“Concentrated investing implies less risk of permanent loss as long as you maintain superior knowledge about the companies you own.” –Â Bruce Berkowitz
Morningstar named him Domestic-Stock Fund Manager of the Decade, that decade being the first of the new century, and a decade that included both the dot-com crash and subprime crisis. Not bad for an investor who launched his flagship fund, the Fairholme Fund (Trades, Portfolio), on the last day of 1999!
Bruce Berkowitz (Trades, Portfolio) still brings in outstanding results – from time to time –Â but to appreciate his performance it’s necessary to take the long view.
Who is Berkowitz?
The manager and owner of Fairholme Capital grew up in Chelsea, Massachusetts. After graduating from the University of Massachusetts in 1980 with a B.A. in economics, he joined the Strategic Planning Institute in Cambridge.
That was followed by positions at Merrill Lynch and Lehman Brothers in London. In 1989, Berkowitz returned to the U.S., becoming a senior portfolio manager for Lehman Brothers in New Jersey. 1993 saw him become a managing director of Smith Barney Investment Advisers.
He founded his own firm, Fairholme Capital Management, in 1997; he established his first fund, the Fairholme Fund, in 1999.
Recognition includes:
- 2009 Domestic-Stock Fund Manager of the Year by Morningstar.
- Domestic-Stock Fund Manager of the Decade (2000-2009) by Morningstar.
- 2013 Money Manager of the Year by Institutional Investor Magazine.
Berkowitz has served on numerous corporate boards and currently serves on the two representing his biggest commitments.
What is Fairholme Capital Management?
Fairholme is an investment adviser based in Miami. At the end of February it managed approximately $4.8 billion worth of client assets.
Those clients include high net worth individual, pensions and profit-sharing plans and other entities. Vehicles include managed account programs (MAPs), private funds and mutual funds.
The company offers three mutual funds:
- The Fairholme Fund: long-term orientation, growth through equity and fixed-income securities. Market cap: $2.29 billion.
- The Fairholme Focused Income Fund: aims to generate current income through investments in cash distributing securities. Net assets: $251.52 million.
- The Fairholme Allocation Fund: long-term total return from capital appreciation and income; invests in equity, fixed-income and cash/cash-equivalent assets. Net assets: $187.66 million.
On the home page of the firm’s Web site, it is rhetorically asked what makes Fairholme different. The short answer is the firm’s motto: "Ignore the crowd." They say dips and downturns are their double espressos while securities that are not ridiculously cheap are not their cup of tea. Further, "when the crowd stampedes left, we advance right – with courage of conviction."
Over two decades, Berkowitz and team have served their clients with three funds, one of which is a relative giant, at more than $2 billion.
The Berkowitz investment strategy
The starting point in Berkowitz’s investing strategy is value. Although he operates three different funds, they all share a number of traits including a value orientation. As noted above, he’s looking for "ridiculously cheap" securities.
To find those securities, they start with fundamental, bottom-up research that seeks to identify numerous favorable metrics including free cash flow yields in relation to market values and risk-free rates, capital allocation policies and competitive positions. They also look at balance sheet strength, liquidity and leverage.
Broadly, he is interested in stressed industries that should recover, long-term growth potential and the provision of essential goods and services.
In its Form ADV brochure, the firm lists what it calls its investment strategies:
- A nondiversified, focused portfolio: It does not try to diversify its investments in any way and holds a limited number of issuers and securities.
- Buy and hold: Securities are held for relatively long periods, and the managers do not respond to short-term elements such as market fluctuations or stock price volatility.
- Equity: When searching for stocks, the firm applies both core and value styles, and looks to global, multinational developments, rather than specific countries.
- Fixed-income: Includes both government and corporate debt as well as bank debt. It invests in both domestic and foreign securities.
- Distressed and special situations: It may invest in cases where securities are expected to appreciate because of company actions rather than overall business conditions.
- Fundamental value: The focus is on companies that it considers to be undervalued.
- Leverage: The private funds may use "moderate" leverage (bank loans, etc.) occasionally; apparently the mutual funds do not borrow to grow the portfolio.
- Control and substantial positions: The firm may buy its way into control of the company, or invest in such a way that it can influence management.
