In Freddie, Legg Mason maverick met his match

The Baltimore Sun

Legg Mason money manager Bill Miller built his reputation on making contrarian picks, betting on downtrodden stocks to make a comeback. His Value Trust mutual fund beat the Standard & Poor's 500 Index for 15 straight years before the streak ended in 2006.

So Wall Street took note when Miller gambled on Freddie Mac this summer, adding 30 million shares to his already-sizable holdings of the mortgage company. It made Baltimore-based Legg Mason Freddie's largest shareholder and signaled that Miller believed the stock could turn around.

But yesterday, Miller and other Freddie shareholders saw the company's stock lose more than 80 percent of its value in the aftermath of a government bailout of Freddie and Fannie Mae, the nation's other mortgage giant.

Miller's Legg Mason Capital Management subsidiary and its affiliates owned 12.4 percent of Freddie's common shares, or nearly 80 million, as of July 31, according to a filing last month with the Securities and Exchange Commission.

The shares were worth $652.6 million then, when Freddie's stock traded at $8.17, already down substantially from a year earlier. Based on yesterday's closing price of 88 cents a share, such a stake would be worth a little more than $70 million now. It's unclear whether Miller and Legg still owned that many shares. Miller and company executives declined to comment yesterday.

But Miller's high-profile bet on Freddie Mac could further worry investors in the Value Trust mutual fund, which has lagged behind its peers during the past two years, analysts said. And it is more bad news for the corporate parent, Legg Mason, which has seen its shares drop 34 percent this year as clients take their mutual fund investments elsewhere.

Investors pulled $18.4 billion from Legg funds in the quarter that ended June 30, with some of the equity withdrawals coming out of Legg Mason Capital Management.

Analysts say the news of Miller's gamble doesn't help restore investor confidence in his investment style. As of last week, the fund was down almost 31 percent so far this year, according to Morningstar. Shares of the Value Trust gained 64 cents, or 1.6 percent, to close at $40.86 yesterday.

"Investors will assume the worst, either take more funds out of Bill Miller's fund or not invest in it again," said Morningstar analyst Alan Rambaldini.

At the same time, analysts cautioned about reading too much into Miller's bet on Freddie, noting that his Legg Mason Capital Management division represents a small slice of the parent's $923 billion of assets under management.

Other value-driven money managers also stumbled with investments in Freddie and Fannie.

Roger Smith, an analyst at Fox-Pitt Kelton, said Miller's Freddie stake is not likely to affect Legg's earnings potential. "It's more [reputation] than anything else," Smith said.

Added Robert Lee, an analyst at Keefe, Bruyette & Woods, "Let's put it this way: The perception of his impact on the Legg Mason business overall, I think, tends to be greater than the actual impact. I don't want to say there is no impact. You have to put it into perspective. It's not positive, but given his notable holdings of the [government-sponsored entities], Legg Mason is up today."

Shares of Legg Mason gained $2.83, or 6.4 percent, to close at $47.35 yesterday.

Several analysts pointed to Legg's potential upsides in the government takeover of the two mortgage giants.

Mortgage debt guaranteed by Fannie and Freddie rallied yesterday as investors showed signs of confidence in the government's action to increase the companies' holdings of mortgage-backed securities.

If the improvements continue, it could benefit Western Asset Management, Legg's fixed-income division, which owns some of those bonds, analysts say.

Western Asset is Legg's largest subsidiary, and fixed-income assets represent 53 percent of the company's total assets under management.

Financial stocks also gained yesterday, offsetting losses in Fannie and Freddie for some equity investors, including Legg's Value Trust, analysts say.

Under the conservatorship that operates Fannie and Freddie, the government is injecting money into the two troubled companies to keep them afloat. The government will receive warrants representing an 80 percent ownership stake in each company, reducing ordinary shareholders' equity to 20 percent.

The more money the government injects, the more diluted shareholder equity becomes. Shareholder value can increase if the housing market recovers, though it's not expected to happen anytime soon.

Miller began investing in Freddie at the end of last year, accumulating 14.6 million shares as of Dec. 31.

The money manager increased his stake to about 50 million as of March 31, when the stock was trading in the $20 range.

"Unfortunately, it's another case where Bill Miller and the rest of the team was a little too optimistic about the potential losses on the books," said Morningstar mutual fund analyst Greg Carlson. "One of the things they've argued is, accounting rules being what they are, firms have been forced to take bigger write-offs than they otherwise might."

Of Miller's 80 million stake in Freddie, the Value Trust fund held 17.7 million shares as of June 30.

Freddie represents 3 percent of the fund's portfolio, said Carlson. Other fund investments include American International Group, Capital One Financial Corp. and Citigroup Inc., which all gained in the market yesterday.

"I still like the long-term prospects," Carlson said of the fund.

Bloomberg News contributed to this article.

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