The Icahn Indicator: Are Fannie Mae and Freddie Mac Worth a Revisit?

Value-oriented money managers are flocking to Fannie Mae and Freddie Mac shares.

Jun 4, 2014 at 10:15AM

U.S. stocks are slightly off Monday's record high this morning, with the benchmark S&P 500 and the narrower Dow Jones Industrial Average (DJINDICES:^DJI) down 0.08% and 0.17%, respectively, at 10:20 a.m. EDT. Perhaps the dip reflects traders' disappointment with this morning's employment report from payroll processor ADP, according to which private payrolls increased by just 179,000 in May, compared to a consensus estimate of 210,000. The miss does not bode well for the Labor Department's May employment report scheduled for release on Friday, the most important economic data release of the month; the consensus forecast for nonfarm payroll growth is 213,000.

Two stocks whose fortunes are normally dependent on the economy, government-sponsored enterprises Fannie Mae (NASDAQOTCBB:FNMA) and Freddie Mac (NASDAQOTCBB:FMCC), have become a playground for value-oriented hedge fund managers. The latest to enter the fray is the legendary Carl Icahn.

Fannie Mae headquarters, Washington, D.C. Source: Wikipedia.

Is the billionaire investor providing investors with a useful buy signal? Yesterday it emerged that Icahn bought $50 million worth of Fannie Mae and Freddie Mac common shares on March 11 -- the same day that Senators Tim Johnson and Mike Crapo announced a bill to do away with the companies in order to reshape the government's role in the housing market.

Icahn was acting opportunistically, as Fannie and Freddie shares respectively lost roughly a third and a quarter of their value on news of the bill. However, the Johnson-Crapo legislation is one of several plans for housing market reform that have been batted about Congress. Icahn bought his shares from another respected value manager and Fannie and Freddie's largest shareholder, Fairholme Funds. And Icahn and Fairholme are not alone among the elite of the hedge fund world to bet that Fannie and Freddie will not only survive, but begin returning capital to shareholders.

Others include the brash and media-friendly Bill Ackman of Pershing Square Capital Management and a superinvestor that no one has heard of but ought to be following anyway. On Monday,The Wall Street Journal profiled highly discreet hedge fund manager Abrams Capital Management. Led by David Abrams, the firm oversees $8 billion in assets with just three analysts. Since its inception in 1999, Abrams Capital's flagship fund has better than tripled the cumulative return in the S&P 500, despite employing no leverage and holding substantial amounts of cash at times (Abrams' cash allocation is currently roughly 40%). If that sounds like the modus operandi of the Baupost Group's Seth Klarman -- the greatest investor you've never heard of -- that might be because David Abrams was a Klarman protege at Baupost before striking out on his own.

I follow Carl Icahn because he's an outstanding investor. On Jan. 27, I suggested that, in rejecting Apple's fiscal first-quarter results, Wall Street was handing investors an opportunity to own the shares at an attractive price. I received confirmation of my instinct the next day when Icahn announced that he had bought an additional $500 million worth of shares, which closed at $506.50 that afternoon. So far, the stock market has vindicated the idea: Apple's stock closed at $637.54 yesterday.

Of course, Fannie Mae and Freddie Mac are a special situation that is completely different from Apple. Given the political uncertainty surrounding the organizations, which is very difficult to handicap, I can't label Fannie and Freddie anything other than a speculation. However, the concentration of smart investors suggests it may well be a speculation that offers an attractive risk-reward profile.

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Alex Dumortier, CFA has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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