Is It Time to Sell the Fairholme Fund?

A few years ago, I met Bruce Berkowitz, manager of the Fairholme Fund (symbol FAIRX), and his new co-manager, Charlie Fernandez, for dinner in Chicago. I had already spoken with Berkowitz several times, but I was eager to get to know Fernandez and so I peppered him with questions. But each time Fernandez opened his mouth, he got out only two words or so before Berkowitz interrupted him.

The evening helped give me an insight into Berkowitz that isn’t evident in Fairholme’s excellent long-term numbers or in the various conversations I’d previously had with him: He doesn’t mesh well with others. I wasn’t surprised when word broke recently that Fernandez had quit. (Neither Fernandez nor Berkowitz would comment for this article. An October 19 news release discussing the departure also said that Berkowitz had hired two new analysts.)

None of this is meant as a criticism of Berkowitz as a stock picker. Great stock pickers are, almost by definition, independent thinkers. They often cling stubbornly to ideas that are at odds with the common wisdom. But often that character trait can make them lousy bosses.

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Fairholme boasts a wonderful long-term record, but this year has been a disaster. Year-to-date, the fund has plunged 23.7%, while Standard & Poor’s 500-stock index has inched up 1.4% (all returns are through October 24). Fairholme ranks in the bottom 1% of its peer group -- funds that focus on large, undervalued companies. Over the past ten years, Fairholme returned an annualized 8.1%, an average of 4.7 percentage points per year better than the S&P 500. Over that period, the fund ranks in the top 1% of its peers.

What went wrong? Start with this: Berkowitz, having proved himself a great fund manager, decided to test his abilities running companies. Unfortunately, he’s not Warren Buffett.

Fairholme took a huge position in St. Joe Corporation (JOE), a large Florida landowner. Berkowitz forced out the management and had himself installed as chairman of St. Joe’s board of directors. He thought the company had been poorly run and that he and Fernandez could turn it around.

Fernandez was supposed to be Fairholme’s operations whiz, possessing just the right skills to repair St. Joe and other companies in which Fairholme would take big stakes. Berkowitz said he was delegating that work to Fernandez.

St. Joe has been a mess. The Securities & Exchange Commission has launched a probe into the company, and the stock has lost one-third of its value this year. St. Joe accounts for just 3% of Fairholme Fund’s assets, but Berkowitz’s firm at last report held 25% of St. Joe’s outstanding shares.

St. Joe wasn’t Berkowitz’s only misstep. With one successful fund in his trophy case, Berkowitz decided to launch two others in the past two years. Both have fared poorly. Fairholme Focused Income (FOCIX) has lost 1.3% this year, and Fairholme Allocation (FAAFX) has tumbled 15.8%.

Berkowitz likewise failed to close Fairholme Fund when assets skyrocketed, peaking at $18 billion last January. Today it has less than $9 billion, a reflection of this year’s putrid performance and a wave of withdrawals from dissatisfied investors.

It’s extremely difficult to manage a fund that’s shrinking. Usually you must sell stocks that you think have room to grow. Berkowitz historically has held a lot of cash. As investors have fled, he’s reduced his cash stake to practically nothing rather than sell his favorite stocks.

A recent article in Barron’s raises questions about whether forced selling of some of those stocks would push down their prices because Fairholme owns so much of them. The piece also questioned whether Fernandez had the portfolio management experience necessary to serve as Berkowitz’s co-manager.

Berkowitz made his name with big, well-timed sector bets. It was inevitable that some of his bets would turn out to be early or just plain wrong.

Currently, he has 75% of Fairholme’s stock money in financial stocks, including 17% in American International Group (AIG), the insurance giant whose ill-advised sales of credit default swaps led to a near-death experience during the financial crisis. Only a giant bailout from Uncle Sam saved the company. Other big holdings include Bank of America (BAC), Goldman Sachs (GS) and Citigroup (C).

I don’t like the financial giants. Yes, statistically the stocks look incredibly cheap. And if Europe can straighten out its mess, the stocks may shine. But you can’t trust these companies’ shareholder reports because accounting rules give them too much leeway. It was Berkowitz’s leap into financials that initially turned me against Fairholme a year ago.

Once money stops coming out of Fairholme and once Berkowitz focuses on picking stocks for one smaller fund rather than on building an empire, he may put up great numbers again. It’s encouraging that he says he’s no longer interested in running any other companies.

But it’s really hard for a fund manger who stumbles as badly as Berkowitz has to turn things around. If I still owned shares in any of the Fairholme funds, I wouldn’t stick around to find out whether he can get his game back.

Steven T. Goldberg (bio) is an investment adviser in the Washington, D.C. area. He owns shares of St. Joe, as do some of his clients.