Could it be the beginning of the end of the market meltdown? If history is any guide, just possibly. One of the few remaining star fund managers, famed value investor David Dreman, 72, was recently fired from $2.4 billion DWS High Return Equity. Dreman had guided High Return for more than two decades, a period that encompassed numerous market cycles and as well as a series of corporate owners, most recently Deutsche Bank. His tenure came to an end last week, when the fund’s board announced that as of June 1 he would be replaced by a Frankfurt-based team of quantitative managers.
As financial historians are quick to point out, dismissing a manager after a spate of poor returns often backfires, since that particular investing style is probably due for a comeback. During the dotcom era, many well-known value managers lagged badly when they avoided tech stocks, and by 2000 a number had lost their jobs or retired. Among them: Robert Sanborn of Oakmark Select, Gary Brinson of Brinson Global, and George Vanderheiden of Fidelity Destiny. Dreman himself was down 13% in 1999, vs. a 21% gain for the S&P 500. When value investing rebounded the next year, Dreman High Return rocketed 41%, trouncing the index by 50 percentage points.
This time around Dreman’s underperformance was the result of stocks he bought, not those he avoided. A contrarian investor, he held a big stake in ill-fated financials last year, including Fannie Mae, Freddie Mac, Wachovia, and Washington Mutual. No surprise, High Return ended 2008 with 46% loss, placing it near the bottom of its peer group. Says Dreman, “In retrospect, our financial holdings cost us a lot.” It didn’t help that 2008’s disaster followed two previous years of subpar returns, which meant the fund’s three-year and five-year numbers looked grim.
But that kind of underperformance is exactly what you have to expect with value managers. Successful investing requires plenty of patience, since studies show that even the best stock-pickers often lag the market for several years in a row. And if you give up too soon, you can miss out on the good years. Despite its recent stumbles, Dreman’s High Return fund ranks in the top half of its category over the past 10 years, according to Morningstar, and since inception the fund’s 9.2% average annual return beats the S&P 500 by more than a full percentage point.
Of course, there’s no guarantee that any fallen manager will soar again. But Dreman, who has no immediate plans to retire, is clearly gunning for a comeback. Along with his heir apparent Clifton Hoover, he still manages three other DWS funds (including a top-performing small cap value portfolio), as well as the no-load Dreman Contrarian funds. “Low P/E investing is a proven strategy,” he says. “And this is exactly the kind of market we do well in—many great stocks got knocked down to levels we have not seen since the 1950s.”
And those stocks are likely to rebound in the next few years, Dreman says. He is looking for the economy to begin recovering in 2010, although the government’s efforts to pump liquidity into credit markets may cause double-digit inflation. Still, stocks tend to do well during inflationary periods, since companies have pricing power to maintain earnings. “Over the next five years,” Dreman says, “the stock market could possibly double.” A 100% stock market gain? Right now that’s something only a contrarian would predict.