The fund manager of the decade said he’s moving beyond mutual funds.
Bruce Berkowitz said rules that allow mutual fund holders to cash out anytime put his long-term investing style at a disadvantage, according to an interview with Bloomberg Television’s Erik Schatzker, airing today. The rules also prevent funds from owning too much of one stock, a straitjacket for managers like Berkowitz who favor concentrated positions.
“Mutual funds are great vehicles,” said Berkowitz, 54, who heads Miami-based Fairholme Capital Management LLC. “They’re transparent. They give investors daily liquidity. They’re highly regulated. But there are also constraints that go along with that.”
As a result, Berkowitz said he’s considering alternatives that would tie up investors’ capital for longer and free him to buy as much of a stock as he wants. He’s also closing existing funds to new investors as of the end of this month to prevent an influx of capital that could dilute performance.
Berkowitz is raising money for a partnership that takes minimum investments of $1 million, according to a January regulatory filing. He declined to elaborate when asked whether the new entity was meant to attract more patient capital.
“At this point, I can’t talk about it,” he said. “But stay tuned.”
Berkowitz’s flagship Fairholme Fund suffered its worst year ever in 2011 as its holdings of shares in Bank of America Corp. and American International Group Inc. plunged. Both stocks rebounded last year and led the fund to its best performance against the Standard & Poor’s 500 Index in a decade. Investors spooked by the 2011 results abandoned the $7 billion fund and contributed to an almost 60 percent drop in its assets in the two years ended Nov. 30.
“We want to make sure we have a shareholder base that understands the long-term nature of what we do,” he said. Investors in the fund have to “stay the course.”
Berkowitz has talked of finding longer-term capital ever since customers pulled money from the Fairholme Fund during 2011, forcing him to sell stocks before he wanted to, said Kevin McDevitt, an analyst at Chicago-based Morningstar Inc.
“Daily redemptions are a huge burden for money managers, especially ones like him” who make big bets on a few stocks, McDevitt said in a phone interview.
Berkowitz plowed capital into Bank of America and New York-based AIG in 2010 as part of a strategy to “embrace the hated” and buy financial firms he has said were “priced to die” after being recapitalized by the government following the 2008 financial crisis. The bets accounted for more than half of the Fairholme Fund’s assets as of Nov. 30.
Buying the stocks at a fraction of their liquidation values ultimately may help the Fairholme Fund generate fourfold returns on the investments over five to seven years, Berkowitz said. Other investors missed that the fundamentals of the two companies were improving in 2011 because they were concerned about a possible double-dip recession in the U.S. and Europe’s sovereign-debt crisis, he said.
Bank of America more than doubled last year as Chief Executive Officer Brian T. Moynihan, 53, sold assets, boosted capital and worked through a book of faulty mortgages at the Charlotte, North Carolina-based lender. AIG surged 52 percent in 2012 as the insurer bought back stock and exited government ownership four years after a $182.3 billion bailout. Shares of both firms fell by more than 50 percent in 2011.
The returns on those stocks drove the Fairholme Fund’s 32 percent decline two years ago, when it was ranked in the lowest percentile among large-value peers by Morningstar. The fund surged 36 percent last year, ranking it in the group’s top 1 percent, according to data from the research firm.
The fund has posted an annualized return of 11 percent after expenses since its inception in 1999 through the end of last year. That compares with 1.7 percent for the S&P 500, including reinvested dividends, according to a report on Fairholme Capital’s website. That performance led Morningstar to name Berkowitz the domestic-stock fund manager of the decade in January 2010.
More than 80 percent of the Fairholme Fund’s assets were invested in six companies as of Nov. 30. In addition to AIG and Bank of America, holdings include a 13 percent stake in Sears Holdings Corp. and 25 percent of real-estate developer St. Joe Co., the largest private landowner in northwest Florida, data compiled by Bloomberg show.
Berkowitz said his approach demands that shareholders be patient because he’s prone to investing too early in stocks he thinks will recover.
“I haven’t found the right technique or medication yet for premature accumulation,” he said. “I just see it’s cheap. I count the cash. I look at the intrinsic value of the company and the price. And I think, ‘This is too good to be true.’ And I buy and then it goes lower.”