K & Thread: Just in case anyone missed this aMAZing WSJ story on the geniuses at Merrill, here 'tis!! M2
Fund Dumps Energy Stocks
At Exactly the Wrong Time
By PATRICK MCGEEHAN
Staff Reporter of THE WALL STREET JOURNAL
Somebody was shaking up the oil patch by unloading energy stocks, so Apache Corp. wasn't totally surprised when 11 million shares of the oil-and-gas producer changed hands on Feb. 1. The selling, more than 15 times normal volume, drove Apache's stock to its lowest level in several years.
The main seller? While Apache executives don't know for certain, they make the same educated guess a lot of other oil-industry executives, traders and mutual-fund managers make: Stephen Silverman, the new manager of Merrill Lynch Growth Fund. He had been installed in January to overhaul the long-lagging portfolio and decided to dump virtually all oil stocks.
His timing couldn't have been worse. His house-cleaning took place just as the oil sector was about to rebound. Indeed, if he had simply held onto the stocks the fund owned on Oct. 31, the fund would be up more than 25% -- rather than down 8%, which is its performance year-to-date.
The apparent rapid selling of those oil stocks looks to many fund watchers like a prime example of a little-known fund-industry practice: When a manager is handed the reins of a wayward fund, he often has a period of several weeks or months to restructure the portfolio before his superiors start judging his investment performance. As they say in the fund industry, the clock doesn't start ticking right away.
But giving a manager that leeway can result in a fund's investors' suffering even more, as the manager hosts the equivalent of a Wall Street garage sale where everything must go. "Turning over a portfolio as quickly as possible while the clock's not ticking may not be in the best interests of shareholders," says Jerome A. Castellini, a money manager who runs CastleArk Management in Chicago. "An aggressive application of that process can lead to catastrophic losses on the part of shareholders."
While Mr. Silverman, the new Merrill fund manager, declined to discuss details of his trading, he maintains that "there was no hurry" to sell shares. "The portfolio restructuring took place in an orderly fashion."
He adds that at Merrill, "performance monitoring is ongoing, and all fund portfolio managers are reviewed annually." He considers his start date as manager of the fund to have been Feb. 11, when he had assembled his management team. (In defending the fund, Mr. Silverman says it gained 1.6% from Feb. 11 through May 31, compared with 0.43% for the Barra growth-stock index.)
But by that point, the fund had sold the bulk of its energy stock holdings. Most of those stocks have surged higher since Merrill started selling them. Some are up more than 100%.
Mr. Silverman doesn't dispute that the fund's value would be a lot higher today if he had left it alone. He told shareholders in the fund's semiannual report, released this week, that the overhaul produced "negative short-term investment results for the fund relative to its prior holdings," adding that "we believe that over the longer term our portfolio restructuring will benefit performance."
That report, the first complete look at what Mr. Silverman has done with the fund, doesn't present a pretty picture. It shows that investors continued to yank money out of the fund during the first four months of 1999. Those redemptions, combined with the fund's investment losses, have shrunk its assets to about $3 billion from almost $4.5 billion at year end.
In the past six months, the report shows, the fund realized investment losses of $448 million. Much of that was incurred in selling the energy stocks that were its biggest holdings last year, including 18.4 million shares of Ensco International Inc., 16.3 million shares of Global Marine Corp. and nine million shares of Apache.
Other fund managers and oil-company executives remember the sell-off vividly.
"We had a very motivated seller, and there weren't many natural buyers," recalls Charles Freeman, manager of the Vanguard Windsor fund. "In a situation like that, you can pretty much name your price."
Mr. Freeman bought one million shares of Apache at $18 apiece on Feb. 1 as part of a huge block trade handled by Goldman Sachs Group. Robert Dye, Apache's vice president of investor relations, says Merrill's sales method probably knocked $3 or $4 off Apache's already-depressed price that week.
"To me, a better way to sell it would be to sell into rallies," Mr. Dye says. "Take your time; get out of it gradually."
On the same day, Mr. Freeman bought 300,000 shares of Burlington Resources, another energy company that Merrill Growth Fund had a big stake in, for $29.50 apiece. Wednesday, Apache closed at $38.0625 and Burlington Resources closed at $43.75.
"It was like a gift," Mr. Freeman says. "You do see this from time to time when there's a manager change because there's a honeymoon period."
Mr. Freeman and other managers say it was common knowledge on Wall Street that Mr. Silverman was looking to sell virtually all of his energy stocks. The fund's portfolio was circulating on trading desks around the country, they say.
"We were all waiting for them," says John Segner, manager of the Invesco Energy Fund in Denver. "They sold all the energy stocks at the bottom. It seemed to go on for days. I'm just convinced it did not have to be done that way."
All this criticism of Mr. Silverman's methods must seem like piling on to executives at Merrill's asset-management unit. The fund has appeared to be star-crossed for more than a year since its longtime manager, Stephen Johnes, died in March 1998.
Mr. Johnes was the architect of the fund's big bet on energy and real-estate stocks and his successor, Arthur Moretti, hung on to almost all of those positions with the belief that energy prices would rebound soon. They didn't. With almost half of its portfolio sunk in the energy sector, the fund racked up a loss of 24% last year.
In late January, Merrill replaced Mr. Moretti with Mr. Silverman, a star Merrill manager who had built an impressive record managing Merrill's Pacific Fund. As he unloaded energy shares, Mr. Silverman began shifting the fund's assets into some staple growth-fund sectors, such as pharmaceutical companies.
Among his first purchases was a big chunk of McKesson Hboc Inc., a drug-distribution company that was then selling between $60 and $70 a share. That stock briefly was the revamped fund's biggest holding, amounting to 5% of its assets.
Then, McKesson gave investors the first of two warnings that it would have to restate its earnings because of accounting problems. The stock plunged and is now selling for $36.1875 a share. Mr. Silverman says he has since unloaded that stock.
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