Fund placed bad bets on mortgage companies

Arnold Schneider s small-company mutual fund went from best to worst after three of his mortgage company holdings slumped 77 percent this year. The Schneider Small Cap Value Fund had 13 percent of its $110 million in Anworth Mortgage Asset, American Home Mortgage Investment and Luminent Mortgage Capital, mortgage lenders battered by the deepest U.S. real estate recession in 16 years.

Schneider, who oversees $6.2 billion in total, has produced average annual gains of 24 percent in his Small Cap fund during the past five years by purchasing shares of companies he finds undervalued. The fund ranks first of 100 competing small-cap funds tracked by Bloomberg in the period. It has dropped 15 percent so far this year, placing last among those that purchase companies considered inexpensive when compared with financial yardsticks like earnings growth.

“The fund has gotten killed,” said Karen Dolan, an analyst at Morningstar in Chicago. “It s not unusual to see Arnie Schneider in an area of the market that s risky and controversial, but this time he underestimated the risks.” Overdue payments on subprime mortgages, those extended to people with poor credit, rose in the first quarter to their highest level since 2002, according to data compiled by the Mortgage Bankers Association.

That has led to bankruptcies among mortgage companies, including American Home, based in Melville, New York, that were required to pay back their lenders. Today in Marketplace by Bloomberg ESPN may bring Disney less profit Enel predicts higher profit for 2007 Merck wins large court victory in U.S. Schneider, 46, made his name by investing in companies with market values of less than $3 billion that other investors shunned.

He bought shares of Boykin Lodging, a real estate investment trust that runs Marriott, Hilton and Radisson hotels, after the Sept. The company s stock rose 65 percent in the next four years, twice the pace of the Standard Poor s 500-stock index. Schneider added shares of Reliant Energy in 2003 when the company, the largest electricity retailer in Texas, was under investigation for alleged manipulation of energy prices. The company admitted to sham trades, and some employees were indicted.

Reliant emerged from the scandal, and the stock more than quadrupled over the next two years. The Small Cap Value fund has a Sharpe ratio of 0.66, compared with 0.74 for rival funds, Morningstar reported. The fund has Morningstar s second-highest rating, four stars. Schneider, a former fund manager at Wellington Management in Boston, is president and chief investment officer of Schneider Capital Management in Wayne, Pennsylvania. He declined to be interviewed for this article.

Schneider, who graduated from the McIntire School of Commerce at the University of Virginia, began acquiring shares of mortgage companies in early 2006, filings with the U.S. Securities and Exchange Commission show.

In a report in February, Schneider wrote that he was purchasing shares of real estate investment trusts with holdings of mortgage-backed securities because they “are not exposed to credit risk.” The fund had 4.8 percent of its assets in Anworth Mortgage, a REIT investor in mortgage-backed securities, at the end of June.

The company, based in Santa Monica, California, the fund s largest position, said this month that it might have to sell most of the holdings in one unit because lenders wanted their money back. American Home, which represented 4.7 percent of assets, filed for bankruptcy protection this month because of margin calls by creditors. Shares of American Home, which reached a 52-week high of $36.40 in December, traded at 19 cents Wednesday. The company was the fund s third-largest investment in June.

Schneider s fund also had 3.3 percent in Luminent Mortgage, the REIT in San Francisco that received default notices from lenders this month. Luminent, the fund s sixth-biggest investment, reached a financing deal with Arco Capital this month, analysts said, helping it avert bankruptcy. Luminent shares traded at $1.64 Wednesday, down from a 52-week high of $10.84 in October.

Besides mortgage stocks, the Small Cap Value Fund has 4.7 percent of its assets in the truck maker Navistar International of Warrenville, Illinois, and 2 percent in American Axle Manufacturing Holdings in Detroit. Navistar shares have climbed 63 percent this year through Wednesday after winning a $623 million award from the U.S. Marine Corps to make blast-resistant trucks, the largest contract for such vehicles to date.

The stock had fallen to a four-year low in 2006 when Navistar said it would restate financial results and replace its outside auditor. American Axle s stock has risen 21 percent this year through Wednesday as the company, the largest supplier of axles to General Motors, reported a profit in the first half of 2007, rebounding from a fourth-quarter loss.