Michael Price hasn't been in charge of investments at Mutual Series since 1998, but his values still impact how the fund family is managed.
David J. Winters, at the helm of the funds since May 2001, remains committed to the ideas espoused by predecessors Price and Max Heine, who was a director of the company that founded Mutual Series' flagship fund, Mutual Shares, in 1949. Price joined Heine Securities Corp. in 1975 and has been an outspoken and well-known proponent of investing in deep-value stocks. In 1988, he became sole owner of Heine Securities, and his fame as a shareholder activist continued to grow. Price sold the firm on November 1, 1996, to Franklin Resources of San Mateo, Calif., for $610 million and now is chairman of Franklin Mutual Advisors, which was formed at the time of the merger to act as investment advisor to Mutual Series, based in Short Hills, N.J.
Despite the departure of Price and some of his proteges, some longtime co-workers of his continue to play a role in managing the portfolios of Mutual Series funds. Among them is Winters, a veteran of Heine Securities, where he began as a research analyst 14 years ago. Winters, president, CEO and chief investment officer of Franklin Mutual Advisors, has primary responsibility for the investments of Mutual Shares and Mutual Discovery funds. He also is involved in managing Mutual Beacon and Mutual European funds. In all, Mutual Series includes six funds.
"My style is simply to think and act as an owner," Winters says. "And part of doing that is acknowledging our right and obligation as fund managers to take a stand on matters that affect shareholder value."
Winters' overall strategy is to invest in stocks he considers undervalued, based on measures such as cash flow, book value and long-term earnings outlook. His goal is to buy a dollar's worth of value in a company for 50 or 60 cents.
Winters looks for companies in the midst of a catalyst that will spur the market to realize its true worth. Such a catalyst might be a merger, restructuring or a change in management. Mutual Shares also invests in distressed securities of companies in dire financial straits and even those that have already declared bankruptcy.
In case corporate managers intent on keeping their jobs don't get that message or conduct business in other ways that could be construed as self-serving or detrimental to shareholders, Winters says he's committed to changing their stripes through proxy fights, speaking to the press or whatever else it takes.
Currently, Winters is taking aim at ICN Pharmaceuticals. In March, Franklin Mutual Advisors banded together with pension fund manager Iridian Asset Management to file a Schedule 13D with the Securities and Exchange Commission. The two firms, which together own 8.8% of ICN shares, are trying to get three independent directors elected to the ICN board to help pick up the pace of the restructuring process. Winters believes ICN shares trade at a significant discount to the company's intrinsic value largely because of the slow progress toward restructuring.
Shareholder advocacy aside, trying to affect the outcome of corporate endeavors is not enough to keep shareholders happy if Mutual Shares doesn't keep pace with the market, which happened in 1998. During that year, when growth stocks dominated the market and value stocks lagged badly, the fund climbed just 0.45%, compared with a rise of 28.6% for the S&P 500 Index. But with value investing back in vogue since the high-tech bubble popped, Mutual Shares is once again beating the index. Over the last three years ended May 31, the fund's "A" class shares had an average annualized total return of 7.75%, compared with an average annual decline of 5.2% for the S&P. The "Z" class shares, which date to the fund's inception in 1949, returned 14.89% annualized for the 10 years ended May 31.
Winters thinks that bad news for the bull market can only continue to help a fund that capitalizes on corporate misfortune.
"In an environment where the bull-market bubble has clearly burst, we're seeing more opportunities in distressed security situations, reorganization and merger arbitrage," he says. "As securities get more reasonably valued, there is much more for us to choose from than in a bull market. All kinds of companies are experiencing financial distress." And when stocks trade at a discount, he adds, mergers that promise to unlock shareholder value for target companies should naturally follow.
Merger arbitrage, in which investors play the "spread" between a target's takeover price and its current stock value, is a lesser-known but useful tool in the fund's arsenal. In a cash transaction, Winters will simply buy the target's stock. In a stock deal, he will buy the stock of the target and sell short stock of the acquirer to lock in the spread.
