Fairholme Fund Goes from Bottom 99% to Top 1% of Funds

Bruce Berkowtiz, founder of the Fairholme Fund, has an outstanding investment record but a poor performance last year that placed him in the bottom 99 percent of funds and incited a wave of client redemptions. This year is showing the beginnings of validation of his long-term investment theses and a comeback as his fund has returned to the top percentile. Four of his five top holdings are up significantly year to date. They are: American International Group (AIG), CIT Group (CIT), Bank of America (BAC) and Sears Holdings (SHLD). The one that is down is his fourth-largest, MBIA Inc. (MBI).

Berkowitz assembled a highly concentrated portfolio after the near collapse of the U.S. financial system. His top five holdings compose more than 60 percent of it. It is filled with some of the most unpopular and beleaguered names of the crisis. American International Group (AIG) is the largest holding, with a 34.9 percent weighting.

AIG is the multinational insurance corporation that faced a liquidity crisis in 2008 and required an $85 billion bailout from the U.S. Federal Reserve Bank to prevent bankruptcy. AIG reported a loss of $61.7 billion in the fourth quarter of 2008 � the largest loss in corporate history to that point.

Berkowitz bought 15,038,100 shares of AIG in the first quarter of 2010 at an average price of $29. The company had reported its first quarterly profit since the third quarter of 2007 in the second quarter of 2009 and had another positive quarter in the third quarter, but Berkowitz did not buy. The company then swung to a fourth quarter loss. In the first quarter of 2010 there was a large dip in the share price and the company posted net income of $1.5 billion though he still suffered from what he called �premature accumulation.�

In the first quarter, the company was also working on selling assets to repay its obligations to the Federal Reserve Bank of New York and improve its capital structure. Berkowitz continued to add shares throughout the year.

Then, in 2011, Berkowitz made his largest and perhaps costliest move [?] with AIG when he bought 58,966,502 shares in the second quarter of 2011 at the average price of $30.50 per share. By the end of the year, the price was near $23. Since the start of 2012, however, it is up 21.3 percent to $28.

Berkowitz outlined his thesis on AIG in his conference call with investors in May 2011: �The intrinsic value is significantly higher, in my opinion, than where we bought AIG and where AIG is trading today. Chartis, Sun America are intact, they made reasonably good money last year, fabulous money compared to the price where the stock is today. I see no reason why AIG can�t make a 10% return on equity.

I see no reason why they can�t meet their goals for the next few years. There�s tremendous value in AIG � people spent a huge amount of time focused on the right hand side of the balance sheet. It�s now time for people to take a look at the left hand side and have a better understanding of the earnings power of the remaining companies and a better understanding of the assets and liabilities.

For example, the $23 billion deferred tax asset valuation allowance is not on the books. As the company begins to earn a more consistent profitability stream you will see that tax deferred asset come onto the books. As I mentioned in my opening comments, I can see the company earning about $6 per share, pre-tax and, on a normal basis, they will not pay taxes on that for quite a few years. As that process evolves you�ll start to see that grow and earn more pre-tax.�

See Bruce Berkowitz�s portfolio here or check out the Undervalued Stocks, Top Growth Companies, and High Yield stocks of Bruce Berkowitz.

CIT Group (CIT) and Bank of America (BAC) are Berkowitz�s second and third-largest holdings. He has been gradually selling small amounts of CIT. He launched his Bank of America position at the same time he bought AIG, the first quarter of 2010, with 39,309,900 shares at an average price of $16 per share. He continued adding until the third quarter of 2011. His holding peaked at 105,012,795 shares. But the stock price fell to $4.92 per share� another costly error and drag on performance that year.

The year has been good so far for Bank of America. Its stock is up almost 44 percent to close at $7.99 on Monday. It reported net income of $2.0 billion for the fourth quarter of 2011, compared to a net loss of $1.2 billion in the year-ago period. It also originated 20 more small business loans and had 13 percent higher commercial and industrial loan balances from the previous year.