Gold Fever Was This Manager’s Downfall

It was a force of nature--a stock fund that seemingly couldn’t lose money. From 1975 to 1996, FPA Paramount Fund didn’t.

During that unprecedented 21-year stretch, the fund--which invests in small- and medium-sized, out-of-favor stocks--didn’t experience a single losing calendar year.

It marked the longest money-making streak in stock fund history. Better still, during the streak, FPA Paramount also beat the benchmark Standard & Poor’s 500 index of blue chip stocks.

Much of the credit belongs to William Sams, a veteran money manager with a deep devotion to “value” investing and an even deeper Texas drawl.

Since he took over FPA Paramount in 1981, the unassuming Sams established a record so impressive that fund-tracker Morningstar Inc. in 1997 ranked him as one of the 10 best fund managers ever.

Of course, as is often the case, just as investors begin to think that a fund manager can do no wrong, he does.

In 1997, FPA Paramount stunned investors by losing money for the first time since the early ‘70s bear market. The fund slipped 1.8%--even as the market overall soared. It was the worst performance by a mid-cap value fund that year, according to Morningstar.

In 1998, FPA Paramount lost even more, plunging 24% and trailing the S&P; 500 by a staggering 53 percentage points.

“Now,” Sams says in his self-deprecating Southern style, “I can’t seem to do anything right.”

The Fund: FPA Paramount, based in Los Angeles.

The Problem: Talk about a reversal of fortune. Two years ago, this was the No. 1 fund in its category, based on its 15-year track record. Now, FPA Paramount, part of the First Pacific Advisors family, finds itself in the cellar.

Thanks to two downright abysmal years, FPA Paramount ranks in the bottom 5% of its fund peer group over the last one-, three, five- and 10-year periods.

More frustrating than its relative performance is the fund’s absolute numbers. Despite the second-quarter rally in small and value-oriented stocks--the very types of companies that Sams favors--FPA Paramount is still down 7% year to date. By contrast, the average mid-cap value fund is up 9.7%.

Over the last 12 months, the gap is even wider: FPA Paramount is down 30.8% while the average mid-cap value fund is up 7.2.%

To put it in dollar terms, a $100,000 investment in FPA Paramount three years ago would be worth just $74,700 today. That same $100,000 would have grown to $153,700 in the average mid-cap value fund and $210,200 in an S&P; 500 index fund.

Which explains why, after reopening the fund to new investors in 1997, FPA Paramount’s assets have fallen from $750 million to $212 million--a function of both portfolio depreciation and fleeing investors.

What Went Wrong: How is it that a fund that couldn’t lose money now can’t make any?

Partly, the issue is Sams’ contrarian style of investing, which involves buying small, beaten-down stocks in out-of-favor industry sectors. That investing style has itself been out of favor in recent years.

“So many of the sectors he was overweighted in dived in the past couple of years,” notes Value Line Mutual Fund Survey analyst Joseph Espaillat.

But that doesn’t explain why Sams’ value-minded peers are doing so much better, on average.

What Really Went Wrong: This Texan with the Midas Touch turned a good portion of his portfolio to gold. Literally.

Back in 1997, Sams--fearing that stocks overall were getting overheated--started to play a little defense.

In the past, Sams has kept as much as 40%, even 50%, of his portfolio in cash when he feared a market pullback, or when he couldn’t find out-of-favor stocks trading at bargain-basement prices.

This time, Sams did something different. In addition to loading up on cash, Sams also began moving money into gold-related stocks.

The reason? As he explained it to Money magazine in May 1997: “We’re starting to see consolidations in the industry, which is a plus.” Besides, he added, “I don’t see much risk other than these [gold] stocks move sideways rather than up.”

Wrong.

In the ensuing two years, the three gold-mining stocks in which Sams invested sizable portions of the fund’s money--Homestake Mining, Newmont Mining and Placer Dome--proceeded to move down, not sideways.

As gold’s price fell from $350 to $300 an ounce in 1997, those stocks lost 30% to 40% of their value. And as gold continues to lose luster (it now trades at about $260 an ounce) worldwide, those stocks continue to bleed. They’ve fallen another 10% to 40% since the end of 1997.

“That turned out to be a disaster,” Sams concedes. “That really backfired.”

