Nortel investors sideswiped - again
Many funds hold NT as it drops bomb
Last week, Nortel again dropped a mini-bomb on financial markets when it announced the termination (with cause) of three senior executives - including the CEO. Adding salt to the wound was the revelation that its fiscal 2003 profit would be sliced in half after the completion of a secondary financial review. Fund managers have been burned before - less than four years ago - when then-CEO John Roth admitted that his previous earnings guidance was way off the mark.
This latest surprise was less dramatic but it begs the question of how so many managers bought into this infamous stock so soon after its last act of deception? This is of particular interest in the context of funds and managers who seemingly possess a style or mandate that doesn't quite fit with this stock.
More than 500 investment funds held Nortel Networks among its biggest investments as of the end of March (source: Morningstar Canada's Paltrak 98). Here are some of the funds that caught my eye.
AIM Canadian First Class
Managed by Roger Mortimer in AIM's San Francisco office (Mortimer is, ironically, a Canadian), this fund is rare among 'AIM' funds. The unusual part is its fairly strong value-tilt in a mainly growth-oriented fund family. Interestingly, a brief inspection reveals that this fund's participation in the Nortel party the first time around (from late 1998 through late 2000) came mainly via then-parent BCE Inc. However, its top holdings as of the end of March included Nortel.
While some value managers - like Templeton and Brandes - did buy Nortel a couple of years ago, most divested their stakes last year. That was precisely the time when growth and momentum managers were beginning to once again take to the Brampton-based company.
While I've not spoken with the Mortimer or AIM, it doesn't make a great deal of sense that this fund still holds Nortel, particularly after it shot up past $10 earlier this year. That said, this fund continues to sit in a profit position on this stock.
Fidelity True North
Originally managed by Alan Radlo (after Veronika Hirsch's scandal-driven departure), this fund has thrived. Just over eighteen months ago, Steven Binder took over as Radlo was given a new responsibility (to start the NorthStar global equity fund). While Binder is as price-sensitive as Radlo (if not more so) there is a simple explanation as to why this fund is holding Nortel. Two words: tracking error.
Fidelity keeps tight reigns on their portfolio managers with their firm-wide policy of not taking big bets against a fund's specified benchmark. Just a couple of Fidelity managers have earned enough success to make more significant bets but most must be very mindful of the benchmark and this must be reflected in their portfolios.
Nortel remains a benchmark heavyweight - even after its infamous descent - so all benchmark sensitive managers must hold 'some' Nortel. Others that fall into this category include (but are not limited to) Legg Mason Canada, McLean Budden, PH&N, and Standard Life.
TD Canadian Equity
Interestingly, lead manager John Smolinski was briefly part of Mackenzie's Ivy team. At the time, he was hired to assist Jerry Javasky with Canadian equities - Ivy Canadian in particular. He was part of the team when Ivy Canadian purchased Nortel Networks in late 1999. Javasky noted in a November 23, 1999 Globe and Mail article that he added to Ivy Canadian's Nortel stake.
Smolinski didn't stay with Mackenzie for long before moving on to TD Asset Management. However, now that Nortel has popped up in Smolinski's TD Canadian Equity fund, it seems that Smolinski is either very benchmark sensitive - or that he has really bought into the Nortel story twice in five years.
That's not to say that he's been hurt this time around. In fact, it appears that the Nortel position remains profitable. Most of the 12 million shares Smolinski purchased for this fund happened during the first five months of last year at an average price south of $4 per share. However, the bigger issue is whether this firm can really be trusted and what the financials really should look like. Therein lies the risk
Before you get upset if one of your preferred mutual funds holds this troubled company, it is first instructive to examine a couple of things. First is style. A growth, momentum, or benchmark sensitive fund should be expected to have Nortel. However, if the style seems inconsistent with a holding like Nortel, it's time to do more homework to understand why it's there and what the manager's current thinking is in the context of that stock.
If a mistake was made, look for a simple and candid admission. Otherwise, look for further insight as to how to value a company whose financials have been plagued with problems for years. It's just one of many holdings for such funds, but using individual examples is a good way to better understand how money is managed.
Dan Hallett, CFA, CFP is the President of Dan Hallett & Associates Inc. in Windsor Ontario. DH&A is registered as Investment Counsel in Ontario and provides independent investment research to financial advisors. He can be reached at firstname.lastname@example.org
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