Bruce Berkowitz Annual Letter for the Fairholme Focused Income Fund
January 29, 2013
To The Shareholders and Directors of The Fairholme Focused Income Fund:
The Fairholme Focused Income Fund (the "Fund") increased 5.19% versus 4.22% for the Barclays Capital US Aggregate Bond Index (the "Barclays Bond Index"), for the one-year period ended December 31, 2012. Since inception, the Fund increased 16.08% versus 19.74% for the Barclays Bond Index. The following table compares the Fund's unaudited performance (after expenses) with that of the Barclays Bond Index with dividends and distributions reinvested for the period ended December 31, 2012:
While the Fund did outperform the Barclays Bond Index last year, it has yet to surpass the Index's returns since inception three years ago. We expect 2013 to be a watershed year given our current focus on the debt of two companies, MBIA (MBI) and Sears (SHLD), which comprise 55.1% of the Fund's assets. MBIA parent company debt is 33.9% of the Fund. Sears Holdings debt represents 16.7% and the surplus notes of MBIA's subsidiary comprise 4.5%. Cash and T-Bills aggregate to 39.6%. Today, the portfolio has a current yield of 4.5%, a yield to maturity of 5.7%, duration of 3.3 years, and is positioned for the eventual rise of interest rates as the U.S. economy enters its fourth year of recovery. The Fund's 30-day SEC yield was 7.73% as of December 31, 2012.
We expect MBIA's lawsuits against Bank of America and its division Countrywide over representations and warranties on mortgages insured by MBIA to settle. A positive result should lift MBIA bonds. A negative result appears to be priced in to today's marketplace. We believe that Sears will continue to pay all scheduled interest and principal on its debt obligations. If all bonds were to trade to par, the Fund's NAV would be much higher even with 39.6% cash and equivalents — a "barbell" strategy.
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.
Bruce R. Berkowitz
Fairholme Capital Management
The Portfolio Manager's Report is not part of The Fairholme Focused Income 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 and precedes a more formal Management Discussion and Analysis. 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 Focused Income Fund are as of the latest public filing of The Fairholme Focused Income Fund with respect to such holdings at the time of publication, unless specified.