Assets + No Hedging = Increased Market AND Individual Stock Risk. LMVTX could suffer from similar problem. Its top holding is also 7%. It happens to be Amazon which has done well. It might has well could have done badly. I dunno if LMVTX can protect itself by hedging.
And the final nail in the coffin - the mandate to be fully invested. You have a concentrated fund, unmanageably assets, unwillingness to hedge AND want to stay fully invested. Big Problem. I have mentioned on the boards in the past that I thought Turner Investment Partners were IMO the best growth managers in the business. Problem - they are always 100% invested and don't hedge. I wil just not invest in a fund like that. In retrospect, perhaps OAKLX was a mistake. Maybe OAKWX is too. I sold my THPGX at one point because inspite of having the flexibility the manager stayed fully invested - no can do.
So maybe, just maybe the way to buy a concentrated fund is to look at flexibility - either to go cash, or to hedge. Lower asset base can only help. So look at FAIRX, JORDX, CGMFX, WGRNX (though it has 50 stocks now), FMIRX, PVFIX, etc.
In summary, concentrated funds IMO is not by itself the problem. OAKLX has paid of handsomely for shareholders by being fully invested in few stocks. So has CGMFX. The difference I think is that CGMFX moves on when the market proves it wrong. And doesn't pay itself on the back too much the market proves it right. OAKLX on the other hand does the reverse on both ends. Kind of like M* who refuses to change their opinion on a fund for the most part. Give me concentration rather than over-diversification (translation : I dunno WTF I'm doing, but just maybe I'll beat the index) any day. But give me flexiblity. That is KEY.

Thoughts from a Fund Manager

Bill Nygren manages the Oakmark Select Fund (OAKLX) portfolio, and has been doing so since the fund was started more than 10 years ago. His fund has significantly outperformed the S&P 500 over this period (more than twice the index performance!). I was reading through the fund manager's quarterly commentary on fund performance - Nygren makes several important points about his (and the fund's) investing philosophy, and tries to explain his style to the investors. An important exercise, it allows the investor to understand how his money is being put to use. According to Nygren,

At Oakmark, we are long-term investors. We attempt to identify growing businesses that are managed to benefit their shareholders. We will purchase stock in those businesses only when priced substantially below our estimate of intrinsic value. After purchase, we patiently wait for the gap between stock price and intrinsic value to close.

Of course, one might argue that this is nothing but the classic definition of a value investor. So if Nygren is running a value fund, then what's so special if he is sticking to what he said would do. But then that's precisely what is important for me - to find out how closely is he following the fund's proposed plan. The sheer 'boring' nature of value investing can be excellently summed up as:

... successful long-term investing is much closer to "three yards and a cloud of dust" than it is to the West Coast offense!

In response to the stock market plunge of February 27 (when the stock market fell by 4%), Nygren clearly emphasizes his flair for value investing, sticking with basics in the face of panic:

Following that drop, I had several calls from reporters, all asking the same question: "The market is down 5%, what does that mean?" My answer, which not surprisingly wasn't used by any of them, was that five-year compound annual returns were now going to be 1% higher than they were before the market fell. That answer didn't convey quite the level of fear they wanted.

Nygren's commentary is a delightful read - as long as I believe that he can pick undervalued stocks correctly, I will hold the fund. I don't have to worry about his adherence to the value investing philosophy.

My Mutual Fund Picks - Part 1

A quick note about my fund picks - they are heavily biased towards Fidelity funds, and those available as NTF (no transaction fee) funds at Fidelity. Obviously, all of them are no-load funds.

Fidelity Balanced Fund (FBALX)
Moderate Allocation, FBALX has a conservative blend of about 60-65% stocks and about 30-35% of bonds. The stocks have the usual suspects - conservative value stocks such as Bank of America, Citigroup, JP Morgan, Altria, General Electric, Proctor and Gamble etc. But its a Fidelity fund - chasing high energy growth stocks is a natural instinct. Therefore no surprises to see the growth stocks in there - especially in the energy space - Valero and National Oilwell Varco (this is infact the #1 equity holding for this fund!!). Its rated as a 5-star fund by Morningstar - and a solid reputation to boot. If there is only mutual fund I had to buy, this would be the one.

Fidelity Contrafund (FCNTX)
Largecap Growth, FCNTX is now closed to new investors, and has been heavily criticized for asset bloat (more than $60B in an actively managed fund!!). But it does have a super star fund manager - William Danoff. So till then, it continues to get attention and a second look.

