Bruce Berkowitz's 2012 Letter for the Fairholme Fund
January 29, 2013
To the Shareholders and the Directors of The Fairholme Fund (FAIRX):
The Fairholme Fund (the "Fund") gained 35.81% versus 16.00% for the S&P 500 Index (the "S&P 500") in 2012. The following table compares the Fund's performance (after expenses) with that of the S&P 500 with dividends and distributions reinvested for the period ended December 31, 2012:
A $10.00 investment in the Fund at its inception has grown to $40.65 (after expenses and assuming reinvestment of distributions) compared to $12.44 for the S&P 500. The difference between those returns on a $10.00 investment, more than anything, demonstrates how the Fund has outperformed the market (as represented by the S&P 500) over the long run. This difference is graphed below.
The Fund's average rolling 5-year return was 71.22% versus 16.01% for the S&P 500. The Fund has outperformed the S&P 500 in 94 of 97 5-year periods, calculated after each month end. The Fund's worst 5-year period return was (6.89)% versus (29.05)% for the S&P 500. In its best 5-year period, the Fund's return was 163.08% versus the S&P 500's best return of 105.13%.
To recite an old Merrill Lynch advertisement, "We're bullish on America." Our companies are capable of generating reasonable returns on equity and the companies sell for significantly less than our estimate of current equity values. In each case, earnings potential continues to be obfuscated by costs to fix past problems. Company equity values within the Fund were up 32% last year, but related market prices remain far below.
We had a great 2012, after a horrible 2011, and expect the Fund to reach new highs in the not too distant future. The U.S. is in its fourth year of recovery, housing prices are increasing but have yet to reach replacement values, unemployment is starting to decline, and interest rates remain at record lows. Our holdings are cheap relative to underlying equity values – as cheap as in the beginning of 2012. The Fund is highly focused on 5 companies representing nearly 80% of its net assets, with the knowledge that it is better to own more of your best ideas than your 10th best. Today, cash and equivalents stand at $1.49 billion, about 19.7% of the Fund. Given current liquidity and the potential for performance dilution to shareholders, the Fund has determined to suspend the sale of shares to new investors after the last day of this February. The Fund will remain available for purchase to existing shareholders, may make exceptions to this suspension, and reserves the right to recommence sales to new investors in the future.
Fred Fraenkel and I now oversee risk analysis on a day-to-day basis utilizing a multi-path, independent process. For those who do not know Fred, we first worked together in 1990 at Lehman Brothers when he led 110 analysts around the globe to the #1 rank and where a younger portfolio manager used him to critique work on the resurgence of financials after the commercial real estate collapse of that time. Two decades later, it's déjà vu all over again.
Onwards and upwards,
Bruce R. Berkowitz
Fairholme Capital Management
The Portfolio Manager's Report is not part of The Fairholme Fund's Annual Report due to forward-looking statements that, by their nature, cannot be attested to, as required by regulation. The Portfolio Manager's Report is based on calendar year performance. A more formal Management Discussion and Analysis is included in the Annual Report. Opinions of the Portfolio Manager are intended as such, and not as statements of fact requiring attestation. All references to portfolio investments of The Fairholme Fund are as of the latest public filing of The Fairholme Fund with respect to such holdings at the time of publication, unless specified.