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Bruce Berkowitz about his outlook for the economy, stock selection criteria, portfolio construction

January 19, 2008

Listen in as investor news editors talk to Mr. Berkowitz about his outlook for the economy, stock selection criteria, portfolio construction formula, favorite stocks and more. Bruce Berkowitz is president of Fairholme Capital Management LLC and manager of the $4.6 billion Fairholme Fund. He has recently been named a contender to win the Morningstar Mutual Fund Manager of the Year award in the Domestic-Stock Manager category.

Rating: 4.1/5 (33 votes)


Texalope - 9 years ago    Report SPAM
Why do you think he agreed to be interviewed? What a horrible attitude. Really arrogant and self centered. I don't care how much he's made. I'd never invest money with this guy
Eddie - 9 years ago    Report SPAM
Don't blast him for being like that, he is extremely intelligent and was nice enough to enlighten us with the general philosophies of what makes a good value investor. We should be thankful for that.
Munger - 9 years ago    Report SPAM
Disagree. Not everyone has Buffet's jovial way about them. I think it is:

a) just the way he talks

b) the person conducting the interview asking redundant questions, not doing his research prior to the call and not knowing much about finance

c) b/c of b) it probably lasted way too long. his approach is simple and he explained what he looks for in the first 5 minutes of the interview.
Alanb9 premium member - 9 years ago
Totally agree with the last 2 posts by munger and ravinsu. I don't think he displayed arrogance at all. Self confidence, absolutely.
Eric McGough
Eric McGough - 9 years ago    Report SPAM
texalope> Really arrogant and self centered

North East accent (New Jersey?) is always harsh on my ears. I even grew up in the North East and it still hurts my ears. I wonder if the accent is contributing to your feelings in a negative way?

If I simply read everything Bruce said (thus eliminating the accent), I would agree with just about everything he said.

Given his public investment record, he not only talks the talk, but walks the walks (value style!)

If anything, I think he was either annoyed (just a little) or was laughing internally about the interview questions about the macro economy and the future.

When the interviewer tried to poll the public audience to find their opinion on where the stock market would be in 2008 I had to laugh. Worthless information!

Arrogant for not giving current stock picks? No way, WEB is not going to do that either. They are too big. Their investments can temporarily increase the market price of a stock when they start investing. When you are a buy and hold value investor trying to take acquire a large long-term position at a fair-price you don't want the stock price to raise as you are buying (just because you are buying).

Bottom line: I give Bruce a big thumbs up!

Crafool premium member - 9 years ago
I thought the interview was great. The reason it came off as odd was it was clear that the interviewers had not a clue of true investing. Bruce described "true Graham and Dodd", Charlie Munger and Warren Buffett value investing to a tee. These interviewers just did not have a clue.

He could have helped them by saying something like this:

"We will continue to ignore political and economic forecasts which are expensive distractions for many investors and businessmen. Thirty years ago, no could have foreseen the huge expansion of the Vietnam War, wage and price controls, two oil shocks, the resignation of a president, the dissolution of the Soviet Union, a one-day drop in the Dow of 508 points or a Treasury Bill yields fluctuating between 2.8% and 17.4%.

but surprise--none of these blockbuster events ever made the slightest dent in Ben Graham's investment principles...Fear is the foe of the faddist, but the frined of the fundamentalist.

A different set of major shocks is sure to occur in the next 30 years. We will neither try to predict these nor profit from them." Warren Buffett and Lawrence Cunningham, Essays of Warren Buffett.

He did say something like: "Diversification is insurance against ignorance. Why put money in your tenth best idea and not your first or second". This is commonly said by Buffett and especially Munger.

If anyone was rude, it was Investment News in my opinion for obviously have two interviewers who based upon their redundant questions regarding leverage and short selling have not one iota of knowledge or understanding of the true value style of investment. These guys you can almost hear in the back of your mind are the ones that yell in the back ground at Jim Cramer events 'Hell, yah. Boo Yah Your the man Jimmy Boy."

What is valuable is you could see that most investors as Buffett has said, demonstrated, and written about just don't get value investing or should I say as most of us know "Business Investing" versus speculating.

Bruce was nice and did tell them where he was looking more than once. He looks at "stressed out areas". If anybody can't figure out what the stressed out areas are in this market, then run and definitely invest with Bruce.

