The Secret of Bruce Berkowitz's Success

Few mutual funds look or behave like  Fairholme . That's by design. Manager Bruce Berkowitz knows that to beat the pack, you need to break from it, and he acts accordingly.

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Michael Breen is a senior fund analyst with Morningstar.

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Berkowitz's process is the inverse of most managers'. He focuses on what could go wrong, not right, with potential investments. Only after determining that going bust isn't possible does Berkowitz look for a firm's positives. Even then he anchors on the here and now, shunning the projections and big assumptions about the future that are needed for the discounted cash-flow analysis many rivals use. The phrase "positive catalyst" is never uttered at Fairholme. Berkowitz simply looks for firms with loads of cash on their balance sheets and double-digit free cash-flow yields where the coupon appears to be rising or stable. Like Warren Buffett, Berkowitz prefers to be approximately right, rather than precisely wrong.

Off the Beaten PathBerkowitz and Charlie Fernandez are the only investment professionals at the firm. Berkowitz says having dedicated industry specialists leads to skewed results, as those operating in one space often fall prey to relativism, perhaps advocating for the best option in a horrible group that should be avoided altogether. Instead, Fairholme hires an array of outside experts who not only provide raw data but also try to poke holes in Berkowitz's analysis on specific stocks and bonds. Berkowitz rarely meets with management, preferring a deep dive on the data to see if they've delivered on past promises.

A few years back, Berkowitz broadened the fund's charter, giving him flexibility to invest in a wide range of securities. This shop has one main fund that can hold nearly anything, not the dozens of funds that can hold only one type of investment. Berkowitz says he chose this route after watching several prominent investors he admired devolve into corporate keepers of their family's broad and growing fund lineups, taking them away from what they did best--investing.

Lots of RopeBerkowitz makes the most of his flexibility. The portfolio has two thirds of its assets in equities, with the remainder split between cash and a mix of short-term fixed-income securities that includes floating-rate loans, commercial paper, high-yield corporates, and convertible bonds--hardly a typical mix for a large-blend fund.

A recent deal highlights Berkowitz's adaptability. The fund owns more than $1.5 billion of convertible debt and floating-rate loans from mall operator General Growth Properties displayPTip('GGP', 'GGP','YTD', '', '', '', '', '', '','msg','P'); . Fairholme has partnered with real estate firm  Brookfield Properties displayPTip('BPO', 'BPO','YTD', '', '', '', '', '', '','msg','P'); and hedge fund Pershing Square to provide a $3.9 billion financing plan and capital backstop to help the struggling REIT emerge from bankruptcy. If General Growth continues shoring itself up, the fund's convertible bonds will pay off in spades. It's the sort of creative and advantageous deal Warren Buffett regularly does, but few mutual funds would dream of making.

The fund made a similar bet with CIT Group displayPTip('CIT', 'CIT','YTD', '', '', '', '', '', '','msg','P'); . Fairholme bought a mix of equity, senior debt, and floating-rate loans after the small-business lender's bankruptcy. In the process, CIT shed liabilities, got new management, and has returned to profitability.

This isn't the first time Berkowitz has used this playbook. In late 2008, Fairholme did a recapitalization deal with auto lender  AmeriCredit displayPTip('ACF', 'ACF','YTD', '', '', '', '', '', '','msg','P'); , exchanging its debt for a pile of new common shares. AmeriCredit got credit relief in its time of need. Fairholme gained control of a quarter of the firm's shares at a rock-bottom price and created a self-fulfilling situation. Once it was clear that AmeriCredit had shored up its liquidity, the market bid up its shares fivefold.

