Where Oakmark's Bill Nygren Went Wrong
The bear market hasn't been kind to most value investors. Even before the bear started to growl, many prominent value investors were lagging Standard & Poor's 500-stock index.
In general, poor results were due to acts of both omission and commission. Underperformers typically didn't own enough energy and other commodity stocks and owned too many financial stocks, which a year ago appeared to be attractive on the basis of above-average dividend yields and low price-to-book-value ratios. We now know what happened to so many banks and mortgage lenders after the credit crisis erupted a year ago: Those book values were about as solid as the trap door in a gallows, and the dividends have all but vanished.
Like many value investors, Nygren generally shies away from these types of companies. He explains: ">
He has few regrets about missing the bull run in commodities, which has reversed course in recent weeks. But Nygren is chagrined about his funds' heavy exposure to housing and mortgage-related stocks, which crushed his funds' performance in the second half of 2007. As a value investor, Nygren says, the risk he most wants to avoid is the permanent loss of capital. Nygren concedes that he blew it on several holdings: "When you misjudge business value, that's the most serious mistake you can make."
Nygren saw that residential housing markets were weakening in early 2007 but says he expected prices to steady -- the historic pattern in weak markets -- rather than plunge by 20% or more. Irresponsibly high loan-to-value ratios crushed many housing-related lenders and related businesses when the residential roof caved in.
Select was burned by its positions in Pulte Homes (PHM), "a horrible investment," and H&R Block (HRB), a company that wrecked a perfectly good tax-preparation business by a hare-brained diversification into the subprime-mortgage business.
But Nygren's largest blunder by far was his heavy investment in Washington Mutual (WM), the country's largest thrift. At one point, WaMu represented a towering 15% position in Select's portfolio. The Seattle-based bank has written off $20 billion of losses on home mortgages and dramatically diluted shareholder value by raising new capital. The stock price has plunged nearly 90% in a year. Nygren says that WaMu management was ill-prepared for a significant decline in housing prices. "In hindsight, that looks really, really stupid," he says. "The macro environment got much worse than we thought the case."
We don't know yet if there's a happy ending to this story, but Select's relative performance has improved dramatically in 2008. Nygren has ridden some canny investments in names such as YUM Brands (YUM), McDonald's (MCD) and Western Union (WU), and he thinks his large positions in media and entertainment stocks such as Comcast (CMCSA) and Discovery Holding (DISCA) are bearing fruit. A wiser Nygren may also be on the rebound.