Bruce Berkowitz, the prominent manager of the Fairholme Fund, gained recognition as Morningstar’s Manager of the Decade in 2010. However, despite his previous accolades, Berkowitz’s name has faded into obscurity for many investors. That may change in 2023. The Fairholme Fund (ticker: FAIRX), currently valued at $1.2 billion, has demonstrated remarkable performance, boasting a 23% increase. This accomplishment becomes even more impressive when one considers that the fund does not include any artificial intelligence stocks.
Unconventional Portfolio Design
Before diving into this potentially lucrative opportunity, it is essential to understand the peculiar portfolio design and management structure employed by Fairholme. Astoundingly, a staggering 82% of the fund’s portfolio is invested in a single stock—Florida real estate developer St. Joe (JOE). What’s more, Berkowitz himself serves as the chairman of St. Joe’s board of directors. Significantly, he reveals that approximately one-third of the Fairholme fund is composed of money affiliated with his own family, amounting to an estimated $340 million. In essence, the Berkowitz clan is essentially paying the fund’s 1% management fee to itself.
Berkowitz affectionately refers to his family’s Fairholme assets as “permanent capital,” underscoring their unwavering commitment to the fund’s success.
The Dual Nature of Concentrated Funds
Fairholme provides a prominent example of the inherent promise and risk associated with concentrated funds. Although such funds often yield impressive long-term returns, not all investors can tolerate the volatility that accompanies them. Given that the performance of concentrated funds heavily relies on just a handful of stocks, returns can consistently fluctuate between feast and famine scenarios.
Astoundingly, almost two-thirds of Fairholme’s 2023 return can be attributed to a single exceptional day—July 27. On that day, the fund’s share price skyrocketed from $33.25 to $38.24, representing a remarkable 15% gain. In contrast, Fairholme experienced less favorable outcomes in 2021 and 2022, with respective returns of 6.9% and -20.5%, ranking it in the bottom 100th percentile. Nevertheless, in 2020, it achieved a stellar 46.9% return, securing a top 1% rank. Over the past five years, if one had held onto Fairholme, they would have outperformed 99% of their peers with a respectable 14.8% return. However, in the decade leading up to October 23, 2023, it underperformed 97% of its peers, delivering a modest 5% return.
As investors consider the allure and potential pitfalls of Fairholme, it becomes evident that Bruce Berkowitz remains a resilient and impactful figure within the investment industry.
The Growth of St. Joe’s: A Bumpy Path
The surge on July 27 was a result of a strong earnings report from St. Joe’s. According to Berkowitz, the progress of St. Joe’s is not smooth sailing. Building thousands of homes cannot be done overnight. Despite this, the overall growth rate remains impressive.
Investor Returns: A Lesson in Patience
Unfortunately, most investors lack the patience required to reap the benefits of St. Joe’s growth. Morningstar’s Investor Returns, which compares trading activity with regular returns from the fund, paints a revealing picture. From a monthly calculation, up until September 30, Fairholme had an annualized investor return of 1.7% over the span of 10 years. In stark contrast, the fund itself boasted a 6.4% return. This stark difference in returns has led to approximately $7 billion in outflows over the past decade, tarnishing its reputation as the “manager of the decade.”
Mind the Gap: A Tale of Volatility
Return gaps are common for funds with high levels of volatility. Morningstar’s “Mind the Gap” study delves deeper into this discrepancy between investor and regular returns for various fund categories. The latest version from 2023 found that the least-volatile quintile across all categories had an average annual gap of 0.94%. Conversely, the most-volatile quintile experienced a larger gap of 1.94% per year. Fairholme, with a standard deviation of 25% over ten years, falls into the latter category. In comparison, the average Large Value fund boasts a more modest standard deviation of 15%.
Concentrated Funds: A Diversification Solution
Ironically, concentrated funds like SouthernSun Small Cap (SSSFX) can offer diversification to investors’ portfolios. According to Phillip Cook, the co-manager of SouthernSun Small Cap, most clients are already overly diversified. Owning multiple mutual funds means that adding 50 or 100 more stocks from SouthernSun is unnecessary.
The Cost of Fairholme: Opting for St. Joe Stock
For investors looking to avoid paying the 1% management fee of Fairholme, purchasing St. Joe stock directly is a viable alternative. In fact, Berkowitz mentions that he is open to exchanging shares of St. Joe with institutional shareholders who wish to sell their Fairholme fund stake, rather than providing cash.