PCM's stumble stumps investors

The Baltimore Sun

It has been a rough stretch for those who have invested with Bruce S. Sherman, the co-founder of Private Capital Management.

After years of stellar performance, his asset management firm has stumbled. Based in Naples, Fla., it was one of the big losers in the near-collapse of Bear Stearns Cos., with total losses estimated at several hundred million dollars.

That debacle followed huge losses in newspaper company stocks, which Sherman abandoned by the end of 2007, according to public filings. (One of those losses was in stock of The New York Times Co.)

Today, much of Private Capital's glitter is gone - and some investors wonder whether they should bail out or hope for better days. It is the type of quandary faced by investors whenever money managers with strong records stub their toes badly - whether they run managed accounts, as Sherman does, or hedge funds or mutual funds. The common wisdom is to grit your teeth and hang on, said R. Allen Purkiss, the founder of Purkiss Capital Advisors, a financial planner in Ridgefield, Conn.

"If you have a fund where nothing has changed and performance wanes a bit, chances are you are better off staying with what you have," he said, adding that it is only natural that highfliers sometimes falter. "There are times when they are ahead of the market and so their performance languishes."

Sherman declined to comment for this article. Private Capital has operated as a unit of Legg Mason Inc. of Baltimore since 2001, when it was acquired for $1.4 billion. Legg Mason reported a $255.5 million loss in the three months ended March 31 that included an impairment charge related to Sherman's firm. The company had to write off $151 million in management-contract values because some clients stopped doing business with Private Capital.

In a statement, Legg Mason said, "We continue to believe in Private Capital management's disciplined, high-conviction investment process."

But many investors have grown weary of the firm's misadventures. Private Capital, which caters to wealthy investors, has shrunk to $15 billion in assets from $31 billion in 2005.

Over the last three calendar years, Private Capital has reported a 4.52 percent average annual return, trailing Morningstar's composite of similar investment funds by 5.47 percentage points, according to Morningstar. That contrasts with what had been a spectacular record: an average annual return of 16.95 percent over the 10 years ended Dec. 31.

That return was propelled by savvy bets on small- and midcap stocks, but characterizing Sherman's approach is tricky. While Private Capital calls its strategy a "value-oriented investment approach," it has also had substantial holdings in Apple, which is not typical of value portfolios. Other early successes included bets on International Gaming Technology, the slot-machine maker, and Qualcomm, the wireless technology and chip supplier.

Private Capital's performance was already weak in 2007, when it lost 2.07 percent, placing it in the lowest quarter of midcap value separate account funds tracked by Morningstar. This year, it declined 14.2 percent through March.

Harold Evensky, a financial planner in Coral Gables, Fla., said he wasn't sure that anything was significantly wrong at Private Capital, but that investors could look for signs that might help them decide whether to stick with any money management firm.

Abrupt growth in assets under management may be a problem, he said. "One of the criteria we look at is if a manager is in the small- and midcap space, and they have a huge inflow of funds, we are not likely to go there," he said. "We need to be sure that they can continue to implement their style." When a fund becomes very big, it's harder to find opportunities in smaller-cap stocks.

Peter J. Tanous, an adviser whose 1997 book Investment Gurus included a profile of Sherman, said: "There is no question that as the asset pool grew, Sherman had to look at some larger companies. In some cases, such as Apple, it paid off. But the foray into newspapers, for example, was not successful."

While any fund may hit a rough patch, Evensky says it is worrisome when one underperforms its benchmarks for five years. For Private Capital, he said, the most relevant indexes are the Russell Mid Cap Value and the Standard & Poor's 400. The fund lagged behind those indexes for the five years ended in March, according to Morningstar. Some analysts say problems at Private Capital may stem from the structure of Legg Mason's purchase deal.

"The minute Bruce Sherman sold to Legg Mason, Private Capital Management became a different fund," said Bedda D'Angelo, president of Financial Solutions, an advisory firm in Durham, N.C. Under the purchase terms, Private Capital had incentives to increase its asset base.

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