It was no coincidence that we interviewed Bruce Berkowitz two weeks ago. The Fairholme Fund, which he manages, has been on my radar screen for the last few months. The fund is ranked by Lipper Analytical as one of their leaders over the last 3-and 5 year periods. In 2009, I noticed it was up over 41.48%, according to the company’s latest performance numbers on their website. Last year, although it was down 29%, the fund still managed to out perform its benchmark by 7%. Just this week, Morningstar, the premier mutual fund rating company, named Berkowitz the top U.S. mutual fund manager of the year. It couldn’t have happened to a smarter guy.
Berkowitz and his staff work hard and they invest right along side their shareholders.
“We eat our own cooking,” Berkowitz said from his offices in Miami, Florida. “I have every bit of my long-term investment money in the fund and I feel it’s important that everyone that works on the fund are shareholders as well.”
That philosophy has proved to be a winning concept. The Fairholme team has generated roughly 13% annualized returns since its inception in December of 1999, according to the Fairholme Capital Management literature, which means it is up 236% compare to a 1.1% loss for the S&P 500 Index during the same time period.
How, I asked, are they different from their competition?
“Our tagline here is to ignore the crowd. We run toward while the crowd is running away from something,” he explained, “and we always keep a lot of cash on hand, about 15% on average.”
That cash (which can be more or less than their long-term average depending on the markets) came in handy last year and allowed Berkowitz to take advantage of what he calls”stresses in the system.”
“It’s amazing how ‘once in a hundred year’ storms seem to occur every few years,” he chuckles.
Fairholme is a value fund which will invest in any security, regardless of market cap, in any sector or asset class.
“A dollar doesn’t know how it was earned,” he says “we will go up and down any given company’s capital structure as long as it holds value. Senior secured or unsecured debt, preferred shares, it’s all fair game, although we are primarily focused on equity, if bonds are giving equity-like returns plus safety, we’ll go there, too.”
He uses the health care sector as a case in point.
“The perception versus reality of the health care bill is that the administration and congress will destroy the health care system, causing pricing to fall off a cliff.”
His work says the opposite. “They can’t kill it,” he argues.
So he has invested heavily in the health care sector including Pfizer, which is his top holding.
Berkowitz’s style is to make big bets on companies while investing for the long term. It is a similar approach to Don Yacktman, of the Yacktman Funds, (see “Don Yacktman, a Manager for all markets”) who also happens to be one of the leading contenders for Morningstar’s fund manager of the decade, along with Berkowitz.
The Fairholme portfolio tends to hold 15 to 25 securities on average and his top five or six holdings often represent over half of the portfolio’s value historically.
“If you count cash in there,” he says,” it’s more like two thirds of the portfolio.”
What’s his thinking behind making such concentrated bets?
“Why should I buy my 20th best idea when I can put more money in my first or third best idea? Besides, how many companies can you realistically expect to follow? From my math days at the University of Massachusetts at Amherst, I remember one central tenant: when you own 30-40 securities you are approaching infinity and that will give you, at best, mediocre performance.”
Readers will be happy to know that Berkowitz disdains front and back end loads or any other kind of fee or kickback. He charges a flat 1% (see my column “It’s No Load or No Thanks” for more on these unethical charges).
“We’re trying to be like the private partnerships you read about that charge the investor 1/20—one percent management fee and 20% of the profits. We’re trying to be a 1/20 partnership without the 20.”
As for being selected as Morningstar’s fund manager of the year, he is honored, humbled and gives all the credit to his shareholders.
“Our shareholders number close to 300,000 now and they stayed with us during the tough times. Without them, a smart, long-term oriented shareholder base, we couldn’t do what we do.”
This year investors will also be offered an income version of the Fairholme Fund called the Fairholme Focused Income Fund (symbol FOCIX).
“In analyzing so many companies’ capital structures we’ve come upon some great opportunities in the fixed income areas. We will focus on these ideas in the new fund.”
So what are his forecasts for 2010?
“I don’t have the slightest idea. My predictions plus $2 might get me a cup of coffee somewhere. At Fairholme, we tend not to predict but to take advantage of stresses as they develop. That takes patience.”
He does believe there will definitely be further opportunities as the financial system continues to de-leverage and as interest rates go up.
“Companies are going to need money. Mistakes are going to be made. In the fixed income market, there will be great opportunities to protect existing wealth as well. One thing is for sure. There will always be another opportunity just around the corner if you have the patience and the cash to take advantage of it.”