Some hedge funds win big with Fannie, Freddie bets

By Svea Herbst-Bayliss

BOSTON (Reuters) - Hedge fund managers who bet that housing finance companies Fannie Mae and Freddie Mac would plummet further won big on Monday, while investors in the common shares who expected a recovery saw their losses widen.

"We are still short," said Douglas Kass, head of hedge fund Seabreeze Partners Management, as the two widely held mortgage companies' stock prices plunged to below $1 a share after the U.S. government seized the companies over the weekend.

People familiar with Kass' fund said he is up about 25 percent this year, ranking him among a small group of investors who turned conventional wisdom on its head and delivered huge gains while long-time investment icons like Bill Miller and David Dreman got it wrong.

Similarly, William Ackman's Pershing Square Capital Management made money on Fannie and Freddie, thanks to the manager's early warnings of an impending credit crisis and bets against the companies, a person familiar with the fund said.

For some short-sellers -- investors who borrow shares in the hopes of seeing the price drop and then repaying the loan for less later -- Fannie and Freddie gave them new legitimacy in a world in which their research skills were sometimes ridiculed, investors said.

"I don't know how they could get it so wrong. There were so many red flags. I feel sorry for them," said one hedge fund manager, who asked not to be identified, echoing several other managers' thoughts.

"They" referred to the investment industry's most gifted stock pickers whose bets on beaten down stocks have often paid off handsomely.

This time, though, faulty research led some managers to take the wrong positions at the wrong time, Kass said. "These guys were throwing the equivalent of Hail Mary passes," he said, referring to the decision to add more shares as the stock prices were falling.

Legg Mason Inc star manager Bill Miller, the only man to have beaten the Standard & Poor's 500 index for 15 straight years, said in August he increased his holdings in Freddie shares to roughly 79.8 million from about 50 million. That made Legg Mason the largest shareholder in the stock.

In July, Miller said there was a "frenzy" over the capital concerns of the mortgage companies.

With his flagship fund off 31 percent, Miller is experiencing what may be the worst year in his career, possibly putting pressure on the 53-year old manager to step aside, several analysts and fund managers said.

Analysts at Credit Suisse forecast last week that more investors would pull money out of Legg's most prominent funds. Miller was not available for comment, and a company spokeswoman declined to comment.

Miller isn't alone.

Fund manager Dodge & Cox, the second biggest holder in Fannie Mae with roughly 119 million shares, held the position for months. The firm bought the stock when it was trading at $18 or more.

Similarly, Capital Research, which manages the hugely popular American Funds series, ranked as the third biggest investor in Fannie Mae with 116.9 million at the end of June.  Continued...