While the average hedge fund was mired in the single-digits in 2013—the HFRX Global Hedge Fund Index stood at 6.72% for the year—Berkowitz's $200+ million Fairholme Partnership Fund was up 33% net of fees. Berkowitz launched the long-only hedge fund (which has a Caymans-based counterpart, the Fairholme Offshore Partners Fund) with $23 million of internal capital in January 2013 and opened it to outside capital in October.
Fred Fraenkel, president and chief research officer of Miami-based Fairholme Capital Management, said the idea of launching a hedge fund began to form three years ago:
“[W]e at Fairholme ran into the reality that Bruce's investment horizon [didn't] match up that well with the daily liquidity available in a mutual fund in 2011,” Fraenkel toldFINalternatives in a recent phone interview. “[T]hat was...the kind of year that a real deep-value... investor longs for, where he sees stressed companies, he's identified them, he wants to own their stocks.
“The world...believes that things are really bad and you, in performing your analysis on the companies, figure out that things are not bad, they're actually getting much better. Because what happens is, the prices go down a lot and you load up, and that's exactly what we wanted to do in 2011 but because of a bunch of circumstances—including that [Berkowitz] was named the Manager of the Decade for [domestic] equities in Morningstar for 2000-2010—he had huge inflows in front of that year, and then as soon as things started looking bad in the newspapers and on TV, we had dramatic outflows. So Bruce was confronted with not only not being able to buy more as the perceived crisis made stocks go down, he had to sell stocks off to meet the liquidity needs.”
The takeaway, said Fraenkel, was “that there was a divergence in the business plan and the investment plan.” What Fairholme needed, they decided, was investors who understood how good Berkowitz's long-term record was and were willing to wait with him “until they realize huge returns.”
Out of that realization came the Partnership. The fund has an unusual fee structure which Fraenkel said was designed to reward those investors willing to “wait with” Berkowitz.
“[W]e don't charge any management fee so we don't make anyone pay unless they make money and we receive a declining percentage of the profits that we take depending on how long they want to entrust their money with us,” said Fraenkel.
The hedge fund is designed to deliver “the same exact investment, process, strategy and hopefully results that Bruce has achieved for 25 years,” said Fraenkel, “which is deep-value investing where we do an enormous amount of work on a small number of names and buy them when they're exceedingly stressed and sell them when everybody wants them.”