Against the GrainBerkowitz is dodging the herd elsewhere. Save for  Berkshire Hathaway displayPTip('BRK.A', 'BRK.A','YTD', '', '', '', '', '', '','msg','P'); , he wouldn't touch banks or insurers in 2007 because of a lack of clarity on their liabilities. That was a big reason the fund lost less than nearly all its rivals when financials went off the rails in 2008's downdraft. But now the fund has half its assets in financials. In addition to Berkshire Hathaway, AmeriCredit, and CIT Group, the fund now holds  Citigroup displayPTip('C', 'C','YTD', '', '', '', '', '', '','msg','P'); ,  Bank of America displayPTip('BAC', 'BAC','YTD', '', '', '', '', '', '','msg','P'); ,  American International displayPTip('AIG', 'AIG','YTD', '', '', '', '', '', '','msg','P'); ,  Regions Financial displayPTip('RF', 'RF','YTD', '', '', '', '', '', '','msg','P'); , and  Goldman Sachs displayPTip('GS', 'GS','YTD', '', '', '', '', '', '','msg','P'); --a recent buy. Berkowitz says government scrutiny and Treasury audits have better illuminated the landscape, giving him a comfort level in the firms' balance sheets.

Berkowitz's case for Goldman Sachs typifies his approach. He bought the stock right after the SEC charged Goldman with trading improprieties. Not many managers joined him. But Berkowitz saw little merit to the SEC's case, saying Goldman was following standard operating procedures for investment bankers. And at any rate, he says the stock tumbled by a much greater amount than any lasting damage to its operations. The firm continues to generate strong returns, and downside is limited at his entry price, according to Berkowitz. The stock trades at a forward P/E of just 7.4.

What Could Go Wrong?The fund runs big issue-specific risks, but Berkowitz's skill as a security analyst has kept that risk from biting investors.

A couple of other factors keep things on an even keel. First, Berkowitz loves cash. The fund nearly always has 20% of its assets in cash, so Berkowitz can quickly take advantage of unexpected opportunities without liquidating existing holdings. And the big cash hoards on the balance sheets of most holdings, including Berkshire Hathaway, WellCare Health Plans displayPTip('WCG', 'WCG','YTD', '', '', '', '', '', '','msg','P'); , and  Sears displayPTip('SHLD', 'SHLD','YTD', '', '', '', '', '', '','msg','P'); , have a stabilizing effect as well. As Berkowitz is fond of saying, "Cash is worth an awful lot of money when others don't have it."

Berkowitz has a good record of averaging down in stocks. He did so in 2008 and early 2009 when Sears' shares dropped by two thirds. He backed up the truck near the stock's lowest point ever, citing the firm's solid balance sheet and nearly 25% free cash-flow yield. Sears shares have since tripled, but the firm still generates a double-digit free cash-flow yield.

An area of small concern is the fund's structure as a 1940 Act mutual fund. Berkowitz is increasingly doing hedge-fund-type deals, such as the recent General Growth Properties transaction, that require patience and can be illiquid. If a rough patch leads to redemptions, Berkowitz might lose some ability to do the creative deals that are becoming his hallmark. It's a minor quibble, and it would take a landslide of redemptions to eat into the fund's gargantuan cash reserves, but it's worth monitoring.

ConclusionOnly time separates luck from skill, and this fund's risk/reward profile since its 1999 inception is no fluke. Even so, Berkowitz will stub his toe at some point. It is matter of when, not if. But expect him to remain adept at carving his own path over time.

A version of this article appeared in Morningstar FundInvestor.