As far as a stock pick, no he didn't give one directly, but if you listen closely you could speculate that Wells Fargo just maybe in his cross hairs.

I thought he was great. Someday people will understand that systemic risks are far more dangerous that firm specific risk.

Go Bruce!!!

Buffetteer17 premium member - 9 years ago
A confession and a new year's resolution.

I've been a fan of leverage, mostly margin debt, but also some use of LEAPs versus stock, as I've stated before several times in this forum. Lately, I've let my amount of margin debt run up to about 35% of The Portfolio. This happened incrementally and somewhat unconsciously, as I was averaging down on what I considered (and still consider) great bargains. The consequences have been disasterous to my returns. The Portfolio as of 1/18/08 is sitting at a total return since inception of 6%. Just three months ago, it was at 30%. Without the leverage of margin debt, the return still would have been down precipitously, perhaps to 10-12% (I haven't done the calculation).

There are various rationalizations I could make. For example, the 6% mentioned above is return on assets, but my return on equity is around 9% (that is to say, return on stocks owned less margin debt owed). I could point out that had I invested the same funds at the same times in the S&P 500 index, my return would have been minus 6%. I could note that many of my positions have a much larger margin of safety than ever before, due to currently depressed stock prices. My portfolio total return is almost sure to bounce back significantly as the current market mess sorts itself out.

All these things are true but that doesn't change the fact that I've lost a friggin 24% of my portfolio return in the past 3 months. That is a staggering blow. And stupid. Don't cry for me, learn from my mistakes. I can still retire comfortably later this year, but it looks like Porsche Carrera 4S will morph into a used Volvo station wagon, the $100/bottle wines I like are down the drain, and the $80K hi-fi speakers I've had my eye on will have to wait.

So I was keenly interested in the Berkowitz interview, particularly his stress on keeping a cash reserve. Because I have no cash reserve, and I have a cap gains tax bill coming due on April 15 for a 6 digit sum, I've actually sold off my 4.5% position in WMT, and 2% of my 10% position in JNJ, simply to make sure I can survive a possible further market crash. Had I a cash reserve, I could have bought more of these.

From the Berkowitz interview:

Q. What about leverage, and derivatives, and all those other kinds of tools?

A. No, thank you. First of all, we may be precluded from using that. And we are in the mutual fund. In general, it's not necessary. I think with keeping a pile of cash, buying good companies, run by good people, generating huge amounts of cash, buying it at the right price, is all you need. And you only need a few of those in a lifetime to do extremely well. We see no reason to play Russian Roulette.

That's where I want and intend to be. Lots of cash in reserve, zero margin debt. I still will make judicious and light use of LEAPs, as they've served me well to date. I can't simply sell enough stocks to pay of the margin debt next Tuesday, because I'd be selling things that are worth 2x what they're priced at in this market. I will start liquidating my S&P 500 index puts, but will keep enough of them to insure against disaster (which for me, is not having enough money to retire on in my portfolio). As my positions begin to cross over the 80% of fair value line, I'll start selling down until I have about 20% in cash. I'll stay that way until a future really big opportunity gives me motivation to go 0% cash. There's really no reason for me to play Russian Roulette with margin debt any more.

Crafool premium member - 9 years ago
Leverage or margin debt rather goes against the base principal of a true value investor ("Business investor"). I say this based upon my interpretation of what Benjamin Graham described an investor to be versus a speculator. It went something like this " an investor makes an investment after thoroughly researching the business and after being afford a margin of safety the investment provides an adequate return". He goes on that this type of investing is possible because of Mr. Market's "manic depressive swings", and that he ("Mr. Market") could be taken advantage of during his depressed states.

By following and implementing the patience and discipline of value investing in order to hit those fat pitches as mr. Market famously serves up during markets in fear of possible recessions and in recession it seems self-defeating to allow Mr. market to have a hand in you portfolio decision making by having you portfolio on margin.

Buffett I believe does not recommend margin. He has said something like Berkshire Hathaway's stock has had a good run over the years but there have been times like 1987 when it was off around 50% in value. Margin might have forced you to do something you would later regret at that time.

I however like you do like LEAPS. My thought process is that the time is definite, the strike price definite and I prepaid for the interest ("time premium") and it is definite. Mr. Market does not have a hand in my thought process later on as far as margin call etc. Thus, I feel that knowing myself, my time horizon, and level of risk tolerance that if I incorporate all these other variables into my investment decision process that I am maintaining good value investor/business investor principles and actions. Or maybe i am just trying to have my cake and eat it too. What are others opinions regarding LEAP Options and are they like I believe margin not appropriate for any true value investor?

