A Daring Mutual Fund Bet on European Banks

Value managers’ returns suffer while they wait for a rebound

David Herro, a portfolio manager of the Oakmark International Fund, Fidelity International’s Sanjeev Shah, and Marc Halperin of Federated Investors beat 80 percent of their rivals over five years. Then they bet on European banks. Their investments in such lenders as Credit Suisse Group, Intesa Sanpaolo, and Lloyds Banking Group have plunged the three managers into the bottom third of their peer group rankings, according to data compiled by Bloomberg.

For value managers, who invest in beaten-down stocks hoping they’ll bounce back, stretches of low returns go with the territory. “How many times have we gone through a period like this when there’s blood in the streets and sheer panic?” says Halperin, manager of Federated’s $400 million International Leaders Fund “We’ve stayed the course, not panicked, and held onto the highest-quality companies at the most attractive valuations. We’ve emerged out of every crisis even stronger.”

European lenders’ stocks dropped below the value of their assets (or book value) on July 18 for the first time in two years after stress tests released three days earlier failed to reassure investors that banks could withstand the region’s debt crisis. Lloyds is down 34 percent this year, while Credit Suisse is off 22 percent and Intesa Sanpaolo is 18 percent lower. That has tempted some of the world’s best-performing fund managers to purchase stocks that would benefit from a resolution to the European debt crisis and an upturn in global growth. The success of the strategy may hinge on whether Europe can prevent a sovereign default. “There are going to be things that aren’t good,” Herro said on June 9. “But the worst-case scenario, contagion, the collapse, I think is a very low probability.”

Herro’s Oakmark International Fund, with $8.5 billion in assets, has beaten 81 percent of its rivals over the past five years. This year investments in European banks have plunged the fund into the bottom 17 percent of its peers, according to data compiled by Bloomberg. “If you’re a deep value investor, one of the chief risks you run is that a bad situation gets worse,” says Russel Kinnel, director of mutual fund research at Morningstar.

Herro, who was named Morningstar’s International Stock Fund Manager of the Decade last year, declined to be interviewed for this article. He had four of his top 10 holdings in European banks—Zurich-based Credit Suisse, BNP Paribas, Banco Santander, and Intesa Sanpaolo—as of Mar. 31, the latest date for which information is available. Credit Suisse’s “business value has continued to go up and up and up, its price is going down, down, down, which means that the value gap has opened up,” Herro said in the June 9 interview. “As long as that business value continues to be created, we won’t lose patience.”

Sanjeev Shah, who took over Fidelity Special Situations Fund in 2008, is another value investor who’s being hurt by declines in bank stocks. Lloyds and Royal Bank of Scotland, both bailed out by the British government in 2008, are two of Shah’s 10 largest holdings. HSBC, Europe’s biggest bank, was his largest position on Mar. 31. “I’m a contrarian value investor,” Shah said in an interview posted on Fidelity’s website in June. “The banks are at the low end of their historical range in terms of valuations, which is very attractive.” While Shah’s $4.8 billion fund has beaten 84 percent of its competitors since 2006, its performance has dropped into the 32th percentile this year, having lost 2 percent since Jan 1. Shah declined to add to his comments.

Federated’s International Leaders Fund, run by Halperin, beat 82 percent of its peers over the past five years, according to data compiled by Bloomberg. This year investments in HSBC, Credit Suisse, and BNP have caused it to fall into the lowest 8 percent of its peer group. “They’ve taken such a hit in the last month,” Halperin says. “But we’re continuing to hold these names. The valuations are attractive. I can’t imagine they allow the whole euro system to simply unravel.”


    The bottom line: Three top-performing mutual funds are suffering because of bets on European banks, which are down as much as 34 percent this year.

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