Mutual Shares has recently used arbitrage strategies with defense and automotive contractor TRW, which has received a hostile takeover bid from defense contractor Northrop Grumman, Winters says. Several other companies in the portfolio, while not immediately involved in takeover talks, make attractive targets because they are reasonably valued and in consolidating industries. Names in this group include Fleet Boston Financial, tobacco-products company UST, Principal Financial Group and Sprint. "All these stocks are cheap, the companies have good businesses, and their value is growing," he says. "While a takeover would be great, they certainly stand well on their own."
"Distressed" companies involved in reorganizations, financial restructurings or even bankruptcy provide another fertile hunting ground. Last year, Winters bought battered bonds of Pacific Gas & Electric, now the fund's largest distressed position, after the company filed for bankruptcy in April. The filing followed financial difficulties that surfaced when deregulated wholesale prices soared and a rate freeze prevented the utility from passing the increase on to consumers. After reviewing information about the California deregulatory process and the company's assets, Winters thought the bonds had been punished too severely and bought them. With a restructuring underway, the bonds now trade above par value.
But betting on companies teetering on the brink can backfire if a business can't dig itself out through reorganization, bailout or other last-ditch efforts. Last year's fund blunders included Railtrack Group, Britain's largest railway infrastructure operator, which saw its primary operating subsidiary forced into the British equivalent of bankruptcy when the government unilaterally withdrew promised funding.
Winters says he's "probably lost about 40%" of his investment in Qwest Communications, a consumer and business communications services provider that floundered when its revenues plummeted with demand for telecommunications services.
Although Mutual Shares is best known for its bold bets on distressed-company securities and restructuring plays, most of the names in the portfolio are what Winters calls "unloved, overlooked or misunderstood" stocks. They are trading at a discount to their intrinsic value, based on measures such as book value, cash-flow potential and long-term earnings.
Winters believes the fund's largest holding, Berkshire Hathaway, falls into the classic undervalued camp. That's not a viewpoint all financial analysts agree with.
"A lot of people know about Warren Buffett, but they don't really understand Berkshire Hathaway's business," says Winters of the diversified holding company. "The company has $42 billion in cash and bonds, which gives it one of the most liquid balance sheets on the planet. It's a self-financing money machine that doesn't even need a bank to make an acquisition."
Beaten-down stocks that Winters wouldn't touch include tech-wreck victim Cisco Systems. "I'm not comfortable with the company's stock valuation, accounting procedures or management," says Winters. "The fact that a stock has taken a beating does not make it worth buying."
Fund Managers Get Vocal
ost money managers believe that voting with their feet or quiet, behind-the-scenes pressure gives them ample clout in corporate governance matters. Aside from some managers of socially responsible mutual funds, few of them seem to have much interest in giving corporate America a nudge in the ribs through proxy fights or other forms of shareholder activism.
But with the pumped-up prophecies for growth that led to the tech bubble and the Enron debacle still fresh in everyone's mind, investor trust in Wall Street stock analysts has dwindled. Accounting-firm auditors entrusted with keeping companies honest aren't looking much better as investors become more familiar with questionable, though legal, balance sheet shenanigans. So who better than mutual fund managers to rekindle investor faith by taking up the role of corporate watchdog?
In February, venerated Vanguard founder John Bogle trumpeted that message when he gave a speech to the New York Society of Security Analysts in which he called on mutual fund managers to increase their role in corporate governance. In the following months, two industry titans, William Miller of Legg Mason and William Gross of PIMCO, publicly denounced what they considered self-serving corporate practices. (Gross' target was General Electric and what he considered its overreliance on short-term debt, while Miller blasted corporate America's penchant for massaging analysts' expectations and manipulating accounting rules.)
Winters, though pleased by the new spotlight on shareholder activism, remains unimpressed with the swelling ranks of fund manager watchdogs. "We've always been a proponent of good corporate governance and behavior," he says. "Now, everyone is suddenly waking up to something we've always done."