VALUE ADDED


A Great Fund for a Volatile Market

Steven Goldberg

With savvy, conservative management, Fairholme fund knows how to make money and keep risks low.



Fairholme fund won't lead the pack in a bull market. But the fund knows how to do something much more important: Not lose your money. And that makes it a perfect addition for this volatile market.

Don't get the idea that this fund takes so few risks that it barely makes money. From its inception at the end of 1999, Fairholme (symbol FAIRX) returned an annualized 16% through March 31. By contrast, Standard & Poor's 500-stock index gained just 3% annualized. Over the past five years through April 17, Fairholme ranked in the top 3% among large-company blend funds, with an annualized return of 19%, according to Morningstar.

And Fairholme has only lost money in one year since its launch. That was in 2002, when it fell less than 2%. The S&P 500 plunged 22% that year.

Lead manager Bruce Berkowitz and a team of seven co-managers and analysts employ a two-pronged strategy. First they look for a handful of truly great owner-managers -- that is, people who own significant stakes in the companies they run. The fund has 20% of its assets in Warren Buffett's Berkshire Hathaway (BRK.A). Another 4% is in conglomerate Leucadia National Corporation (LUK).

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Then Berkowitz and team fill in the rest of the holdings with companies that throw off lots of free cash flow. Free cash flow is essentially a company's reported earnings plus depreciation and other noncash charges, minus the capital expenditures needed to maintain the business.

"We want free cash flow yields of 10% or better," Berkowitz says. "Every time I break that rule, I pay for it." (Free cash flow yield is a company's annual free cash flow divided by its market capitalization.") Usually the companies Berkowitz buys are experiencing temporary difficulties.

Lately, Berkowitz has been finding values in managed-care companies. Health care costs rise continually rising, and governments and businesses are using managed-care companies to try to control those costs.

Berkowitz recently invested in the shares of WellPoint, Inc. (WLP), one of the nation's two largest health insurers. The stock lost half its value this year after the company lowered earnings estimates because of higher medical costs and reduced enrollment. "In this kind of market, people sell first and ask questions later," Berkowitz says.

Last year, he picked up WellCare Health Plans, Inc. (WCG), a managed-care company that serves Medicaid and Medicare clients. The stock price had been sliced practically in half because of a federal probe of the company's billing practices. With the benefit of new management, Berkowitz says, WellCare will ultimately put its problems behind it.

Fairholme invests in only a handful of companies -- and, when the managers find a stock they like, they're not afraid to buy a large position in it. For instance, the fund has 15% of its assets in Canadian Natural Resources, Ltd. (CNQ), an oil and gas exploration and production company. Once the fund buys a stock, it tends to hold on for about five years, on average. Fairholme tends to hold lots of cash -- typically more than 20% of its assets.

Berkowitz, 49, has the experience and savvy to pick good stocks. He's been investing for a living since 1981. "Nothing's really new after doing this for so many years," he says.

Despite the selloff in financials, he has been avoiding them. "I don't understand how anyone can figure out who owes what to whom. And I don't own what I can't figure out."

But he has found a couple of beaten-down stocks of solid companies on the periphery of the housing slump. Mohawk Industries (MHK) is one of the largest manufacturers of rugs and other flooring products. USG Corporation (USG) makes building materials, mainly wallboard.

Fairholme isn't perfect. Given its assets, which have grown to $7.4 billion, the expense ratio seems a tad high at 1%. That's particularly so when you consider that the fund has 20% of its assets in cash and another 20% in the shares of Berkshire Hathaway. But it's hard to argue with Fairholme's results. And, at the end of the day, results are what matters.

Steven T. Goldberg (bio) is an investment adviser and freelance writer.




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