Return to Discuss Submit your articles to Morningstar. Comments 1"“- of - Comments Oldest First | Newest First     1"“- of - Comments Oldest First | Newest First Add a Comment Please login or register to post a comment. Log In Register E-mail me new replies. Post Cancel Securities mentioned in this article Ticker Price($) Change(%) Morningstar Rating Morningstar Analyst Report With Morningstar Analyst reports you can get our expert Buy/Sell opinions on over 3,900 Stock and Funds Michael Breen does not own shares in any of the securities mentioned above. Find out about Morningstar's editorial policies. Video Reports How Berkowitz Got Comfortable... More Videos... Most Popular Related News Also in Fund Spy Weitz Funds Follow a Predictable PathMorningstar Fund Analyst Picks' Batting Average ImprovesA Rough Patch for Flexible Allocation FundsSome Target-Date Funds Are Grossed Out Sponsored Links Buy a Link Now Sponsor Center Please Wait... var title = $("#mstarTitle h1").text(); showAddToThisLink = function(){return addthis_open(this, '', location.href, $("#mstarTitle h1").text());}; document.getElementById('titleLink').href = document.location.href; document.getElementById('loginLink').href += escape(document.location.href); document.getElementById('addToThisLink').onclick = showAddToThisLink; if (document.referrer.toLowerCase().indexOf('discuss')>0 || document.referrer.toLowerCase().indexOf('socialize')>0 || document.referrer.toLowerCase().indexOf('peanut')>0) $(".adiscuss").show(); //Henry added code to highlight the header tab $(".h_tab1On").each(function(){ $(this).attr('class','h_tab1'); }); var colName=$("#mstarColName").text(); var fundRegx=new RegExp('\\bfund\\b', 'gi'); var stockRegx=new RegExp('\\bstock\\b', 'gi'); var etfRegx=new RegExp('\\betf\\b', 'gi'); var marketRegx=new RegExp('\\bmarket|markets\\b', 'gi'); if(fundRegx.test(colName)) { $("a[title='Funds']").attr('class','h_tab1On'); } else if(stockRegx.test(colName)) { $("a[title='Stocks']").attr('class','h_tab1On'); } else if(etfRegx.test(colName)) { $("a[title='ETFs']").attr('class','h_tab1On'); } else if(marketRegx.test(colName)) { $("a[title='Markets']").attr('class','h_tab1On'); } else { $("a[title='Investment']").attr('class','h_tab1On'); } var articleId = 350818; var title = $("#mstarTitle h1").text(); var email='michael.breen@morningstar.com'; OAS_AD('Bottom'); Content Partners Site Directory Site Map Our Products Corrections Help Advertising Opportunities Licensing Opportunities Glossary RSS Mobile Portfolio Affiliate Careers Company News International Sites: Australia Canada China France Germany Hong Kong Italy The Netherlands Norway Spain U.K. Stocks by: Title Ticker Popularity Interest Funds by: Title Symbol Popularity Interest Articles by: Title Date Popularity Interest Stock Groups by: Popularity Interest Favorites Title Fund Groups by: Popularity Interest Favorites Title Article Groups by: Popularity Interest Favorites Title Premium Stocks by: Title Ticker Popularity Interest Premium Funds by: Title Symbol Popularity Interest Premium Articles by: Title Date Popularity Interest Independent. Insightful. Trusted. Morningstar provides stock market analysis; equity, mutual fund, and ETF research, ratings, and picks; portfolio tools; and option, hedge fund, IRA, 401k, and 529 plan research. Our reliable data and analysis can help both experienced enthusiasts and newcomers. © Copyright 2010 Morningstar, Inc. All rights reserved. Please read our Terms of Useand Privacy Policy.Dow Jones Industrial Average, S&P 500, Nasdaq, and Morningstar Index (Market Barometer) quotes are real-time. Russell 2000 quote is 10 minutes delayed. var HeaderBox = initBoxQuote("AutoCompleteBox","AutoCompleteDropDown"); HeaderBox.IdleDisplayMsg = ""; HeaderBox.LocalRegion="USA"; HeaderBox.SetPreference('USA','EN',32); var FooterBox = initBoxQuote("AutoCompleteBoxFooter","AutoCompleteDropDownFooter"); FooterBox.IdleDisplayMsg = ""; FooterBox.LocalRegion="USA"; FooterBox.SetPreference('USA','EN',32); //clears all content/image boxes-------------------------------------------------------------------------------------- var imageIDs=new Array('siteDirectoryContent', 'siteMapContent', 'productsContent'); //content boxes .mi_row3{display: none} Fund Spy The Secret of Fairholme's Success

Michael Breen is a senior fund analyst with Morningstar.

