Bruce Berkowitz founded Fairholme Capital Management at the end of the last century, a firm from which he manages several investment funds. The Fairholme Fund (Pattern Dog Cartoon Comfort Hoodie Casual Color Block Loose Fashion 1qxwBITRw) has the longest track-record and is undoubtedly his flagship.
It is a non-hedge fund that invests in both stocks and bonds and, given its status as a 'non-diversified fund', does not have to meet normal diversification requirements. This is clearly stated by the fund's disclaimer, which "does not seek to diversify its investments". Thus, its main position can perfectly reach 30% of the portfolio. In some periods, it has even reached 50% (Skirt Casual Boutique Boutique Skirt Casual Casual Casual Casual Boutique Boutique Skirt Boutique Skirt Skirt Casual Boutique tCqxn7A1, for example). This high concentration is one of its most remarkable features. Another of its distinguishing features is that it usually holds very high levels of cash and cash equivalents.
Although he is very well-known in the industry, many may not know him. Probably because he's not at his peak, far from it actually. As with all truly active managers (those who separate themselves from the indices), temporary spells of bad luck are part of the game. Howard Marks says that to achieve extraordinary results, you have to get out of the ordinary, out of the average. Fairholme Capital Management is clear about this, since one of its premises, and the phrase that appears under the name of the firm, is: "Ignore the crowd". That's one of the reasons he moved his headquarters to Florida from Wall Street.
While this may sound very nice, in practice it implies things that are not so nice or easy to handle for the average investor: it means that there are bad or even horrible periods, when returns are much worse than those of the neighbor's low-cost ETF. In those moments, and even though the manager has a great track record behind him, doubts about his ability to recover will appear. There are many cases in the last few decades that fit this description, but it is David Einhorn who is perhaps the most notorious one today.
Berkowitz was chosen in 2010 as Morningstar's manager of the decade. These kinds of awards speak highly of the past, but are often a bad omen for the future. Past performance does not guarantee future performance. But past extraordinary returns often do "predict" mediocre future returns. As in the case of Fairholme. At the end of 2010, the Fairholme fund managed a whopping $17 billion, it even reached $20 billion at some point. Fortune described him as "arguably the top mutual fund manager on the planet". The money kept flowing into the fund.
Morningstar's award was given for an average annual return of 13.2% in the 2000s, well above the 0% average for the Morningstar category and the S&P 500. Remember, that decade comprised two major bear markets.
Source: Fortune, December 2010.
But in the last 5 and 10 years, the opposite has happened, losing part of the enormous outperformance. Thus, the S&P 500 including dividends had an annualized return of 13.4% and 10.2% at 5 and 10 years, respectively, compared to the poor 1.9% and 4.2% of the Fairholme Fund. Not even in the last 15 years has Berkowitz done any better than the index. Today, the fund's assets under management have fallen to $1.4 billion.
But even so, the fund since its inception on December 29, 1999 has beaten its benchmark by a wide margin: 9.2% vs. 5.4% of the S&P 500 in annualized terms. Little consolation for those investors who bought the fund in 2010 and would have fared much better if they had invested in almost any index fund.
All this data can be seen in the following chart:
We can observe that it had a much better performance in the bursting of the dotcom bubble and took advantage of the bullish market that accompanied the next bubble, the real estate and credit bubble. Although it fell 24% in the last quarter of 2008 (leading the Wall Street Journal to wonder if it had lost its "touch", despite falling only 2 points more than the S&P 500!), in 2009 and 2010, it recovered all that it had lost, and then some due to having bought banks and insurance companies at panic buying prices. While, it took the index longer to surpass the previous maximum again.
This was its portfolio at November 30, 2008, where Pfizer's (NYSE:PFE) position of 19% and the pharmaceutical and healthcare sector stood out, with very little exposure to the financial sector.J Promotion Crew Promotion J J Crew Crew Promotion Promotion xIwA5S
Data as of 30 November 2008. Source: Fairholme Fund annual report, 2008.
