Real estate recession sends winner plummeting to worst

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 Corp., American Home Mortgage Investment Corp. and Luminent Mortgage Capital Inc., home-loan lenders battered by the deepest 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 Value fund during the last five years by purchasing shares of companies he finds undervalued. The fund ranks first of 100 competing small-capitalization funds tracked by Bloomberg in the period. But it was down 13.39% as of Wednesday, placing last among those that buy companies considered cheap when compared with financial yardsticks such as earnings growth.

"The fund has gotten killed," said Karen Dolan, an analyst at Morningstar Inc. "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 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, N.Y., that were forced to pay back their lenders.

Schneider, 46, made his name by investing in companies with market values of less than $3 billion that other investors shunned.

He added shares of Houston-based Reliant Energy Inc. in 2003 when the electricity retailer 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. A higher Sharpe ratio reflects better risk-adjusted returns. It has Morningstar's second-highest rating of four stars.

Schneider, who graduated from the McIntire School of Commerce at the University of Virginia, is a former fund manager at Wellington Management Co. L.L.P., of Boston. He is president and chief investment officer of Schneider Capital Management Corp., based in Wayne. He declined to be interviewed.

Schneider began acquiring shares of mortgage companies in early 2006, filings with the Securities and Exchange Commission show. In a February report, Schneider wrote that he was buying 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 Santa Monica, Calif., company, the fund's largest position, said Aug. 9 that it may have to sell most of the holdings in one unit because lenders want their money back. Anworth shares have dropped 48 percent this year.

American Home, which represented 4.7 percent of assets, filed for bankruptcy protection last month because of margin calls by creditors. Shares of American Home, which reached a 52-week high of $36.40 in December, now trade around 19 cents. The company was the fund's third-largest investment in June.

Schneider's fund also had 3.3 percent in Luminent Mortgage, the San Francisco REIT that received default notices from lenders last month. Luminent, the fund's sixth-biggest investment, reached a financing deal with Arco Capital Corp. on Aug. 20, helping avert bankruptcy, analysts said. Luminent shares trade around 8 cents, 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 truck-maker Navistar International Corp. and 2 percent in American Axle & Manufacturing Holdings Inc.

Manager: Arnold Schneider.

Assets: $110 million.

Performance: Down 13.39 percent in 2007.

Notable holdings: Anworth Mortgage Asset Corp., American Home Mortgage Investment Corp., Reliant Energy Inc.

Ticker: SCMVX.

EndText