ebook essays pieces of the puzzle
Wednesday, August 17th, 2011
feeling the pain

Josh Brown had an outstanding posting yesterday on Bruce Berkowitz and the Fairholme Fund.  It’s required reading for the insight it provides into the investment process (and, therefore, manager selection).

The chart above shows the total return over the last year for Fairholme (FAIRX), as well as the S&P 500, the Russell 1000 Value Index (Fairholme’s prospectus benchmark), and two of the stocks that have led to “the pain of running money in the public eye,” as Brown’s title so aptly stated.

There is a great deal to chew on here.  In behavioral terms, the attributes that can lead to success in one kind of market can lead to failure in another, and unless you have regular contact with a portfolio manager, you can’t discern whether you are seeing obstinance that will lead to tragedy or focus and guts that will lead to glory.  Plus, there is a very thin line between the two and luck plays a role in which way it breaks.  Furthermore, buying every dip in “your” stocks was a much easier path to success when you could count on investor cash flows coming in.  (That was then, this is now.)

As Brown notes, the Berkowitz drama is being played out for all to see.  There is truly “a nation of armchair portfolio managers” (advisors and investors) watching closely, too closely, and often making judgments for just the wrong reason.  And Berkowitz clearly loves the spotlight that shines upon him.

So, if the concentrated bets in some of the riskiest names pay off, what will happen?  Berkowitz will be said to have been “right,” will get mutual fund awards, and the assets will flood in.  If it goes the other way, he’ll be “wrong,” and the redemptions will be massive.  There seems to be relatively little chance of middling performance.

So, if you look at process and not outcome, you can see what you are getting if you invest in Fairholme.  Its manager is a gambler, one who will make big bets and often play the long odds.  Every detail you examine (and every bit of performance information you digest) has to be viewed in light of that reality.

As for the chart, you can see the fund moved with the indexes during the first half of the period.  After that, it began to be weighed down by significant declines in several key holdings, including AIG and JOE, and it severely underperformed overall.

Who knows what the next act of this drama will bring?  But you know who the lead is and how he plays his part.  (Chart:  Bloomberg terminal.)