WSJ/ Mutual Funds: Short-Term Greed Fueled Big-Time Losses on Enron
December 13, 2001
By AARON LUCCHETTI
Staff Reporter of THE WALL STREET JOURNAL
Janus Fund. American Century Ultra Fund. Alliance Premier Growth Fund. What do these huge mutual funds have in common?
Besides having tens of billions of dollars in assets and the highly paid stock pickers of major money-management firms at their disposal, all three funds earlier this year had outsize positions in Enron Corp., the Houston energy-trading firm now seeking bankruptcy-court protection.
How could these funds -- and numerous others -- blunder like this? Turns out it isn't an isolated incident. Mutual-fund companies, which manage money for millions of individual investors, held large stakes in just about every broken stock of the past few years, from Cendant Corp. and Waste Management Inc. to Lucent Technologies Inc.
To some extent, this isn't a surprise. For a big stock to fall from lofty levels, it almost by definition has to start with some acceptance from institutional investors, including mutual funds. And since mutual funds often hold dozens, if not hundreds, of stocks, they are bound to make big mistakes once in a while.
Nevertheless, the frequency with which funds have been caught holding stocks that plummet amid accounting problems raises two questions: What are the fund managers missing as they evaluate stocks? And is there anything they can do about it?
Lawrence Zicklin, former managing partner at money manager Neuberger Berman Inc., says part of the problem comes from the age-old motivator: greed. When Enron stock was surging and enriching investors across the country, portfolio managers not holding the stock had to defend themselves. "It's very hard for a portfolio manager to hold a stock that's going down, but it's even harder when he has to explain why he doesn't own a stock that is going up," Mr. Zicklin says.
Indeed, some critics say mutual-fund managers these days are so fixated on keeping up with benchmarks and competitors over short-term periods that they forgo critical independent analysis of a company's prospects. "This is the risk" of focusing "on the short term," says Russel Kinnel, director of fund research at Morningstar Inc., the Chicago fund tracker. "When Enron or some of the other speculative companies are driving the performance, it's very hard to stay out. If you're longer term, you can forget the benchmark and take a pass."
1See full coverage of the rise and fall of Enron.
During the past year, Enron shares were particularly tempting to managers who seek fast-growing companies. Since many industries were suffering through an earnings slump, these "growth" fund managers were desperately seeking any companies whose businesses were still accelerating.
"Growth-fund managers weren't getting a lot of good pitches, so when we got one [in Enron], we had to take our swing," said John Waterman chief investment officer at Rittenhouse Nuveen Investments, which bought Enron shares in June and sold them in October at about half the price.
Growth-fund specialist Janus Capital Corp., a unit of Stilwell Financial Inc., owned about 5% of Enron's shares outstanding earlier this year, after accumulating a large stake during the late 1990s. Enron "epitomizes the opportunistic thinking of the 'new economy,' " one Janus analyst wrote to shareholders last year. Fund managers from Janus met Enron's management repeatedly and even asked about the partnerships that wouldn't gain wider attention until later.
Janus, which manages about $180 billion, gradually reduced its Enron holdings during the period from March through October, but it didn't sell fast enough to avoid losses of about $200 million on the stock. "We'll spend a lot of time internally on our experience with Enron," says Warren Lammert, manager of Janus Mercury Fund, which had about 4% of its assets in the company at the end of April.
According to Rittenhouse Nuveen's Mr. Waterman, fund managers will now start taking a more skeptical view of annual reports or footnotes in filings they don't understand, whether they be about off-balance-sheet partnerships or a company's debt load. Perhaps fund firms will hire more accountants, lobby for tougher accounting disclosure or sell shares when a company doesn't explain indecipherable balance-sheet maneuvers. In any case, Mr. Waterman says, fund managers will have to continue to rely upon auditors and credit-rating agencies, since they have better access to companies' books.
At Alliance Premier Growth Fund, which had 4.1% of its assets in Enron as of Sept. 30, manager Alfred Harrison says many large, widely owned stocks, including Enron, have so many moving parts that "nobody knows how they put it together." He calls such businesses "faith stocks."
With Enron, he says, few investors waded into the fine print, even though many of them were huge shareholders. "The company seemed on a deliberate path not to give full information," Mr. Harrison said at a recent conference. "Shame on me for not doing something on it." An Alliance spokesman said Wednesday that the fund has sold all its Enron shares.
Many large funds took a stake in Enron largely because everyone else was doing it. Take Fidelity Magellan, the largest fund actively run by a stock picker. In 1996, when Robert Stansky took over what then was the largest fund in the world, he reined in his predecessor's big bets and made it a practice to own just about every large stock in his bogey, the Standard & Poor's 500-stock index. If Mr. Stansky liked a stock in the S&P 500, he would buy enough so that he would have a higher percentage than the S&P had. If he didn't like it as much, he bought less.
Mr. Stansky appears to have been ambivalent on Enron, holding about as much as the S&P 500 did at the end of September, 0.2% of the total portfolio. But for Magellan, that small stake added up to 5.7 million shares, which shed about $150 million in value since Sept. 30. A Fidelity spokesman said Enron's stock "hasn't had a material impact on the performance of our funds."
For Scott Schoelzel, manager of the $15 billion-in-assets Janus Twenty Fund, selling Enron shares in increments from July to early October this year was more of a gut decision than one based on the balance sheet. He had discussions with "rank and file" Enron employees who said business wasn't going that well, and when he spoke with Enron Chairman Kenneth Lay, Mr. Schoelzel says Mr. Lay seemed "out of touch" with the business. Then, when Enron Chief Executive Jeffrey Skilling resigned abruptly in August, Mr. Schoelzel sold more shares. Investing, he says, is "25% about the numbers," and "75% about the people running the business."
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Fund Exposure
Mutual funds that had placed the biggest bets on each of these three stocks before their recent blow-ups. Comprising only funds with more than $500 million in assets.
Funds Owning Enron Shares Investment Date % of Fund's Stock
Allocation Invested
Merrill Lynch Focus Twenty July 31, '01 5.87%
Janus 2 Fund April 30, '01 4.89
Janus Special Situations Fund April 30, '01 4.68
Janus Orion April 30, '01 4.52
Funds Owning
Waste Management Shares Investment Date % of Fund's Stock
Allocation Invested
Longleaf Partners June 30, '99 7.48%
Van Kampen Comstock June 30, '99 5.42
ICAP Equity June 30, '99 3.63
Elfun Trusts June 30, '99 3.49
Funds Owning Cendant Shares Investment Date % of Fund's Stock
Allocation Invested
MFS Emerging Growth B Jan. 31, '98 10.38%
Morg. Stan. Inst Equity Growth A March 31, '98 8.97
Alliance Growth B Dec. 31, '97 6.59
Federated Kaufmann K March 31, '98 6.53
Source: Morningstar
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-- Bridget O'Brian contributed to this article.
Write to Aaron Lucchetti at aaron.lucchetti@wsj.com2
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