Some Fund Managers Clung to Fannie, Freddie

Anyone worth their Wall Street pay grade can't be surprised by Fannie Mae (FNM) and Freddie Mac's (FRE) financial ruin.

But it turns out some mutual-fund managers were actually caught off guard. At least that's our guess judging by how much of their portfolios they'd invested in the duo's nearly worthless stock.

By now we know the housing bubble started deflating in 2006, and the credit markets reached a crisis point in the summer of 2007. If you invested in Fannie and Freddie before or even up to those points, so be it. But why on earth would any respectable mutual fund be caught holding Fannie and Freddie shares as late as this summer?

Plenty of folks have long warned that Fan and Fred's "government sponsored enterprise" model could cause trouble. Alan Greenspan urged Congress way back in 2000 to seriously examine their risks to our financial system. His words now look pretty prophetic. If their government subsidy "enables Fannie and Freddie to hold less capital, then bondholders and taxpayers may be at greater risk if these government-sponsored enterprises need financial assistance in the future," the former Fed chairman said.

Even putting aside Fan and Fred's problematic public-private model, the two had major accounting "misstatements" in the early 2000s and expanded their exposure to risky mortgage loans during the housing boom. Now here we are today with taxpayers on the hook for billions and Fannie and Freddie shares trading for less than $1 apiece.

Of course, once the credit crisis ensued investors fled for the hills in droves, sending the stocks down sharply. Yet a handful of mutual funds hung on for who knows what reasons. Morningstar analyst David Kathman has been tracking mutual funds with big exposure to Fannie and Freddie since December 2007. He finds that many funds with big chunks in the stocks back then still held them as late as June and July of this year, based on the latest publicly available holdings data. (See list below.)

"Most of these funds appear to have been hanging on, betting on a turnaround by Fannie and Freddie that never came," Kathman said in a report this week.

Some otherwise well-regarded names are in the bunch, such as Touchstone Large Cap Value (TLCAX), which is down a whopping 42% this year. Nearly 12% of its $25 million portfolio was in Fannie and Freddie stock as of June 30. Schneider Value (SCMLX) is also on the list. The fund has fallen 27% so far this year, and it had almost 9% of its portfolio in Fannie and Freddie as of June 30.

I couldn't reach anyone for the two funds. But I did catch up with some of the other companies on Kathman's list. They all declined to comment on why the funds held on to Fannie and Freddie for so long, although they offered up other talking points. Aim Investments said only that "any individual holding in a particular fund is a small percentage of the fund's portfolio." Morgan Stanley similarly said, "The firm's overall equity exposure to Fannie Mae and Freddie Mac is negligible." Fidelity said it doesn't talk specific stocks, but it pointed out that its sector funds are narrow in scope and that the two funds with high Fan and Fred exposure "have beaten their benchmarks over long periods."

Hopefully these funds will be able to redeem themselves to investors whose money they've lost this year. As for Fannie and Freddie? We're not holding our breath.