Munger - 9 years ago    Report SPAM
From the Berkowitz interview:

Q. What about leverage, and derivatives, and all those other kinds of tools?

Which brings us back to a point I made - that was a stupid question to ask a value investor. The reporter didn't do his homework. He wasn't asking questions to the hedge fund shark churning and burning through his trades while doing the interview.
Buffetteer17 premium member - 9 years ago
"I however like you do like LEAPS. My thought process is that the time is definite, the strike price definite and I prepaid for the interest ("time premium") and it is definite. Mr. Market does not have a hand in my thought process later on as far as margin call etc."

You hit on the main benefits of LEAPs. They aren't callable like stocks on margin. Another benefit is that they magnify upside more than downside. The "delta," the first derivative of the option price as a function of the stock price, is positive. This makes your gains on an increase of the stock price greater than your loss on a decrease of the stock price.

I noticed in Pabrai's annual letter to shareholders (I'm not a shareholder, but I somehow got on his mailing list) that he is considering the use of LEAPs. He is proposing to start using LEAPs on some of his positions in a ratio of 10%/90% LEAPs/stocks. Since he typically doesn't put more than 10% into any one position, he would be increasing his portfolio risk by only 1% on a given position with this strategy.
Buffetteer17 premium member - 9 years ago
"..it seems self-defeating to allow Mr. market to have a hand in you portfolio decision making by having you portfolio on margin."

That's one of the things that bother me. The other is the lack of flexibility, even if I do not get a margin call. I'm more or less locked into my positions now until things get better. I've had to make some regrettable decisions to sell some JNJ and WMT.

It is unlikely that I'll actually get a margin call. I have 13% of my portfolio in S&P 500 index puts. If my stocks go down in proportion to the S&P 500, no margin call: at an S&P level of 1050, the Black-Scholes value of the puts exceeds my margin loan. Of course, my stocks could go down faster than the S&P.
Freehling - 9 years ago    Report SPAM
I have nothing new to add but wanted to agree with other posters. I heard about this interview ahead of time and tuned in live. I am an investor in FAIRX and am very pleased with the results thus far. The interviewers here obviously had no idea who they were talking to. I kept getting more and more annoyed as they asked him macro-type questions that he obviously wasn't going to answer. I e-mailed in like 10 questions during the Podcast that I thought he would answer, but they never used any of them. Overall, a waste of a great opportunity by this Web site. Although Berkowitz made it clear despite this poor interview that he really knows what he's doing.
Vgm - 9 years ago    Report SPAM
Thanks Guru Focus.

Can someone post the link please?
Crafool premium member - 9 years ago
Ravinsu, Thank you for your input, however I can see that Buffett has used options in the past but not for the reason that I would consider using them (specifically I am only interested in LEAPS). obviously, Buffett has stated on numerous times the difficulty that Berkshire's immense capital base (over 440 billion in cash on hand)presents to moving Berkshire's performance needle, and that there is an inherent need for him to do bigger and bigger deals and look at bigger and bigger companies. As he and Munger have stated they believe they can take only up to 20% of the average daily volume of a stock without their own purchases driving the stock price higher. Thus, it generally takes them an inordinate amount of time to build a position of relevance to them (i.e. weeks and even months). Thus, it has been stated that Buffett has sold Puts and bought options but his use seems tied to trying to get shares anyway he can than the leverage that I am using to increase my return.

The margin thing again, presents an obstacle to me as well. The margin rates are just so high (margin rates are now prime plus rates, whatever happened to broker's call?) that their level alone presents issues. Buffett even in his partnership days has far more capital than I personally have at this time and most likely received institutional rates on any margin, that I am sure is not available to me. LEAPS however have allowed me to receive low interest rates ("premiums'), not now, but about a year ago I was able to get around 2% annual rates locked in on KO, JNJ, WMT, and some others, but those days seem over and now get very high rates. Thus, I know I have rambled if the spread is enough you feel leverage is okay?

Again, thanks for all responses.
Sabonis premium member - 9 years ago
Did the interviewer say that Monish Pabrai was a fund manager of the year? Why? Pabrai had a lousy year didnt he?

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