Costly mistakes

How did the smart money lose its marbles?

Many of the market's savviest investors made some very dumb, expensive decisions about the falling knives of the financial stock market over the summer. From the legends to the merely brilliant, those investors ponied up billions to buy shares that looked cheap, but ended up taking serious turns for the worse.

Start with the legendary George Soros, who piled into Lehman Brothers Holdings Inc. stock during the second quarter. Lehman shares had plunged 44 percent over the previous three months and looked cheap by the spring. Soros bought 9.5 million shares when Lehman's price averaged $37.42 per share. Now the investment banking firm is desperately scrambling for a buyer and its stock closed yesterday at $4.22.

What about David Bonderman and Jim Coulter? They became famous 20 years ago by helping billionaire Robert Bass acquire the biggest savings and loan failure of the time and turn it around for mega profits. Bonderman, Coulter, and their private equity investment firm TPG went back to the same playbook this spring, joining others in a $7 billion investment package at Washington Mutual Inc.

The nation's largest savings and loan must have looked cheap at the time. Washington Mutual shares had traded above $38 just last September and the new investment was priced at just $8.75 per share. This week, Washington Mutual fired its chief executive amid growing loan losses that could eventually hit $19 billion. Its shares bottomed this week at $2.32.

Next up: Bill Miller. The mutual fund manager of Legg Mason Value Trust doesn't have many friends anymore. A near career-long record of beating the market every year fell by the wayside when his fund started losing to the Standard & Poor's 500 index in 2006.

Miller is no stranger to bold bets, and he made a big one on Freddie Mac. He kept buying through the summer as trouble mounted. Miller held 89 million shares by the end of July. Freddie stock, worth $8.17 per share on July 31, closed yesterday at 59 cents. Miller's flagship fund is down 32 percent this year.

And which investment firm made the most bad calls? Boston's Wellington Management, by a mile.

Wellington appears prominently on lists of the largest buyers of Fannie, Freddie, Washington Mutual, and Lehman during the second quarter, when prices looked plump compared to today's meager values.

Wellington was the single biggest buyer of Freddie Mac in the quarter, adding 10 million shares. It was among the most aggressive buyers of Lehman - more than 19 million shares. It ranked fourth among buyers of Washington Mutual stock, piling up 39 million more shares. It nearly doubled a large stake in Fannie Mae.

Exactly who made those calls and which investors took the hits are not clear. Wellington, a giant firm that manages over $550 billion, invests money for many Vanguard mutual funds and financial products offered by other companies such as the Hartford Financial Services Group. It also operates hedge funds for big-money clients.

As usual, a Wellington spokeswoman declined to comment. But the $48 billion Vanguard Wellington mutual fund, the largest Vanguard fund managed by Wellington, added 3.5 million Lehman shares and 4.7 million shares of Freddie Mac to its portfolio earlier this year, according to routine records filed by the fund. Both were relatively small parts of a giant portfolio that has outperformed the stock market this year.

Stock holdings can change quickly and public records only provide a snapshot that dates back to midsummer. Investors from George Soros to a Wellington hedge fund manager could have sold big chunks of stock since, but generally speaking those stocks have declined since their purchases.

Vanguard is known principally as a value-oriented firm, and that is probably why it jumped into the troubled financial stocks with both feet.

Stocks that lose big chunks of their value, especially those of long-established institutions, often appeal to value investors who prefer investment bargains over fast-growing companies. But those opportunities can turn into value traps, attracting investors who get burned by new troubles.

Other famous value-oriented firms, such as Dodge & Cox, also got snared. Financial companies like Lehman and Fannie Mae require the confidence of the market to operate successfully. That was the one thing value investors misjudged most.

It's hard to separate bargains from the merely cheap when well-known stocks fall hard. That's one big reason why smart money can end up in dumb places.

Steven Syre is a Globe columnist. He can be reached at syre@globe.com.