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Michael Breen is a senior fund analyst with Morningstar.

Berkowitz's process is the inverse of most managers'. He focuses on what could go wrong, not right, with potential investments. Only after determining that going bust isn't possible does Berkowitz look for a firm's positives. Even then he anchors on the here and now, shunning the projections and big assumptions about the future that are needed for the discounted cash-flow analysis many rivals use. The phrase "positive catalyst" is never uttered at Fairholme. Berkowitz simply looks for firms with loads of cash on their balance sheets and double-digit free cash-flow yields where the coupon appears to be rising or stable. Like Warren Buffett, Berkowitz prefers to be approximately right, rather than precisely wrong.

Off the Beaten PathBerkowitz and Charlie Fernandez are the only investment professionals at the firm. Berkowitz says having dedicated industry specialists leads to skewed results, as those operating in one space often fall prey to relativism, perhaps advocating for the best option in a horrible group that should be avoided altogether. Instead, Fairholme hires an array of outside experts who not only provide raw data but also try to poke holes in Berkowitz's analysis on specific stocks and bonds. Berkowitz rarely meets with management, preferring a deep dive on the data to see if they've delivered on past promises.

A few years back, Berkowitz broadened the fund's charter, giving him flexibility to invest in a wide range of securities. This shop has one main fund that can hold nearly anything, not the dozens of funds that can hold only one type of investment. Berkowitz says he chose this route after watching several prominent investors he admired devolve into corporate keepers of their family's broad and growing fund lineups, taking them away from what they did best--investing.

Lots of RopeBerkowitz makes the most of his flexibility. The portfolio has two thirds of its assets in equities, with the remainder split between cash and a mix of short-term fixed-income securities that includes floating-rate loans, commercial paper, high-yield corporates, and convertible bonds--hardly a typical mix for a large-blend fund.

A recent deal highlights Berkowitz's adaptability. The fund owns more than $1.5 billion of convertible debt and floating-rate loans from mall operator General Growth Properties . Fairholme has partnered with real estate firm  Brookfield Properties displayPTip('BPO', 'BPO','YTD', '', '', '', '', '', '','msg','P'); and hedge fund Pershing Square to provide a $3.9 billion financing plan and capital backstop to help the struggling REIT emerge from bankruptcy. If General Growth continues shoring itself up, the fund's convertible bonds will pay off in spades. It's the sort of creative and advantageous deal Warren Buffett regularly does, but few mutual funds would dream of making.

The fund made a similar bet with CIT Group displayPTip('CIT', 'CIT','YTD', '', '', '', '', '', '','msg','P'); . Fairholme bought a mix of equity, senior debt, and floating-rate loans after the small-business lender's bankruptcy. In the process, CIT shed liabilities, got new management, and has returned to profitability.

This isn't the first time Berkowitz has used this playbook. In late 2008, Fairholme did a recapitalization deal with auto lender  AmeriCredit displayPTip('ACF', 'ACF','YTD', '', '', '', '', '', '','msg','P'); , exchanging its debt for a pile of new common shares. AmeriCredit got credit relief in its time of need. Fairholme gained control of a quarter of the firm's shares at a rock-bottom price and created a self-fulfilling situation. Once it was clear that AmeriCredit had shored up its liquidity, the market bid up its shares fivefold.

Against the GrainBerkowitz is dodging the herd elsewhere. Save for  Berkshire Hathaway displayPTip('BRK.A', 'BRK.A','YTD', '', '', '', '', '', '','msg','P'); , he wouldn't touch banks or insurers in 2007 because of a lack of clarity on their liabilities. That was a big reason the fund lost less than nearly all its rivals when financials went off the rails in 2008's downdraft. But now the fund has half its assets in financials. In addition to Berkshire Hathaway, AmeriCredit, and CIT Group, the fund now holds  Citigroup displayPTip('C', 'C','YTD', '', '', '', '', '', '','msg','P'); ,  Bank of America displayPTip('BAC', 'BAC','YTD', '', '', '', '', '', '','msg','P'); ,  American International displayPTip('AIG', 'AIG','YTD', '', '', '', '', '', '','msg','P'); ,  Regions Financial displayPTip('RF', 'RF','YTD', '', '', '', '', '', '','msg','P'); , and  Goldman Sachs displayPTip('GS', 'GS','YTD', '', '', '', '', '', '','msg','P'); --a recent buy. Berkowitz says government scrutiny and Treasury audits have better illuminated the landscape, giving him a comfort level in the firms' balance sheets.

