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Nov 26, 2012

Bruce #Berkowitz: The return of a star fund manager - $FAIRX

Bruce Berkowitz and his Fairholme Fund have made a comeback - relying on the same stocks that cost his fund so dearly in 2011.

Bruce Berkowitz
FORTUNE -- Only a handful of mutual fund managers have ever had the sort of epic run that Bruce Berkowitz (and his investors) enjoyed. In the first decade of this century, his 13.2% annual returns obliterated the S&P 500 (SPX), which averaged 1% yearly losses. He was crowned U.S. stock manager of the decade by Morningstar, and Fortune anointed him "the Megamind of Miami" in a late-2010 profile. Then came 2011. Berkowitz's Fairholme Fund (FAIRX) plunged 32% amid huge losses in stocks like AIG, Sears, and Bank of America. Clients yanked $7 billion, and critics said Berkowitz, 54, was finished. But instead of retreating in 2012, he doubled down on his favorite stocks. Today he looks like a genius again: Fairholme has roared to a 37% return this year, tops among U.S. stock mutual funds. Is his comeback for real? Berkowitz made his case by phone from his home near Miami. Edited excerpts:

You were criticized last year for poor performance. Was that fair?

I think it's fair. What's not fair is to believe that a manager or a businessperson is in such control of companies that they can control any one-year period or two-year period. I've not seen it done. There's a reason Warren Buffett judges Berkshire Hathaway's (BRKA) book value against the S&P 500. He doesn't use Berkshire's stock price. My question to you is, Can someone like me or anyone else avoid a 2011?

What were you expecting?

I always knew we'd have our day of negative performance. I'd be foolish not to think that day would arrive. So we had billions in cash, and the fund was chastised somewhat for keeping so much cash. But that cash was used to pay the outflows, and then when the cash started to get to a certain level, I began to liquidate other positions.

Was 2011 beyond your worst-case scenario?

The down year was definitely not outside of what I thought possible. I was not as surprised by the reaction and the money going out as I was by the money coming in. When you tally it all up, we attracted $5.4 billion in 2009 and 2010 into the fund and $7 billion went out in 2011. It moves fast.

AIG's stock, which makes up 40% of your fund, has returned 50% this year. What does it need to do to deliver the 20% a year you think is possible? Will Hurricane Sandy claims prevent that?

It's too soon to tell, but it's not critical. AIG (AIG) is priced for 10 Sandys. More broadly, the company needs to reduce expenses, which will naturally occur. There's been a huge amount of time and energy placed in dealing with the Federal Reserve and the U.S. Treasury, and building new information systems. So you'll start to see significant cost reductions over time.
They're also moving away from low-frequency, high-severity insurance, which, in my opinion, is picking up pennies in front of a steamroller. But I think Peter Hancock, who runs their property-and-casualty business, understands that the one-in-100-year storm happens every five years.

Lately you've begun talking about the real estate value of Sears, which accounts for 10% of your fund.

The value of Sears (SHLD) [which trades near $60] would be over $160 a share if the land on the books was fully valued. You can look back at recent transactions and ask a question: How can Sears close stores and generate hundreds of millions of dollars of cash? It gets at the inventory. The liquidation value of its inventory approaches its stock price. Forget the real estate.

You make Sears sound like a liquidation play, not a retail recovery.

The retail recovery is a potential upside. Regardless, you'll see gigantic cash flows from the closing of locations, the pulling-out of the cash from inventory, work in process, and distribution centers. They're not idiots when it comes to real estate. They understand that today's standalone store can be tomorrow's multi-use hotel/residential-retail center. I think Eddie Lampert will end up being one of a few unbelievable case studies on what it means to be a long-term investor.

You own shares of both Bank of America and MBIA. When will they settle their multibillion-dollar lawsuit?

Bank of America's legal issues are the only thing stopping its rise right now. [MBIA's suit accuses BofA (BAC) of fraud related to bad home loans underwritten by BofA's Countrywide unit; BofA denies the allegations.] I know BofA doesn't want shareholders to overpay, but I'm one large shareholder who says, "Settle up!" And yes, it's in part because I'm a large MBIA (MBI) shareholder, but it's also because it's time to move on. I've e-mailed [BofA CEO] Brian Moynihan and said, "Settle." BofA is now the best capitalized bank in the U.S. It generates $5 billion of cash every three months. Its book value is $20 a share, but the stock trades near $10. Everything else is pretty obvious. Moynihan has done a really good job of moving to the Wells Fargo (WFC) model: client-centered. BofA has a huge franchise in the form of a trillion-dollar deposit base. They are America's bank.

Your portfolio is concentrated [see chart, above]. If you get new money to invest, will you buy different stocks?

Are there other investments out there? Yes. Better than what's in the fund today? No.
This story is from the December 3, 2012 issue of Fortune.
 Bruce Berkowitz: The return of a star fund manager - The Term Sheet: Fortune's deals blog Term Sheet

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