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Why Fannie & Freddie May Be Hiding in Your Portfolio

Jeff Cox, |Special to CNBC.com
Thursday, 28 Aug 2008 | 2:16 PM ET

Check your portfolio: You may be invested in Fannie Mae and Freddie Mac and not even know it.

CNBC

While much attention is paid to the daily gyrations of Fannie and Freddie common stock, investors might not realize that the two government-sponsored mortgage giants are common components of mutual funds and company pension plans.

Large commercial banks own billions of dollars in the two companies' stock and debt because it ostensibly offers safety and helps shore up balance sheets as it can be counted as capital against other liabilities. Those same banks are part of funds that make up many 401(k) plans.

But unless you're savvy enough to check where the people who control your money are putting it, you won't know the extent of your exposure to Fannie and Freddie.

Now would be the time to find out. (To see which mutual funds are major holders of Fannie Mae shares, click here. For major holders of Freddie Mac, click here.)

Both companies have been the subject of rampant speculation that the government will take them over and virtually wipe out the value of common stock and perhaps even preferred shares. That has sent Fannie's and Freddie's stocks plunging 57 percent and 66 percent respectively in the past month alone.

While analysts have said fears over Fannie and Freddie may be overblown—Lehman Brothers is projecting that Fannie may not need to raise more capital—the companies are still expected to post steep per-share losses through the year, and the stocks themselves are widely considered unstable.

Despite the recent rebound in their shares, Fannie has lost 87 percent in value this year, while Freddie has dropped a whopping 92 percent.

"I'd be worried for the near term for anything that's not senior debt, especially common shares and preferred shares," says Martin Weiss, president of Weiss Research. "For the long term I'd just be worried, period."

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Still, "I wouldn't be in a panic," Weiss added. "I wouldn't be immediately concerned if my pension fund has avoided the stocks, but I would be starting to think about what I can do to protect myself from what happens in the future."

Video: Where to draw the line on bank bailouts.

The simplest approach for investors who don't want to risk what might happen down the road for Fannie and Freddie is to sell any common shares they hold.

But what if you own a mutual fund that is invested in the companies? Or what if your 401(k) plan is invested in a bank that holds Fannie or Freddie debt?

Then the answers are a bit more complicated.

"If it's a pension plan there's nothing they can do about it," says Julie Murphy Casserly, president of JMC Wealth Management in Chicago. "It's not the decision of the end user of the pension plan, it's the decision of whoever's monitoring how the pension plan is being managed at the corporate level."

However, Casserly says there are exceptions. Workers at companies with cash-balance pension plans, where users can move their money in and out of funds similar to a 401(k), have more flexibility.

For those who are locked into pension plans and cannot make the individual decision to get rid of exposure to Fannie and Freddie, Weiss advises hedging with exchange-traded funds that pay when stock indexes that measure large financial institutions fall.

"Hedging has its own risk, but if that's something you're willing to accept you can use an inverse ETF to hedge against additional declines in returns," Weiss says.

The ProShares Ultra Short Financials ETF is among the more common hedging instruments. The fund gains 2 percent for every 1 percent the Dow Jones US Financials index drops.

A number of big-name firms that handle 401(k) and company pension funds invest in Fannie and Freddie, Vanguard and Fidelity among them. Vanguard spokesman Amy Chain said the company has small stakes in Fannie and Freddie among a variety of its funds.

The good news, though, is that many fund managers already have bailed on Fannie and Freddie.

"If the pension fund guys are doing their job correctly, I don't think that's the kind of stock that should be in a pension plan," says Matthew Tuttle, president of Tuttle Wealth Management. "If I'm managing the plan, I have a fiduciary liability. I'm going to have some questions to answer as to why I'm still holding onto those stocks.

"I'm guessing they've been blown out of most of those plans."

As for mutual funds, the leading Fannie-Freddie holders are American Funds, Dodge & Cox and Fidelity. Those holding funds who worry they might have Fannie-Freddie exposure should contact their fund managers immediately.

In the meantime, about the only ones actually making money off the two stocks are traders with an appetite for risk, who are rapidly buying and dumping the stocks as trading vehicles with no long-term exposure.

"You could have some mutual funds that are actively trading it," Tuttle says. "If you're nimble you can make some money trading those stocks. But in a pension fund where they're not actively trading, I'd be pretty uncomfortable."

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