A Weighty Problem With The Stock Market

Posted: December 15, 1998

The fundamentalists were in town last week, and we don't mean the Promise Keepers.

No, the suits and ties filling the Grand Ballroom at the Park Hyatt at the Bellevue belonged to the Association for Investment Management and Research, which sets certification standards for stock analysts and investment managers-in-training.

The association held a daylong boot camp at which brainy academics and graying industry veterans urged the next generation to remember - despite recent events - that stock prices are supposed to have a rational basis.

``Most valuations are done after the fact. Like Alice in Wonderland, you find the verdict first, and hold the trial afterward,'' said New York University finance professor Aswath Damodran, kicking off a rigorous presentation in which he questioned such modern practices as calling research costs ``expenses,'' labeling operating leases ``assets,'' and making ``onetime charges'' a recurring item.

``With many small-capital folks, you see a complete disconnect between the value of the stock and the value of the company,'' said Barney Wilson, vice president of Putnam Investments in Boston. He recalled old-time stock guru Benjamin Graham's dictum: ``In the short run, the stock market is a voting machine. In the long run, it's a weighing machine.''

That set the stage for John B. Neff, retired manager of the value-oriented Windsor Fund and the University of Pennsylvania endowment, still a folksy apostle of the ``systematic approach'' and the ``meat and potatoes school.''

Neff sees signs that it's ``1929 all over again'' - only this time ``it's not the clerks and elevator operators and shoeshine boys of yesterday'' who are buying stocks on scant information, ``but the people who watch CNNfn and CNBC - it's pretty mindless after awhile!''

Internet stock blowouts? ``It's a new chapter in funny business. I think the market has become less efficient, not more. . . . Momentum investors are just digging their own holes. This market will fall by its own weight.''

Exxon-Mobil and other megadeals? ``It's frenzied finance. A workaholic weekend for investment bankers.'' No, he is not a fan of combinations: ``I like to have as many alternatives around as possible.''

A question from the audience: Hasn't Neff-style value investing missed the biggest gains of the 1990s, while providing little hedge against recent downturns?

``You have to wear the market out,'' Neff replied. ``There's stuff out there; just use your head.''

* Who's afraid of hedge funds? Not Michael Dever, whose 20-year-old Thornton firm, Brandywine Asset Management (not to be confused with the Legg Mason subsidiary of the same name), shares space with his other business, online shopping network Spree.com.

Even after taking a 1 percent management fee and 20 percent of cumulative performance off the top, Brandywine's three-year-old, $30 million-asset Market Neutral USA hedge fund reported 22 percent 1998 returns through November (vs 42 percent last year), thanks to big recent gains in home-builder stocks such as D.R. Horton and Ryland Group.

Shorting oil stocks and Polaroid has also paid off. Indeed, shorts helped Market Neutral report an 8 percent gain when the stock market tanked in August.

In each year since its 1996 inception, Market Neutral has claimed that ideal combination of respectable returns married to low volatility (its standard deviation is lower, and its Sharpe reward-to-risk ratio is higher, than the S&P 500).

A second Brandywine hedge, the $19 million, derivative-balanced Spectra USA, reports more modest gains but less volatility.

Why so strong? Trading director Patrick Kane says Brandywine's funds are unleveraged, diversified, and trade only ``exchange-listed futures and equities,'' reducing downside risk.

The real mystery: How does Dever manage a high-performance hedge fund at the same time he is shopping his high-growth Web business to venture capitalists?

Maybe there's two of him: one long, one short.

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