His bet on the financial sector after the 2008 collapse was very significant. By the end of 2010, his fund was the largest shareholder of AIG (NYSE:AIG) only after the US government. Unlike Bill Miller, who "ate" the whole crash for not seeing that the initial subprime problems were going to turn into a systemic financial crisis, Berkowitz's movement had almost immediate results. During 2008 and 2009, he did a lot of deep research on the financial sector: he read congressional testimonies from Wall Street executives, followed closely the balance sheets of the banks and Fed loan data, and became familiar with the complex framework of policies that were implemented at that time, such as the Troubled Asset Relief Program (TARP).
As we can see below, by mid-2010, he had already made a large part of its acquisitions in the financial sector. In fact, in the six months prior to the May 2010 close, Berkowitz initiated his stock positions in the following financial companies: AIG, Bank of America (NYSE:Boutique Raisins Top Swimsuit Raisins Top Swimsuit Boutique Raisins Boutique wBgwa6), Goldman Sachs (NYSE:GS), MBIA (NYSE:MBI), CIT Group (NYSE:CIT) and Morgan Stanley (NYSE:MS); he also purchased AIG preferred and corporate bonds. He had bought Berkshire Hathaway (NYSE:BRK.A) (NYSE:BRK.B) and Citigroup (NYSE:C) in 2009.
Data as of 31 May 2010. Source: Fairholme Fund semi-annual report, 2010.
Virtually every one of them had just plummeted from the Big Crash. We can illustrate this with his first position at that time, General Growth Properties (a Real Estate Investment Trust, or REIT, specializing in shopping centers).
Source: Yahoo Finance.
However, this strong bet on the financial sector caused an important underperformance in 2011. This time he did accompany Bill Miller in his bad times. In the 12 months prior to the end of November, Fairholme Fund fell by 22% compared to an almost 8% rise in the S&P 500. This is what its portfolio looked like at the end of 2011:
Data as of 30 November 2011. Source: Fairholme Fund annual report, 2011..
But Berkowitz's fund, along with the financial sector in general and AIG in particular, re-emerged and the fund took up again the great returns it had reaped some time ago.
But only until 2014. Since then, its performance has been lackluster: in the last 4 years, Fairholme has lost 15% while the S&P 500 is up 44%.
It is worth noting the sharp fall in the fund from October 2015 to early 2016, a period of upheaval for commodities and some emerging economies, which particularly affected European stock markets. It was also turbulent for Fairholme, which at the time had a high exposure to:
- The Mortgage Finance companies Fannie Mae (OTCQB:FNMA) (Federal National Mortgage Association) and Freddie Mac (Pullover Boutique Boutique Boutique Pullover Glory Faded Faded Sweater Sweater Glory OqwTP7wI) (Federal Home Loan Mortgage Corp.) were 15% of the portfolio.
- The Retail sector with Sears Holdings (NASDAQ:SHLD) (more on this below) leading the way with more than 10% of the fund in the company.
- The multi-line insurer AIG, which still ranked first with almost 12% of the fund. This was to change later, as its weight was reduced to less than 3% by mid-2016.
- The St. Joe (NYSE:JOE) (9.7%), a firm we will discuss later, which belongs to the real estate management and development sector. It suffered a big fall in this period, after having risen sharply months ago. Holding Horses Promotion Holding Promotion Horses Promotion Promotion Holding Promotion Horses Holding Horses Horses Holding W776qfYa
- The commodities sector accounted for around 13%, divided into several sub-sectors (oil and gas, metals) and including both stocks and bonds of companies.Fairholme Fund annual report, 2015.
The fund was once again able to recover outstandingly from the lows of February 2016. Berkowitz bought more from the positions he had the highest conviction at lower prices, benefitting from market volatility. But the last year and a half has been pretty bad.
It can also be observed the very high volatility in the performance of the fund, which is not surprising given the heavy concentration of the portfolio in a few securities. To understand the underperformance of recent years, therefore, it is essential to know the evolution of the following companies: The St. Joe Co., Fannie Mae (OTCQB:FNMAS) and Freddie Mac (OTCQB:FMCKJ) preferred stocks, Sears Holdings and Imperial Metals (III.TO) (OTCPK:IPMLF). These have been consistently Fairholme Fund's main positions in recent years, as shown in the following tables:
Source: Fairholme Fund's annual and semi-annual reports.