Berkowitz's case for Goldman Sachs typifies his approach. He bought the stock right after the SEC charged Goldman with trading improprieties. Not many managers joined him. But Berkowitz saw little merit to the SEC's case, saying Goldman was following standard operating procedures for investment bankers. And at any rate, he says the stock tumbled by a much greater amount than any lasting damage to its operations. The firm continues to generate strong returns, and downside is limited at his entry price, according to Berkowitz. The stock trades at a forward P/E of just 7.4.

What Could Go Wrong?The fund runs big issue-specific risks, but Berkowitz's skill as a security analyst has kept that risk from biting investors.

A couple of other factors keep things on an even keel. First, Berkowitz loves cash. The fund nearly always has 20% of its assets in cash, so Berkowitz can quickly take advantage of unexpected opportunities without liquidating existing holdings. And the big cash hoards on the balance sheets of most holdings, including Berkshire Hathaway, WellCare Health Plans displayPTip('WCG', 'WCG','YTD', '', '', '', '', '', '','msg','P'); , and  Sears displayPTip('SHLD', 'SHLD','YTD', '', '', '', '', '', '','msg','P'); , have a stabilizing effect as well. As Berkowitz is fond of saying, "Cash is worth an awful lot of money when others don't have it."

Berkowitz has a good record of averaging down in stocks. He did so in 2008 and early 2009 when Sears' shares dropped by two thirds. He backed up the truck near the stock's lowest point ever, citing the firm's solid balance sheet and nearly 25% free cash-flow yield. Sears shares have since tripled, but the firm still generates a double-digit free cash-flow yield.

An area of small concern is the fund's structure as a 1940 Act mutual fund. Berkowitz is increasingly doing hedge-fund-type deals, such as the recent General Growth Properties transaction, that require patience and can be illiquid. If a rough patch leads to redemptions, Berkowitz might lose some ability to do the creative deals that are becoming his hallmark. It's a minor quibble, and it would take a landslide of redemptions to eat into the fund's gargantuan cash reserves, but it's worth monitoring.

ConclusionOnly time separates luck from skill, and this fund's risk/reward profile since its 1999 inception is no fluke. Even so, Berkowitz will stub his toe at some point. It is matter of when, not if. But expect him to remain adept at carving his own path over time.

A version of this article appeared in Morningstar FundInvestor.