Regarding the control and influence issue, Berkowitz has actively served on the boards of public companies. He is currently a member of two boards: as a director of Sears Holdings Corp. (SHLD, Financial) since February 2016 and a director and current board chair of The St. Joe Co. (JOE, Financial) since March 2011.
Although many gurus run concentrated portfolios, made up of a relatively small number of stocks, Berkowitz outdoes most or all of them. GuruFocus reports the Fairholme Fund contained just nine stocks at the end of the first quarter. That’s extraordinarily high conviction, especially when one of those nine holdings is Sears, which most observers are writing off as Amazon.com (AMZN, Financial) roadkill.
Sears gets attention in the Portfolio Manager’s Report for 2016. Berkowitz notes that he’s reminded every day that young competitors have significant advantages over "old-line operators." He argues that Sears is accelerating its transformation efforts, and “Bottom line: Sears has degraded net asset values, but there is still much left, and the company is fixing its cash drain.” The retailer’s presence within the portfolio continues to grow, roughly doubling in the past two years, to about 35%.
The bet on Sears, the contrarian bet, is even more pronounced when Seritage Growth Properties (SRG, Financial) comes into the picture. Seritage is a major mall landlord, and at the end of 2016, Sears represented 65% of its leased space. Berkowitz notes that the number was once 90%, and Seritage is diversifying to capture new consumer experiences; he says, “Headlines overlook this renter diversification and ignore Seritage’s acceleration with large mixed-use redevelopments in Santa Monica (California), Aventura (Florida), Hicksville (New York) and Redmond (Washington).”
All of this, of course, underlines the agony of the value investor, “Since Fairholme’s inception, we have pursued a value-oriented investment approach that avoids popular securities in favor of companies that are both unloved and undervalued. Although the world has become more uncertain and the recognition of value is taking longer, we remain optimistic.”
Looking at the big picture, Berkowitz has been and continues to be a classic value investor. He looks among underappreciated stocks for those that sell at a discount and provide a margin of safety, and that should be worth far more in the long term.
Current holdings
With effectively just two companies in his portfolio –Â St. Joe and Sears (the latter in a couple of forms) –Â the sector profile is hardly complicated, as this GuruFocus chart shows:
There is no top 10 for the Fairholme Fund; it holds just nine stocks (with their proportion of the portfolio shown as percentages):
- The St. Joe Co. 40.26%.
- Sears Holding Corp. 32.15%.
- Seritage Growth Properties 15.31%.
- Lands' End Inc. (LE, Financial) 6.8%.
- Sears Canada Inc. (SRSC, Financial) 2.71%.
- Sears - warrants (SHLD.WS, Financial) 2.02%.
- Sears Hometown and Outlet Stores Inc. (SHOS, Financial) 0.29%.
- Washington Prime Group Inc. (WPG, Financial) 0.29%.
- Leucadia National Corp. (LUK, Financial) 0.17%).
Few fund managers would go as far as Berkowitz in taking on conviction positions. Since much of Seritage’s survival depends on Sears retail stores, this guru has bet the fund on just two companies.
Performance
This GuruFocus table shows the Fairholme Fund trailing the Standard & Poor's 500 over 10 years by an average of half a point per year:
Over a 15-year cumulative period, though, the fund has outperformed the S&P 500 by an average 2.5 points per year. This chart from the fund’s fact sheet illustrates the difference in performance:
Berkowitz argues, in the Fairholme Fund’s fact sheet, that his fund has recorded 142 positive five-year return periods and six negative five-year return periods through the end of March. On the other hand, the S&P 500 has recorded 121 positive five-year periods and 27 negative five-year periods over the same span.
As always, with long-term value investors, year-to-year performance cedes the high ground to performance over extended periods.
Conclusion
In the introduction to this article, we saw a Berkowitz quotation that said concentrated investing helps avoid permanent loss of capital – provided you have "superior" knowledge about the companies in which you invested.
Berkowitz has essentially bet his fund on two companies, St. Joe and Sears. He is taking his own advice. He is a director and chairman of St. Joe and a director of Sears. With those positions, he not only has an inside perspective, he also has an opportunity to shape their strategies and operations.
For investors with a patient perspective, that’s been a winning combination so far. Investors who look at their investment on a yearly basis, though, should look elsewhere.
Disclosure: I do not own stock in any of the companies named in this article, nor do I expect to buy any in the next 72 hours.
