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Why the funds didn’t bite on the Fortune 10

At a time when most of us were enthusing about Cisco, Enron and the like, why were these value investors not joining the party? Their responses about why they were elsewhere are quite consistent. Here are some samples of their reasoning:

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    Clipper Fund: “inability to perform a rational valuation. . . .[F]or example, we did not

buy Enron because we could not understand its financial statements.”3

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    FPA Capital: “ridiculous valuations”

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    Oak Value: At Enron, faulty disclosure and we didn’t like management. At Broadcom,

Nortel, Nokia, and Oracle, we didn’t like the industry and price-to-value. The others mainly contented themselves with the traditional Graham-and-Dodd response that the price relative to value was not attractive.

While these verbal responses enjoyed the benefit of hindsight, their portfolio decisions at the time speak for themselves. As the year 2000 opened – the bubble did not peak until March -- most of the funds were openly acknowledging to their shareholders that they were sorely out of step; on average, the group had way underperformed the market in 1999. Over a long period, a manager who trails the index is obviously not doing his job. And given the rapidity with which investors routinely cash out of cold funds and jump into hot ones, to underperform even in the short run is for many funds a serious matter, known in the trade as “tracking error.” One of our group managers facetiously described tracking error as “professional misconduct vaguely comparable to dealing drugs.”21

Even while agonizing over their tracking error, the fund managers were vigorously reaffirming their investment principles. Envy of the crowd never caused them to lower their

3 The lack of adequate disclosure at Enron was clear well before the debacle. An analyst from TIAA-CREF had complained about the deficiencies, only to be told “We’re Enron; we don’t need good accounting.” Origins of the Crash, supra, at 167.

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