Many of our clients have asked about the Fairholme fund. Due to its concentrated nature, the fund’s returns will naturally diverge from those of the market. In prolonged downturns, such as 2000 to 2002, this divergence was tremendously beneficial. In the run-up since the financial crisis, deviating from the market has not been as profitable as we anticipated (although it has been profitable). We thought it would be helpful to summarize Fairholme’s case for its top holdings:
AIG. AIG is currently selling at about 70% of its book value, while other large Property and Casualty insurers sell for 100%+ to book. Bruce Berkowitz (Fairholme’s manager) has stated that he thinks AIG should sell for at least book value. In addition, since 2011, AIG’s book value per share has grown by about 13% per year.
Bank of America. Similar to AIG, Bank of America is selling at about 70% of book value. For reference, the S&P 500 is currently priced at just under 300% of book value. Mr. Berkowitz has estimated that the stock is selling for a substantial discount to the liquidation value of its assets.
Sears. While the retailer has been cutting costs and closing unprofitable stores, Mr. Berkowitz believes the true value lies in the real estate that the company owns. Fairholme has devoted thousands of hours to studying the properties (including site visits and coverage by an analyst solely dedicated to the stock). Sears has recently announced plans to unlock the value of some of these properties through joint ventures with mall operators, as well as the formation of a Real Estate Investment Trust.
Fannie and Freddie. These companies, which buy loans to ensure liquidity to the mortgage market, were taken into conservatorship by the government during the financial crisis. Since then, they have once again become profitable and have repaid more than the original amounts borrowed. In 2012, the government unilaterally changed the terms of the original deal so that Fannie and Freddie must send all profits to the US Treasury. Fairholme is one of many filing suit on behalf of investors, and recently some members of Congress have begun to question the government’s actions in preventing the companies from retaining capital.
This transcript of a February, 2015 conference call with Bruce Berkowitz provides more detail about these positions.
Fairholme’s willingness to swing big when it perceives value is not a new strategy. In the early 2000’s, the fund loaded up on an insurer that was selling at a relatively low price-to-book ratio. That company, Berkshire Hathaway, contributed meaningfully to Fairholme’s gains for the next several years.
We’ve already discussed some of the evidence for buying cheaply-priced stocks. The Fairholme fund is just one piece of a diversified portfolio that we have assembled to pursue this strategy.
Aaron Pettersen, CFA, CFP®