Bruce R. Berkowitz, dubbed the ‘Mega-mind of Miami’ by Forbes, founded Fairholme Funds, a no-load, deep value-oriented and concentrated mutual fund, in December of 1999 in Short Hill, NJ. After six years, Mr. Berkowitz moved the offices to Miami. The intent was to get away from the noise of Wall Street (Short Hill was too close to avoid the distraction), with nicer weather to boot.
The initial outlay of 400 million dollars came from his clients whose money he was already managing in separate accounts at Salomon Smith Barney. As of March 2012, the flagship Fairholme Fund (along with two recent additions of Focused Income and Allocation Fund) has approximately 9 billion dollars in net assets.
Impressive as that is, Fairholme Funds had reached a high of 18 billion dollars in early 2011. Mr. Berkowitz’s top holding were in AIG, Bank of America, and Sears Holding. These stocks plunged 52%, 58% and 57% respectively. But being the contrarian he is, he cost-averaged down on all three of them. Many of the shareholders went for the exits and billions of dollars of redemptions occurred. All in all, by end of 2011, the fund had lost a painful 32% compared to a 3% gain the S&P 500 Index.
Unrelenting, Mr. Berkowitz reminded his shareholders that his deep value investment philosophy has worked in the long run. He was previously awarded the fund manager of the decade award by Morningstar and his fund was included in Kiplinger’s top 25 no-load mutual funds. The latter distinction was lost in 2011 amid shareholder departures. The motto of the fund — “Ignore the crowd” — was more needed now more than ever.
By 2012, the concentrated bet on financials paid off handsomely. Year to date through end of March, the fund posted a return of 31%, outperforming the S&P 500 by more than 15%. The superior performance came from the same stocks: AIG stock gaining 22%, Bank of America 77% and Sears 136%.
Mr. Berkowitz made special presentations to his shareholders to show how they got rewarded for staying the course (and that they should continue to stay the course) and to justify his holding of AIG and BAC. Below are some of the salient points as regards to his thoughts on value investment philosophy.
First of all, the long term performance spoke for itself — since inception now the fund had returned 11.08%, a cumulative return of 292.5%. In other words, a 10,000 dollars investment would have grown to over 39,000 dollars in their fund as opposed to a growth of about 12,000 dollars in the S&P 500 Index. Further, and this is a little tongue-in-cheek, he compares the record to his hero Warren Buffett, whom he did outperform in the stated period, but of course Mr. Buffett’s record goes much further and is indeed higher.
Second, to illustrate that he truly subscribes to the value motto of “Greedy when others are fearful, and fearful when others are greedy”, he presents an interesting chart that shows how his fund’s cash holdings are highest when the markets are up and vice-versa.
Third, and very to the point of the recent volatility of his fund, he insists that a true value investor does not confuse volatility and risk. Current volatility does not translate to long term risk — quite the contrary, current volatility can create reward. Risk, according to his value style, is the possibility of losing capital.
Fourth, in order to emphasize the psychological stance needed to outperform the markets in the long term, he quotes Seth Klarman: “Value…is not quite enough. Buying low is a start…but you need the patience, discipline and grit to buy lower and still lower if the opportunity presents itself, shutting out the extraneous noise coming from within the market and over the airwaves.”
Last, he quotes his own letter to investors from 2006: “Periods of volatility and stress sometimes allow what we buy cheap to become cheaper, creating unusual opportunity. Fairholme’s history includes many instances of short‐term ‘embarrassment’ leading to long‐term victory.” This point is especially relevant to the Fairholme Fund as it is very concentrated — their last holdings breakdown showed top ten positions composing 85% of equity.
Interestingly, he left Salomon Smith Barney because of the constraining oversight he was regularly subjected to by his bosses for running highly concentrated portfolios. (For example, in 1994 he was criticized for investing all his clients’ money in two stocks only — Berkshire Hathaway and the Fireman’s Fund Insurance Co.) To escape this constraint was part of the motivation for his establishing his own fund.
Back then he had been joined by two stock pickers — Larry Pitkowsky from Paine Webber and a value investor called Keith Trauner — to assist with idea generation. Both of them left the firm in 2008 to establish their own fund. In 2011, his co-manager Charles Fernandez (whom he would often refer to as his Charlie Munger) also exited the firm. Since the fund does not employ “analysts” per se (instead Mr. Berkowitz often gets domain experts as temporary consultants), it seems the performance of his fund and necessary value-conviction will have to come solely from him.
Prior to starting Fairholme Funds, Mr. Berkowitz started his financial career at Lehman Brothers where he worked till December 1993 and at Smith Barney Investment Advisers from December 1993 to October 1997, where he was a Managing Director of Smith Barney Inc. He received his Bachelor of Arts in Economics, cum laude, from the University of Massachusetts at Amherst.
“I have a trick I use: I put all of my family’s money into the fund.”
“You know what they say: first comes success, then comes death. It’s nice, but there’s nothing like success to breed failure.”
“At some price, a great business becomes a speculation.”
“At the end of the day, however, I know talk is cheap. You’ll know in three to five years whether I had anything interesting to say today.”
“Cash is like a financial valium, that you can keep your cool during very difficult times.”