But during the height of the financial meltdown, Ellison was decidedly absent from the banking stocks he's spent so many years researching and buying. Like many others, he became concerned that falling home prices and rising unemployment would hammer these investments which were heavily dependent on the housing bubble for profits.
INVESTING LIKE LYNCH
So in late 2007, he began retreating into cash and waiting for friendlier times, a move largely motivated by advice he'd received years earlier from Peter Lynch veteran Magellan Fund manager, and Ellison's mentor. While working together at Fidelity Investments, Ellison had approached Lynch regarding his concern about how poorly savings and loans were performing in the early 1990s. Lynch told him to protect shareholders above all else.
Now, as manager of two funds for FBR Funds of Arlington, Va., where he also serves as chief investment officer of equities, he once again took Lynch's advice. At the end of 2008, his FBR Large Cap Financial and FBR Small Cap Financial funds held 60% of their assets in cash.
In early 2009, shares in high-quality banks had dropped to unprecedented prices, signaling to Ellison that it was time to dive back into the sector he knew so well. Some banks were selling at prices as low as 10% of book value, levels even lower than he had seen in the savings and loans crisis of the 1990s. He invested heavily in those banks he considered high-quality, plain-vanilla names-such as Astoria Financial, Washington Federal, Iberiabank and Hudson City Bancorp.
Ellison's actions helped the FBR funds weather the storm and eventually recover. For the last three years through March 5, the FBR Large Cap Fund is down 3.3% a year annualized and in the category's top 16%. The fund eked out a 0.46% gain for the last five years, besting 86% of its peers in the financial category, according to Morningstar.
Meanwhile, the FBR Small Cap Fund is up 1.25% in the last three years and 1.35% annualized in the last five, placing the fund in the financial category's top 8% and 12%, respectively.
JUST DEPOSITS
Years of following the financial sector have taught Ellison that what he really likes are plain old-fashioned banks that take in deposits and then turn around and make loans. He has no use for complex financial-services supermarkets, with their proprietary trading desks and hedge fund operations.
"I am looking for companies that have stable deposit franchises," Ellison insists. "They have the ability to fund themselves cheaply and with stability." What he is looking for is as much a company's individual characteristics as it is about defined metrics. It might be equal parts low price-to-book value and a CEO with a modest salary, or a company with a loan portfolio light on borrowers in the Rust Belt.
"Of course we want to pay as little as possible for a stock," he emphasizes. "We just came through a period where these stocks were trading at two times book."
Waiting it out is the best strategy in situations where the stock he wants is trading at too high a cost, Ellison says. "It's all about playing the cycles. Those cycles last three or four years." It's also about doing the same thing over and over really well since, after all, managing a fund "isn't about a new product, it's really about not making big mistakes."
One company that exemplifies Ellison's maxim is Washington Federal, a traditional lender that churns out ho-hum 30-year mortgages. The stock's been an Ellison staple since the funds launched.
Taking deposits and making loans kept Washington Federal's nose to the grindstone while the rest of the financial world fell apart. In fact, over the last three years, shares in Washington Federal lost only 3.1%, while the average savings and loan stock fell 11.3%.
That's not to say that Washington Federal hasn't suffered alongside the economy, though. As real estate and the economy soured, the lender saw its defaults rise. In the fourth quarter of 2009, the bank suffered an 18% quarter-over-quarter earnings decline-largely the result of losses on loans-though it still managed to report a $7.9 million profit for the quarter.
Nonperforming assets now stand at 6% of the bank's total assets, but Washington Federal has plenty of capital to withstand the losses, Ellison says. It also has the deep pockets to fund expansion into new markets in California and buy up troubled banks, with the assistance of the Federal Desposit Insurance Corp.