Yet he continues to hang onto his three gold stocks. Not only that, Homestake, Newmont and Placer Dome are now three of the top four holdings in the fund--representing a whopping 36% of its assets.

The obvious question is, why?

Sams says these stocks are still undervalued. And although one of the key reasons gold has been pummeled is because inflation has remained low (gold has traditionally been an inflation hedge), Sams believes that inflation will inevitably pick up, which could create a better environment for gold.

But some of Sams’ hard-nosed approach could reflect a common problem for all investors: taking it too personal when a formula doesn’t work.

“It’s so hard to sell here, after two years of it not working,” he concedes. “If I could just get a rally, I would reduce some of that exposure.”

“I need either Polymer Group [his top holding] or the three gold stocks to rally,” he continues. “That would get me back in the ballgame. Then, I could ease out of some of the gold.”

Morningstar analyst Bill Rocco notes that Sams’ stubborn devotion to value and contrarian investing has always been the reason for his success.

But, Rocco says, “The question is, where is the line between appreciating a manager for his courage of conviction and criticizing him for refusing to say I made a mistake?”

What Else Went Wrong? As Sams puts it: “Some stocks, golly, just haven’t worked.”

In fact, some of Sams’ stock picks have exploded on him.

Included on that list are Service Merchandise, a retailer whose shares fell nearly 90% in 1998; EEX, an oil and natural gas exploration company whose shares lost three-quarters of their value last year; CCA Prison Realty, which lost more than half its value last year; and Paging Network, whose price was cut in half.

Making matters worse is that FPA Paramount is a concentrated fund. Sams tends to have no more than 20 or 25 stocks in the portfolio.

The Plan to Turn Things Around: There is none. Sams says he’s staying the course.

He believes the market is coming back around to his style of investing. And in fact, since the April rally in industrial-cyclical stocks and small-company stocks, many of his holdings have moved off their recent lows.

Can This Fund Be Saved? Sure--if gold prices make a big comeback after a two-decade-long slide. But with major industrial nations increasingly looking to sell part of their gold reserves, the metal faces a tough road, many analysts say.

Shy of a gold rebound--or until Sams changes his mind, which he says he won’t--it’ll be hard for FPA Paramount to rebound.

Why? With 36% of its stake in mining stocks, FPA Paramount is as much a gold fund as it is a mid-cap value fund.

And while there is always the possibility that Federal Reserve Chairman Alan Greenspan will let inflation get by him, and that gold prices will spike along with it, the reality is that the typical gold fund has fallen an average of 14% a year for the last five years.

Value Line’s Espaillat isn’t as pessimistic. He argues that “if the market starts to favor his types of companies, Sams is going to do quite well.”

He notes that because this is a concentrated fund, it may only take a handful of rising stocks to pull the fund into positive territory.

But if that’s the case, why hasn’t FPA Paramount done better over the last three months, when the market has come around to favoring smaller, beaten-down stocks?

In the 13 weeks ended last Thursday, FPA Paramount lost 0.2%, while the average mid-cap stock fund rose 9.2%, according to Lipper Inc. Dragged down by gold, the fund’s performance has worsened in the last four weeks.

Now, the big question is, what happens if the rally in small value-oriented stocks peters out?

“If the market doesn’t favor his types of companies, then he’s out of luck,” Espaillat says.

Which brings us back to the comments by Morningstar’s Bill Rocco: At what point do you stick .with a fund manager who sticks to his convictions? And at what point do you walk away from a manager who refuses to say, “I made a mistake?”

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Staff writer Paul J. Lim can be reached at paul.lim@latimes.com.

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From First to Worst

Two years ago, FPA Paramount was the best mutual fund in its category, and manager William Sams was hailed as one of the 10 best fund managers ever. But Sams’ huge stake in gold stocks--and some bad stock picking--have turned FPA Paramount from a fund that couldn’t lose money to one that can’t seem to make any. Total-return figures for the fund and two benchmarks through June 16:

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YTD 1-year 3-year (as of June 16) annualized annualized S&P; 500 index +8.9% +24.1% +28.1% Avg. mid-cap value fund +9.7 +7.2 +15.4 FPA Paramount -7.0 -30.8 -9.3

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Source: Morningstar Inc.