Fidelity Select Energy (FSENX)
Only sector-specific fund in my list. Many folks will not like owning a sector specific fund, and I myself am not a big fan of this. But hey, I think this sector will be a long term story to look at - I mean look around, we are not suddenly going to switch to solar and wind powered stuff, and oil availability is not increasing at an alarming rate. So energy is a long term hold for me - but you need an appetite for volatility. Extremely volatile sector, and not for the weak-hearted. Ofcourse, both the above listed Fidelity funds have reasonably large energy weightings, so I didn't really need a separate energy fund. But the heart aches last year at the gas pump motivated me to try and build a hedge against it. If I pay at the pump, so I shall hopefully recover some of it in the stock market. And if oil prices go down, I will pay less at the pump - even though the oil stocks will slide as well.

Julius Baer International Equity II (JETAX)
JETAX was launched as a successor to the highly successful international fund Julius Baer International Equity (BJBIX) on the very same day that BJBIX was closed to new investors. It had the same fund managers, and the same philosophy as BJBIX. Its main investments are in diversified international markets (as of Dec 31, 2006 - Europe was ~50%, Emerging Markets ~ 21%, Japan ~ 8%, UK/Ireland ~ 12%, and Asia ex-Japan ~ 1.6%), and it differs from BJBIX in that it cannot invest in small caps (which it defines as $2.5 billion in market capitalization). That strategy had allowed fund managers Rudolph-Riad Younes and Richard Pell to achieve very good success at BJBIX. After about a year or so since inception, JETAX has continued to provide solid results, and has outperformed its benchmark index. It has made key plays in Eastern Europe (Poland, Hungary, Turkey etc.). Another similar fund is the highly successful William Blair International Growth (WBIGX) - also closed to new investors.

Mathews India Fund (MINDX)
A good solid India-focused fund - about a year and half old as I write this. Its expense ratio has been coming down and it is a no-load fund (unlike the other India-centric funds from Eaton Vance, ETGIX and EMGIX). So even with the fund underperforming the BSE Sensex, it is still good one to have - especially given the Indian growth story. MINDX has the BSE-100 as its benchmark and invests in both large and mid-cap stocks (most emerging market funds will have one or more of Bharti, Infosys, Tata Motors, Wipro, TCS, HDFC Bank, ICICI Bank) - but MINDX extends beyond the usual suspect, and owns Dabur Pharma, Glenmark Pharma, Ashok Leyland, etc. But be prepared for volatility, the Indian market is extremely (and I mean that!) edgy, it can swing up and down with a ferocity that is certainly not for the weak of heart. But the long term story for India continues to be bullish, and so the way to play MINDX would be to buy the minimum and slowly increment on a regular basis. Exploit automatic investing for dollar cost averaging.

One more point that has come up with MINDX - an alternative to MINDX would be to invest directly in Indian mutual funds (in rupees), which outperform MINDX - but I prefer to hold my picks in $, rather than in rupees (even though the dollar has really gone down against the rupee in recent times). So consider repatriability issues if you are an Indian guy considering investing in the Indian market.

Royce Value Plus Service (RYVPX)
This is a small-cap fund - and although the name says 'value', its clearly a growth-oriented fund and its Morningstar rating box shows it as such. Its a very solid pick - Morningstar rates it as 5-star, and SmartMoney.com picked RYVPX as its pick for the top small-cap pick of 2006. Marketwatch also likes the fund's managers Whitney George and James Skinner, and has RYVPX among its picks for top-performing low-cost mutual fund options for 2007.

The Oakmark Select Fund (OAKLX)
Oakmark Select is a fund with a concentrated selection of value stocks. It has not had a great run through the bull run of 2003-05, but has enjoyed a solid rebound in the second half of 2006. The fund continues to be highly recommended mainly because of star fund manager Bill Nygren, a favorite with Morningstar analysts, and who successfully navigated the investors through the rough seas of recession following the dotcom bust. Nygren has a reputation of being a 'buy and hold' investor - this can be judged from the fact that in 10 years since inception, OAKLX has held only 80 stocks, and still holds Dun and Bradstreet (DNB), which was one of the 18 holdings with which he started the fund. As the economy slows down, and the market volatility increases, Nygren's value picks may come back into style again!

More picks coming soon .....