On October 1, 2014, the Fairholme fund’s Net Asset Value dropped approximately 10%. This was due primarily to a decline in the fund’s investments in Fannie Mae and Freddie Mac preferred shares, which lost more than 50% that day (these securities comprised about 15% of Fairholme’s portfolio as of 6/30/14).
The reason for the sharp decline in Fannie and Freddie was the decision by a DC District Court to reject a lawsuit filed by Fairholme and other investors challenging the government’s ability to confiscate profits from these companies. While the ruling was a setback, this was just one front in a broader legal battle regarding the constitutionality of the government’s actions. It may take several years for this matter to play out.
During times like these, it is helpful to review Fairholme’s role in our client’s portfolios:
Fairholme is a concentrated fund and is susceptible to large price swings. Bruce Berkowitz (Fairholme’s manager) would rather buy more of his favorite investments than to water down the portfolio with what he views as lesser choices. We believe this has been an important factor in his long-term success, though it has also resulted in periods of significant volatility.
Fairholme should be held with a long time horizon in mind. As with Fannie and Freddie, the investment thesis behind many of the holdings may seem unconventional and can take a long time to yield positive results. We continually monitor the fund but think Mr. Berkowitz should be given latitude to pursue such opportunities.
Fairholme is one part of a diversified portfolio. We generally recommend allocating no more than 20% of a portfolio to the Fairholme fund, even for our most aggressive investors. We also think this fund serves as a complement to our other mutual funds, which by comparison, are much more diversified.
In short, we continue to recommend holding the Fairholme fund for the long-term and urge patience in the short-term.
Please call with any questions or concerns.
Aaron Pettersen, CFA, CFP®