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5 Contrarian Bets From Bruce Berkowitz - 15058 views
As the stock picker behind the $16 billion Fairholme Fund (FAIRX), Berkowitz has built a name for himself as one of the most prescient investors out there. The performance data says it all -- over the last decade, buying and holding the S&P 500 would have yielded 8.91%; doing the same with Fairholme would have returned 113.62%.
They’re gains that were generated by being willing to defy conventional investment wisdom.
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But Berkowitz has come under scrutiny of late because of outsized bets on the financial sector. At present, more than three-quarters of Fairholme’s assets are invested in financial names (and a few other out-of-favor issues as well), and near-term performance has suffered as a result. So does it still pay to be contrarian?
The short answer is yes. Even though Fairholme has vastly outperformed the S&P over the last 10 years (prompting Morningstar to crown Berkowitz Domestic Stock Fund Manager of the Decade), critics forget that those returns have come at a cost of sizable drawdowns and volatility. Put simply, Berkowitz is usually right about his portfolio -- even if he’s frequently early to the party.
Today, let’s take a more analytical look at some of Berkowitz’s biggest contrarian bets to find out whether it still makes sense to invest like this storied manager.
American International Group
It shouldn’t come as a huge surprise that Fairholme’s performance is lagging in the near-term -- the fund’s biggest position has been sinking like a stone in 2011. At present, American International Group (AIG) makes up around 7.6% of the fund’s portfolio, even though the stock has slid more than 50% year-to-date, earning it a spot on 5 Worst-Performing S&P 500 Stocks of 2011 list.
Even after being disgraced by massive bailouts in the depths of the financial crisis, AIG remains one of the biggest insurance and financial services firms in the world. That fall from grace has dramatically changed the way AIG does business, limiting the firm’s risk-heavy investments and trimming its operations to focus back on its core competencies. Because of the intangible nature of AIG’s business, it’s no surprise that investors remain wary of shares in 2011.
The U.S. government is unwinding its positions in AIG right now, a process that’s expected to take a considerable amount of time. Once AIG is on its own again, the company will need to deliver consistent performance to stay out of financial trouble (high debt loads and a limited valuation in the capital markets will ensure that). While this is far from a “widow and orphan stock”, it’s a very good speculative play on a financial sector recovery.
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Bank of America
Bank of America (BAC) currently shares the joint honors of being the largest consumer bank in the U.S. -- and one of the most-hated stocks in the financial sector. It’s also one of Fairholme’s biggest open positions, making up 5.62% of the fund’s portfolio.
Negative media attention has been the name of the game at BofA lately, thanks to a constant flow of one-time charges (like the recent $8.5 billion MBS settlement), embarrassing foreclosure flubs and poor stock performance. But investors are largely ignoring this stock’s positive attributes. While remnants of the financial crisis continue to impact BofA’s financials, the firm shifted its focus back to retail banking fairly quickly after mortgages started melting down. As a result, the bank has been able to maintain a massive deposit base to fund a lending business that’s sporting higher underwriting standards.
Part of that retail focus has been building its fee-based business with the bargain-bin Merrill Lynch acquisition BofA closed in 2008. By integrating Merrill’s wealth management offerings, BofA is taking full advantage of an improved risk-neutral revenue stream. The company will need to shore up its balance sheet before the Fed lets management pay out a meaningful dividend.
Even so, I’m with Berkowitz on this one -- now could be a good opportunity to grab shares on the cheap.
Not all of Fairholme’s top holdings are financials; the No. 2 spot in the fund’s portfolio is retailer Sears Holdings (SHLD). Sears is one of the biggest full-line retailers in North America, with nearly 4,000 locations for its eponymous stores and the Kmart chain it acquired in 2005. Even if Sears isn’t a financial name, it’s certainly contrarian -- the company currently sports a massive short interest ratio of 23.2.
After making a string of bad decisions leading up to the financial crisis, Sears is finally making some significant steps to transform its tarnished image. The most significant for the long-term is the decision to sell some products from its envied brand portfolio at other stores. With names like Kenmore, Craftsman, Die Hard and Lands’ End, Sears should be able to generate significant revenues by expanding its sales presence outside of its own walls.
Also important is the shift in the way management measures its success. By taking a closer look at profitability on a smaller scale, the company should be better able to trim the operational fat.
Even though the economic recover is looking weak right now, consumer spending is at least looking promising for retailers like Sears. As consumers continue to loosen their purse strings, expect rising tides to lift all boats -- even before Sears has to prove the efficacy of its operating changes.
Financial services firm Morgan Stanley (MS) was one of the few legacy investment banks to escape the chopping block during the crisis. Because it wasn’t absorbed by a more stable retail bank, Morgan Stanley’s focus has largely remained the same even if the company is technically a bank holding company. Capital markets remain a major strength for Morgan Stanley, and the firm’s trading business continues to generate a significant chunk of revenues even as peers shied away from proprietary trading.
Like other “banks,” Morgan Stanley is working to build out its exposure to low-risk fee-based businesses like investment and wealth management. Because of the financial stability that MS currently enjoys, it should be able to successfully court affluent clients who are looking for a move from managers whose skills couldn’t cope with the difficult investing environment of the last few years.
While a pure financial play, Morgan Stanley is probably one of the least contrarian names in Fairholme’s top ten holdings. At present, Morgan Stanley makes up 5.25% of the fund’s total portfolio. Berkowitz and company clearly like the stock at current prices -- the fund picked up an additional million shares last quarter.
Morgan Stanley is also one of the top holdings in Richard Pzena's Pzena Investment Management portfolio.
Real estate is another beaten-down sector that Fairholme is betting on right now. The fund owns a 23 million share stake in St. Joe (JOE), the heavily-shorted real estate development company that’s the largest landowner in the state of Florida. In total, St. Joe holds around 577,000 acres of property in the northwest corner of the state.
Even though St. Joe’s status as a real estate holding company in one of the most volatile property-value states in the country comes with significant risks right now, the company is doing a good job of sitting on its hands while it waits for its portfolio to come around in value again. In the meantime, management is paying the bills by taking advantage of St. Joe’s original business plan: timber. Sales of timber generated 15 cents per share in profits last quarter, a message to Wall Street that the firm should have no trouble waiting for values to climb before unloading property.
Financially, St. Joe enjoys a solid net cash position that should help convince investors that this stock can weather further financial storms in the mid-term. Because of a particularly high short interest ratio in shares, this name is one of those controversial plays that investors love to debate – that said, I think that being a bull on this stock holds significant advantages.
To see the rest of Bruce Berkowitz’s stock picks for Fairholme, check out the Fairholme portfolio on Stockpickr.
-- Written by Jonas Elmerraji in Baltimore.
At the time of publication, author had no positions in stocks mentioned.
Jonas Elmerraji, based out of Baltimore, is the editor and portfolio manager of the Rhino Stock Report, a free investment advisory that returned 15% in 2008. He is a contributor to numerous financial outlets, including Forbes and Investopedia, and has been featured in Investor's Business Daily, in Consumer's Digest and on MSNBC.com.