The Fairholme Fund

On her August 27, 2010 show, Wealthtrack, Consuelo Mack interviewed Bruce Berkowitz of the Fairholme Fund.  (Here is a link to the transcript and to the video.) We like Fairholme and have used the fund for our clients since we started Harvest (and have personally invested in the fund for much longer).  The fund and its managers have rewarded that decision, having a fantastic relative and absolute 10 year track record, so fantastic that Morningstar named Mr. Berkowitz its domestic stock fund manager of the decade. 

While we are comfortable with the people, the investment philosophy and the implementation of that philosophy, we are watching two developments with the fund.  First is size, not surprisingly Fairholme has attracted a lot of new investors, pushing the fund size to $15 billion.  Historically, as the size of a fund has increased, relative outperformance has declined. No less an investor than Warren Buffett made that same point.  He wrote in his latest Berkshire Hathaway shareholder’s letter (as he has previously):

The big minus is that our performance advantage has shrunk dramatically as our size has grown, an unpleasant trend that is certain to continue..But huge sums forge their own anchor and our future advantage, if any, will be a small fraction of our historical edge.

Mr. Berkowitz, in the interview, claims that the large size of his fund is an advantage and that it gives him an opportunity to make investments he could not have made in the past.

The second area we are watching is Fairholme’s large position in financials such as AIG, MBIA, Citigroup, CIT, Bank of America and Goldman Sachs.  According to the interview these stocks represent about 60% of the fund’s stock holdings.  (Fairholme has one third of the fund in cash and fixed income.)  Our issue with financials, particularly banks, is that it is difficult to know what the assets are really worth even after looking at the companies’ financial statements.  In the interview, Mr. Berkowitz discusses why he thinks financial stocks are good values with limited downside.

Now if any manager has earned the benefit of the doubt, it’s Bruce Berkowitz and his team at Fairholme.  And while we would not call ourselves doubters, we will be watching to see how the fund manages the size issue and how the large investment in financials plays out.

(Harvest Financial Partners holds this fund in some of its clients' portfolios. The principals of Harvest also own the Fairholme Fund. Holdings may change over time.)