A Fund Struggles and I Can’t Look Away

There are a fair number of reasonably well known investors that I keep my eye on even though I know that we won’t ever invest in their funds.  One of the most fascinating investors in my opinion is Bruce Berkowitz, manager of the Fairholme Fund (ticker: FAIRX).

Berkowitz caught my attention at an investment conference bank shortly after the 2008 financial crisis because he had a booth that was swarmed by financial advisors who wanted to invest with him.  The days of the celebrity manager had largely passed at that point, but no one had told the attendees at this conference who treated him like Tom Cruise or Brad Pitt (I know that there are hotter celebs these days, but I’m older now and don’t keep up anymore).

Investors were pouring money into his fund: in 2008, he was managing $7.2 billion, but by the end of 2010, assets under management had ballooned to $18.8 billion.  In 2010, Morningstar named Berkowitz the ‘Manager of the Decade,’ touting his 10-year returns through Dec 31, 2009 of 13.2 percent compared to the category average of 0.01 percent.

With this setup, I’ll bet that you can guess what happens next…

That’s right, just as soon as investors pile into the fund, Berkowitz has a disastrous year, losing -32.42 percent in 2011 when the S&P 500 gained 2.11 percent.  Berkowitz is a highly-concentrated value manager and he had around 40 percent of the Fairholme Fund in AIG, the insurer, which lost -46.13 percent that year.  Ouch.

As you might expect, Berkowitz was the worst performing fund in his category in 2011.  He rebounded in 2012 and 2013, landing in the 99th and 86th percentiles respectively and beating the S&P 500 handily.

His peer ranking is somewhat fascinating actually, because he always manages to be at the extreme ends of the group.  While he was in the 99th, 97th and 86th percentiles in 2012, 2016 and 2013 respectively, he found himself in the 1st and 3rd percentiles in 2014 and 2015.  Even though he’s been at the top of the heap, being at the bottom has cost him; for the five years ending Friday, Fairhome is in the bottom percentile in his category.

Famed investor Howard Marks of OakTree Capital (another manager that we don’t use worth watching) tells a story that basically says that if you can stay around the 55th or 60th percentile year in and year out, you’ll wind up in the 99th percentile over longer periods because so many managers blow themselves up at one point or another.  I’ve never seen any hard data to that effect, but the story makes sense to me.

When I checked in on Fairholme last night, I noticed that the fund’s assets under management are down to $2.7 billion.  That’s still a lot more than what we manage, so I’m not disparaging it, but it’s a big fall from $18.8 billion in 2010.

Morningstar calculates what they call the ‘investor returns’ for funds based on the asset flows in and out of the fund and performance of those funds over that period.  The idea is to see whether investors do a good job timing their additions and subtractions from funds.

I’ll be that you can guess what happened here too.  If you look at the past 10 years through February 28th, the total return for the fund was 6.25 percent.  That’s not so terrible – it’s less than the S&P 500 by -1.36 percent per year, but value in general hasn’t fared so well during that time.  It puts him in the 61st percentile among managers, which isn’t great, but it isn’t a disaster either.

His investors, though, didn’t do so well because they added money after the good years and pulled it out after the bad years.  Morningstar calculates that the fund investors, based on their bad performance chasing habits, only made 3.51 percent during that period – much worse than the S&P 500, the category and the fund itself.

How many investors bought the fund based on the track record and accolades from Morningstar and others?  How many understood the risks that he was taking?

Berkowitz hasn’t changed his stripes, which I actually admire.  I don’t think that it’s working for him exactly, but he continues to do what he thinks is right.  Even though I wouldn’t put a dime with him, I’ve said in the past that I admire him and stand by those statements (click here for the article).

I thought it was interesting to note that Morningstar has lost their faith in him and cut their qualitative and forward looking ranking on the fund to ‘Neutral’ in September of last year.  I’m not talking about their quantitative star-ranking, which simply looks at past risk-adjusted performance compared to peers, but their analyst rating, which is more of a recommendation than a report card.  (Incidentally, the star rating, or report card, gives Berkowitz just one star).

Morningstar isn’t necessarily wrong, although I can’t help thinking that they heaped praise on his style when it was working and then took it back when he went cold – he never changed.

That said, their analysis has a point in that clients are pulling money out of the fund still, and at this point he’s left with his least liquid assets.  The largest position in his fund is a Florida real estate company (St. Joe) and he owns almost a third of the outstanding shares.  Morningstar estimates that it would take him 100 days to get out of the position without impacting the price.

He has other huge positions in Fannie Mae and Freddie Mac preferred stock that would also take 100 days to exit according to Morningstar.

To complicate matters further, he also serves as the Chairman of the Board for the Florida real estate company and is on the board of directors at Sears, which is his fifth largest holding (not including some Sears bonds).

These positions may well work out for him, I have no idea.  You can bet I’ll be watching, but as I think I’ve made clear, I wouldn’t bet money on Berkowitz either.  We love value investing, but not in this concentrated format.  The diversified approach won’t land us or our funds at the top of the category, win the Manager of the Decade Award or flood the fund family booth at conferences.

Still, we think we’re in a much better position because we won’t find our funds at the bottom of the category either and investors should be able to stick with them through the tough times, which is probably the most important point of the story.