In the following chart, we can see the performance of these stocks in the last two years and a half:
The case of retail company Sears Holdings has been one of his biggest mistakes in his career, a poster child of the difficulties in retail. Berkowitz was also a director in the company, leaving towards the end of last year. It had been one of his top positions since at least 2009. By the end of that year, it was his biggest bet, with 10.6% of the fund in it. Years later, it continued to maintain a similar weight, although in recent quarters, it has been decreasing as the fall in value has accelerated and his conviction has waned.
His thesis was based on the value of Sears' properties, something he didn't make much of a mistake about, "I did not foresee the operating losses that have significantly reduced values... missing the company's inability to stop retailing losses, has been hugely frustrating and fatiguing for me to watch," he acknowledged. In his latest report, however, he writes that Sears' stocks are priced for doom, which he expects will not occur with additional asset sales and cost cutting.
He maintains another major stake in Fannie and Freddie, which he has held for several years. These have been the best performers as seen in the graph above, but they have also disappointed since 2017. He remains convinced that their value is much higher than the price at which they are traded ("about a quarter of their intrinsic value"), and expects regulatory changes to act as a catalyst. On these two companies, he wrote in a previous report that they "are two of the best businesses ever owned by the Funds. Think of these two mortgage insurers as public utilities, just like your local electric company" This is a thesis shared by Bill Ackman of Pershing Square.
Imperial Metals, a mining company, has also reported big losses to Fairholme since 2017. He owns both stocks and bonds. Berkowitz commented that "the securities of Imperial are backed by substantial asset value, notably the copper and gold deposits at the Red Chris mine in northern British Columbia." He believes that the mine's resource depths could make it "a multi-generational asset". He is also positive on copper fundamentals, the raw material that the firm produces by far the largest proportion as of now.
Finally, we have The St. Joe Co., a company that represents about 30% of the fund. It is a real estate development, asset management and operating company with assets in Florida (where Berkowitz resides). This has also been a long-standing position of Berkowitz with weights that have varied substantially. Already at the end of 2008, it accounted for about 4% of the fund. It was the subject of a public discussion with David Einhorn in 2010, who at the time was short and the manager of Fairholme was a major investor in the company, trying to turn it around. As reflected in the price chart, this is another position that has not worked out very well... at least yet.
In this regard, Fairholme's most recent letter states that "entitled land, resort assets, commercial properties, and ample cash pile are presently priced below a reasonable estimate of intrinsic value". This undervaluation is all the more remarkable for Berkowitz in view of the fact that they are "more focused than ever on increasing shareholder value in the coming years through expanding its portfolio of income producing assets," which is why the company has repurchased nearly a third of its outstanding shares in recent years.
While at the peak of his career (2010, for example) we could have blamed the fund's poor performance on the huge volume of assets under management (it accumulated some $20 billion), the current situation has nothing to do with that. Rather, his big bets are not going as well as he expected, at least not yet. Nothing prevents Fairholme Fund's top positions to surge in the coming quarters, silencing many of the most critical voices against him.
Unlike other managers who maintain a diversified portfolio with at least 25 securities, this is a different case. Only one issuer can weigh almost 30%, as is the case with St. Joe's today. Its performance may be very uncorrelated to stock market indices, especially when Berkowitz claims to "strongly prefer to focus on the unpopular, underpriced, and underweighted." The risks of portfolio concentration increase when things go wrong. In his view, concentration results in a "strategic advantage" for his fund, but at the same time he warns that in the short term it may give poor results.
It seems clear that time has shown that his bet on Sears Holdings has been a mistake, no matter how much it may go up from now on. An example that shows that no matter how convinced a brilliant manager is about a position, it is human and can be wrong... something that can be a lesson to us today. But in other of his other big bets, it's not so clear. Will Berkowitz be back up again showing strong returns, as he did on previous occasions?
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