Diane Jaffee, John Osterweis and Ralph Shive share their insights on the market. By Elizabeth Leary, Contributing Editor July 3, 2008 If you think that financial stocks are starting to look enticingly cheap, think again. So say three fund managers who offered nuanced opinions on the sector, in addition to their top stock picks du jour, at the Morningstar Investment Conference, on June 26. Diane Jaffee doesn't like the financial sector as a whole but says mortgage giant Fannie Mae (symbol FNM) has been beaten down more than it deserves. She's been buying the stock for TCW Diversified Value (TGDVX) and TCW Dividend Focused (TGIGX), the two funds she manages that own shares of large companies. "It's a growing business today," she says of Fannie Mae. "They're actually making money and making and guaranteeing loans." Jaffee also manages a fund that buys smaller companies, TCW Relative Value Small Cap (TGONX). Each of Jaffee's funds has delivered better returns than the average similar fund over the past ten years through July 2, but each has also lagged substantially over the past three years. John Osterweis is hearing nothing but a bear's growl coming from banks. "In the modern era, banks originate and securitize loans and then sell them," he says. "We're going back to the old days of banks originating loans and keeping them on their books. The bank model is reverting to a less-profitable model." Advertisement Osterweis's eponymous Osterweis Fund (OSTFX) has delivered an impressive 11% annualized over the past ten years, beating the Standard and Poor's 500-stock index by an average of eight percentage points per year. Meanwhile, Ralph Shive, who manages 1st Source Monogram Income Equity (FMIEX), is worried about missing a "bottom" in financial stocks. But he's bullish, in general, on insurance companies, and he has been adding to the fund's stakes in Allstate Corp. (ALL) and Lincoln National (LNC). Shive's fund has gained 9.3% annualized over the past ten years. All three managers look for cheap stocks to buy, but each takes a different tack on how to find them. Shive targets out-of-favor industries and particularly likes companies that pay dividends. Osterweis searches for temporarily troubled companies that have smart managers and a near-term catalyst to jump-start profit growth. Similarly, Jaffee goes for companies with catalysts, but stocks must look cheap on at least one of five different metrics, such as price-earnings ratio or price-to-book ratio (essentially share price divided by assets minus liabilities), to make it into one of her funds. She says her top pick at the moment is Arena Pharmaceuticals (ARNA). She likes the company's pipeline for obesity and hypertension drugs, and "the founder has never sold a single share," she says. Advertisement Osterweis is bullish on Prudential Financial (PRU), which at $61.66 on July 2 is down 40% from its 52-week high. "People have been worried about the asset side of the balance sheet, but we think they've scrubbed it pretty well," he says. The company is seeing tremendous growth in Japan, Korea and Taiwan, he says, and he expects the stock in the near term to deliver about a 10%-per-year return. And Shive says he's a fan of stalwart General Electric (GE) at its current price. "The company's financial segment is a wild card," he says. "But everyone seems not to like them right now, and that's when I try to buy companies."