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Lorena Dore
VP of Client Analytics
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Successful Investors

Manager Monday: Fairholme Capital Management

Every Monday, we dig through the public filings of a major hedge fund manager. This week we look at Fairholme Capital Management.

AIG and Bank of America are two companies that did not inspire confidence from the public as they struggled during the 2008 financial crisis, but one manager saw potential. Bruce Berkowitz adopts a strategy that invests in distressed stocks at low prices and then waits to make profits out of these opportunities. He founded Fairholme Capital Management in 1997 with this basic investment ideology at the very foundation of its success. This strategy has proven to be consistently profitable for them and has earned Berkowitz many accolades.

Although the fund’s motto is “Ignore the crowd”, and their long history of controversial bets suggests a commitment to this strategy, its 2015 13F filings show that they actually invest heavily in crowded stocks. In recent years, Berkowitz has dealt with backlash for his highly concentrated book and his habit of sticking to his convictions past their prime. The latest 3Q data shows at least a partial change in strategy, with Berkowitz decreasing the position sizes of some of the less profitable securities. Still, the fund remains committed to its high concentration, which continues to present risks to investors and comes with a poor liquidity profile that could be damaging in times of market distress.

Public Data

Everything mentioned in this post is sourced exclusively from public data, including the manager’s profile, simulated performance and all other analysis and commentary. The data used here omits the short side, non-equity securities, many non-US securities and all non-public information such as actual fund performance. To simulate performance and determine portfolio attributes such as liquidity, we combine public holdings data with market and pricing data and make simple assumptions.

Fairholme Capital’s Background

Fairholme Capital’s Market Value has increased 7X since 1999. It reached its highest point at ~$18B in 2011, but has since decreased substantially.

manager monday: fairholme capital management

From January 2005 to now, the fund has outperformed both the S&P 500 and the MSCI World by approximately 6% and 40% respectively.

manager monday: fairholme capital management

Since January 2005, 57% of the securities in the portfolio outperformed their sector benchmark and 57% of the capital was allocated to outperformers. However, the contribution generated by the portfolio was mainly beta-driven since selection alpha detracted around 940bps.

manager monday: fairholme capital management

High Concentration and Associated Returns

The number of securities in the portfolio has steadily decreased over time, making the book less diverse as concentration increases.

manager monday: fairholme capital management

The fund has historically sized up its high conviction names. As of 2Q 2015, 70% of the book was comprised of positions that constituted 10% or greater of the portfolio. These positions only represent 60% of the long book as of Q3. They have been compensated for these bets and the largest position sizes have generated annualized returns of 13% since January 2005, as you can see in the chart below.

manager monday: fairholme capital management

manager monday: fairholme capital management

They have also shifted into Mega Caps, which represented ~60% of the portfolio as of 2Q 2015 but recently decreased to ~36%. The remainder of the portfolio is split between Mid Cap and Small Cap. Since January 2005, Mega Caps have generated annualized returns of 19% and selection alpha of ~4,000 bps. However, during the same period, both Mid and Small caps generated negative annualized returns and have detracted almost 7,400 bps of selection alpha from the portfolio.

manager monday: fairholme capital management

manager monday: fairholme capital management

Financials have historically dominated the portfolio, currently accounting for 56% of the portfolio’s sector exposure, followed by Consumer Discretionary at 22%. Since January 2005, Financial names have generated annualized returns of 9% and selection alpha of 3,300 bps while Consumer Discretionary produced a negative annualized return of 17% and was the largest selection alpha detractor with negative 4,800 bps.

manager monday: fairholme capital management

manager monday: fairholme capital management

Poor Liquidity Profile

The fund’s liquidity has been volatile. Since 2005, 30 Day Liquidity has fluctuated between 10% and 70%. YTD it has hovered around 50%.

manager monday: fairholme capital management

During 2Q 2015, almost 90% of the portfolio’s capital was in positions that would require more than 120 days to liquidate, assuming 20% of ADV could be liquidated daily. This has improved. Currently 54% of the book falls into the >30 days liquidity category. Although illiquid positions present added risk, they have generated positive annualized ROIC in the more illiquid names.

manager monday: fairholme capital management

manager monday: fairholme capital management

Crowdedness

One important factor investors need to understand is the risk of owning crowded names. Novus research assigns crowdedness scores to each security based on the percent of ADV hedge funds represent and the number of funds invested in the security. Fairholme’s largest positions carry high crowdedness scores, which could amplify losses if crowd selling occurs.

manager monday: fairholme capital management

Final Remarks

Berkowitz has shown great talent in managing a fund founded on a very risky investment strategy. The fund’s consistently positive performance helps it stand out. However, investors should remember that lack of diversification and reliance on Beta to deliver results could amplify drawdowns in times of market distress.


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