April 2011 IssueLong scroll reading

Fairholme Asset Allocation (FAAFX)

By Editor

Objective

The fund seeks long-term total return from capital appreciation and income by investing opportunistically and globally in a focused portfolio of stocks, bonds, and cash.

Adviser

Fairholme Capital Management. Fairholme runs the three Fairholme funds and oversees about 800 separate accounts. Its assets under management total about $20 billion, with a good 90% of that in the funds.

Manager(s)

Bruce Berkowitz and Charles Fernandez. Mr. Berkowitz was Morningstar’s Fund Manager of the Decade for 2000-2010, a distinction earned through his management of Fairholme Fund (FAIRX). He was also earning his B.A. at UMass-Amherst at the same time (late 1970s) I was earning my M.A. there. (Despite my head start, he seems to have passed me somehow.) Not to underplay his formidable skills, but Mr. Fernandez is inevitably thought of as “the other guy running Fairholme” (rather like Charlie Munger to Berkshire’s Warren Buffett).

Management’s Stake in the Fund

None yet reported. Each manager has a huge investment (over $1 million) in each of his other funds, and the Fairholme employees collectively have over $300 million invested in the funds.

Opening date

December 30, 2010.

Minimum investment

$25,000 (gulp) for accounts of all varieties.

Expense ratio

0.75% on assets of $165 million.

Comments

Fairholme Fund (FAIRX) has the freedom to go anywhere. The prospectus lists common and preferred stock, partnerships, business trust shares, REITs, warrants, US and foreign corporate debt, bank loans and participations, foreign money markets and more. The manager uses that flexibility, making large, focused investments in a wide variety of assets.

Fairholme’s most recent portfolio disclosure (10/28/10) illustrates that flexibility:

62% Domestic equity, with a five-year range of 48-70%
10% Commercial paper (typical of a money market fund’s portfolio)
6% Floating rate loans
6% Convertible bonds
5 % T-bills
3% Domestic corporate bonds
1% Asset backed securities (uhh… car loans?)
1% Preferred stock
1% Foreign corporate bonds
.3% Foreign equity (three months later, that’s closer to 20%)

On December 30, Fairholme launched its new fund, Fairholme Allocation (FAAFX). The fund will seek “long-term total return from capital appreciation and income” by “investing opportunistically” in equities, fixed-income securities and cash. Which sounds a lot like Fairholme fund’s mandate. The three small differences in the “investment strategies” section of their prospectuses are: the new fund targets “total return” while Fairholme seeks “long term growth of capital.” The new fund invests opportunistically, which Fairholme does but which isn’t spelled out. And the new fund includes “and income” as a goal.

And, oh by the way, the new fund charges $25,000 to get in but only 0.75% (after waivers) to stay in.

The question is: why bother? In a conversation with me, Mr. Berkowitz started by reviewing the focus for Fairholme (equity) and Fairholme Focus Income (income) and allowed that the new fund “could do anything either of the other two could do.” Which is, I argued, also true of Fairholme itself. I suggested that the “total return” and “and income” provisions of the prospectus might suggest a more conservative, income-oriented approach but Mr. B. dismissed the notion. He clearly did not see the new fund as intrinsically more conservative and warned that it might be more volatile. He also wouldn’t speculate on whether the one fund’s asset allocation decisions (e.g., to move Fairholme 100% to cash) would be reflected in the other fund’s. He suggested that if his two best investment ideas were a $1 billion stock investment and a $25 million floating rate loan, he’d likely pursue one for Fairholme and the other for Allocation.

In the end , the argument was simply size. While “bigger is better” in the current global environment, “smaller” can mean “more degrees of freedom.” The Fairholme team discovers a number of “small quantity ideas,” potentially great investments which are too small “to move the needle” for a vehicle as large as Fairholme (roughly $20 billion). A $50 million opportunity which has no place in Fairholme’s focus (Fairholme owns over $100 million in 17 of its 22 stocks) might be a major driver for the Allocation fund.

Finally, he meant the interesting argument that Allocation would be able to ride on Fairholme’s coattails. Fairholme’s bulk might, as I mentioned in the first Berkowitz piece, give the firm access to exclusive opportunities. Allocation might then pick up an opportunity not available to other funds its size.

Bottom Line

Skeptics of Fairholme’s bulk are right. The fund’s size precludes it from profiting in some of the investments it might have pursued five years ago. Allocation, with a similarly broad mandate and even lower expense ratio, gives Berkowitz a tool with which to exploit those opportunities again. Having generated nearly $200 million in investor assets in two months, the question is how long that advantage will persist. Likely, the $25,000 minimum serves to slow inflows and help maintain a relatively smaller asset base.

Fund website

Fairholme Funds, click on “public.”

© Mutual Fund Observer, 2011.  All rights reserved.  The information here reflects publicly available information current at the time of publication.  For reprint/e-rights contact [email protected].