Betting Against the Bank-Rescue Plan
Charles Lahr is worth listening to for his views on the financial crisis. Not only does he manage Mutual Financial Services fund and co-manage Mutual Discovery A (symbol TEDIX), he has been tearing apart financial-services stocks for a living since 1993.
His expertise and experience make his message all the more troubling. Lahr says the Obama administration's latest bank-rescue plan -- known as the Public-Private Investment Program (PPIP) -- will fail to clean up the banking system.
Fixing bank balance sheets is, without question, a necessary precondition to recovery in the markets and the economy. PPIP heavily subsidizes private-sector investors -- such as Pimco and Blackrock -- to buy the toxic assets on banks' balance sheets, one of the major causes of the financial crisis.
Lahr fears that many banks will choose not to sell. Why? Because it would force them to record on their balance sheets the real price these complex derivatives fetched in PPIP sales. Unquestionably, banks have been carrying many of these assets on their books at unrealistically high prices. Selling for much less would force banks to admit that they're a lot weaker than they have claimed -- perhaps bankrupt in all but name.
Just as bad, if not worse, Lahr fears that investors will cherry-pick only the most attractive of these toxic assets-leaving bank balance sheets holding the worst of the worst. "If I'm Pimco or Blackrock, I'll get a great return by buying relatively safe structured financial products," says Lahr. "Why would I chase after the riskiest stuff, when I can buy the safer stuff?"
What's more, PPIP is limited to mortgage and asset-backed securities that were originally issued with triple-A ratings. So banks won't be able to take advantage of the program to unload lower-grade debt.
The bottom line, says Lahr, is that "PPIP will confuse things. It will create volatility." The only cure for the current mess, he argues, is nationalization of the banks-that is, the government would take them over, sell off their good assets, and hold on to their bad assets at great cost to taxpayers. PPIP will merely delay the inevitable. "The more you dillydally, the more the damage there is."
Not surprisingly, Lahr is bearish: "We're still in a banking crisis that is of epic proportions. Until the banks get themselves sorted out, it's hard to be constructive."
A low-risk global stock fund, Discovery has returned an annualized 8% over the past ten years through March 30, putting it in the top 3% of funds that invest in both the U.S. and foreign markets.
Discovery lost 27% last year, but that was ten percentage points less than Standard & Poor's 500-stock index. The fund looks even better compared with foreign-stock indexes.
Currently, Discovery holds about 46% of its assets in cash. "We have a war chest in cash here," says Lahr.
Another 45% is in stocks. But even here, Lahr and his colleagues -- Anne Gudefin and Mandana Hormozi -- are focusing on limiting risk. That means the fund is chock-full of tobacco, beverage and food stocks-classic defensive plays that tend to hold up well during recessions.
Discovery's holdings include such companies as Altria (MO), the tobacco giant, and Fomento Económico Mexicano (FMX), which runs the Coca-Cola franchise in Mexico. Lahr thinks that Warren Buffett's Berkshire Hathaway (BRK-B) "is worth more than the sum of its parts." He's also found value in Dell (DELL), which, at its March 31 closing price of $9.48, sells at five times estimated 2009 earnings of $1.06 per share, if you back out the $4.66 per share in cash on Dell's balance sheet.
Lahr is finding increasing opportunities in distressed debt-that is, the IOUs of companies in bankruptcy or otherwise in trouble. Currently, distressed debt accounts for less than 5% of Mutual Discovery's assets, but that percentage is likely to grow, says Lahr.
Mutual Series is part of the Franklin Templeton funds but is largely run independently. Based in Short Hills, N.J., Mutual Series employs about 20 analysts and managers, who conduct some of the most intensive and successful stock research of any firm I know.
I very much hope that Lahr is wrong about the PPIP program. The American public is clearly suffering from bailout fatigue, and the politicians are following suit. They lack the political will to spend more government money to fix the banks, no matter how necessary it may be.
But even if you disagree with Lahr about the program, Mutual Discovery is a terrific fund-one that has offered solid returns in up markets and index-beating returns in down markets. Its Class A shares levy a maximum sales charge of 5.75% and carry an annual expense ratio of 1.30%. The Class Z shares of Mutual Discovery (MDISX) have no load and charge only 1.02% annually for expenses, but they're open only to existing Mutual Series investors.
Steven T. Goldberg (bio) is an investment adviser.