June 9, 2011

Fairholme’s Berkowitz Defends Performance, Details Decisions: Morningstar Conference

Fund manager upbeat, defiant in wide ranging interview

Fairholme Capital Management’s Bruce Berkowitz was the lunchtime keynote speaker at the 23rd annual Morningstar Advisor Conference on Thursday. Berkowitz, suffering from laryngitis, nonetheless answered questions from Morningstar’s Don Phillips about the investments he makes, his macroeconomic viewpoint and the criticism he’s received over his fund’s poor performance during the past six months.

Phillips began by asking him about the genesis of the Fairholme Fund, and why he felt the height of the technology bubble in 2000 was a smart time to launch a value-based fund.

fairholme's bruce berkowitz“The time then reminds me a lot of what’s happening today,” Berkowitz (left) said. “Fully a third of my clients said I needed to get more heavily involved in tech. I said, ‘no, you’ll lose money,’ and we stayed true to our value discipline. So that third of our client base ended up leaving.”

When Phillips noted the firm’s tag line, “ignore the crowd,” Berkowitz slammed the groupthink mentality present at many firms, believing the least educated person in the room usually wins the day when discussing investment direction.

“When investing, one person has to take responsibility for pulling the trigger,” he said. "Groupthink happens far too often, and just ends up dumbing down the discussion.”

Phillips asked Berkowitz about his heavy use of industry consultants in debates over the investments he makes. Berkowitz said he likes outside consultants to pick apart his ideas. He’d rather spend the money on experts in defined areas in which he's considering investing, rather than on internal consultants; his personal relationships with his internal consultants would risk coloring his judgment.

“It can’t be about my family,” he said. "And it can’t be about my employees. The investment decisions have to be about the shareholders, period. I have to put myself in their shoes when considering decisions that impact the fund.”

Phillips asked about the size of the fund, and if it was too big to take advantage of many opportunities.

“So far, scale has helped us,” Berkowitz responded. “I don’t know if that will continue, but we need a critical size to be relevant. One day we won’t, and I hope I figure that day out before our shareholders.”

Berkowitz says his “early warning system” on the fund’s size will be when he takes every dime of his family’s money and invests it in the fund. In that way, he will be hurt by performance more than helped by the offset that would occur from the investment fees he collects.

“In that way, I won’t do anything stupid,” he said to laughter from the audience.

Berkowitz said he doesn’t know if he’s sane or insane for having such a large exposure to the financial sector. Its complicated nature meant prior to the financial crisis, it was hard to know who actually owned a given company.

Phillips jumped in to say he spoke with an advisor who understood to be invested in the Fairholme Fund meant “stressful” investments would be made, but he didn’t understand why Berkowitz had to invest in "all of them." Phillips then asked Berkowitz about some of those investments.

On Bank of America, Berkowitz said the company is currently hated by the general public, and thought to be solely responsible for the real estate mess. The reality is that everyone pushed universal home ownership as something good “until it was not.” He notes Bank of America was the first bank to lower its fees. Referring to the real estate crisis in particular, he said the bank has 30,000 extra people working on the issue.

Phillips then switched to Goldman Sachs, noting another advisor said they’re always on the front page, but never for anything good. Berkowitz responded by admitting that they too are considered to be part of the “evil empire,” but he likes the people at the firm, believes they are ethical and likes what they have done, particularly in Asia.

An audience member asked about his recent investment in Cisco Systems, a company that has experienced poor earnings of late. Berkowitz said he often asks his partner, Charlie Fernandez, about companies that are critical to the efficient operation of the country.

“Cisco is one such company, due to the equipment they make,” Berkowitz said. “WorldCom was one such company, even in their bankruptcy. They were critical to the country’s defense, the orderly processing of payments and so many other essential functions. So I ask Charlie about them. I learned from Warren Buffet that everyone needs a Charlie,” he added referring to Buffets partner and vice-chairman, Charlie Munger.

Another audience member asked how Berkowitz could simultaneously invest in Bank of America and MBIA, two companies currently involved in lawsuits against one another. Berkowitz says he believes a win will be huge for MBIA relative to the company’s size, while conversely, a loss for Bank of America would be small.

“It’s a legal arbitrage play,” he said.

One of the last questions involved Fairholme’s recent foray into China.

“China reminds me off America in the 1950s,” he explained. “It was critical for people to want the next generation to be better off then theirs. China has a growing middle class and this is where they are now. Life insurance is critical to ensuring that next generation does better, and it is underutilized in Asia.”

As a result, he sees a good value in AIA and China Pacific, two life insurance companies that have a significant presence in China.

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