Return to Discuss Submit your articles to Morningstar. Comments 1"“- of - Comments Oldest First | Newest First     1"“- of - Comments Oldest First | Newest First Add a Comment Please login or register to post a comment. Log In Register E-mail me new replies. Post Cancel Securities mentioned in this article Ticker Price($) Change(%) Morningstar Rating Morningstar Analyst Report With Morningstar Analyst reports you can get our expert Buy/Sell opinions on over 3,900 Stock and Funds Michael Breen does not own shares in any of the securities mentioned above. Find out about Morningstar's editorial policies. Video Reports How Berkowitz Got Comfortable... More Videos... Most Popular Related News Also in Fund Spy Weitz Funds Follow a Predictable PathMorningstar Fund Analyst Picks' Batting Average ImprovesA Rough Patch for Flexible Allocation FundsSome Target-Date Funds Are Grossed Out Sponsored Links Buy a Link Now Sponsor Center Please Wait... var title = $("#mstarTitle h1").text(); showAddToThisLink = function(){return addthis_open(this, '', location.href, $("#mstarTitle h1").text());}; document.getElementById('titleLink').href = document.location.href; document.getElementById('loginLink').href += escape(document.location.href); document.getElementById('addToThisLink').onclick = showAddToThisLink; if (document.referrer.toLowerCase().indexOf('discuss')>0 || document.referrer.toLowerCase().indexOf('socialize')>0 || document.referrer.toLowerCase().indexOf('peanut')>0) $(".adiscuss").show(); //Henry added code to highlight the header tab $(".h_tab1On").each(function(){ $(this).attr('class','h_tab1'); }); var colName=$("#mstarColName").text(); var fundRegx=new RegExp('\\bfund\\b', 'gi'); var stockRegx=new RegExp('\\bstock\\b', 'gi'); var etfRegx=new RegExp('\\betf\\b', 'gi'); var marketRegx=new RegExp('\\bmarket|markets\\b', 'gi'); if(fundRegx.test(colName)) { $("a[title='Funds']").attr('class','h_tab1On'); } else if(stockRegx.test(colName)) { $("a[title='Stocks']").attr('class','h_tab1On'); } else if(etfRegx.test(colName)) { $("a[title='ETFs']").attr('class','h_tab1On'); } else if(marketRegx.test(colName)) { $("a[title='Markets']").attr('class','h_tab1On'); } else { $("a[title='Investment']").attr('class','h_tab1On'); } var articleId = 350818; var title = $("#mstarTitle h1").text(); var email='michael.breen@morningstar.com'; OAS_AD('Bottom'); Content Partners Site Directory Site Map Our Products Corrections Help Advertising Opportunities Licensing Opportunities Glossary RSS Mobile Portfolio Affiliate Careers Company News International Sites: Australia Canada China France Germany Hong Kong Italy The Netherlands Norway Spain U.K. Stocks by: Title Ticker Popularity Interest Funds by: Title Symbol Popularity Interest Articles by: Title Date Popularity Interest Stock Groups by: Popularity Interest Favorites Title Fund Groups by: Popularity Interest Favorites Title Article Groups by: Popularity Interest Favorites Title Premium Stocks by: Title Ticker Popularity Interest Premium Funds by: Title Symbol Popularity Interest Premium Articles by: Title Date Popularity Interest Independent. Insightful. Trusted. Morningstar provides stock market analysis; equity, mutual fund, and ETF research, ratings, and picks; portfolio tools; and option, hedge fund, IRA, 401k, and 529 plan research. Our reliable data and analysis can help both experienced enthusiasts and newcomers. © Copyright 2010 Morningstar, Inc. All rights reserved. Please read our Terms of Useand Privacy Policy.Dow Jones Industrial Average, S&P 500, Nasdaq, and Morningstar Index (Market Barometer) quotes are real-time. Russell 2000 quote is 10 minutes delayed. var HeaderBox = initBoxQuote("AutoCompleteBox","AutoCompleteDropDown"); HeaderBox.IdleDisplayMsg = ""; HeaderBox.LocalRegion="USA"; HeaderBox.SetPreference('USA','EN',32); var FooterBox = initBoxQuote("AutoCompleteBoxFooter","AutoCompleteDropDownFooter"); FooterBox.IdleDisplayMsg = ""; FooterBox.LocalRegion="USA"; FooterBox.SetPreference('USA','EN',32); //clears all content/image boxes-------------------------------------------------------------------------------------- var imageIDs=new Array('siteDirectoryContent', 'siteMapContent', 'productsContent'); //content boxes .mi_row3{display: none} Fund Spy The Secret of Fairholme's Success

Michael Breen is a senior fund analyst with Morningstar.

http://news.morningstar.com/articlenet/article.aspx?id=350818 michael.breen@morningstar.com; function AdjustSpace() { $(".a").each(function () { $(this).html($(this).html().replace(/displayPTip\(.*/ig,'').replace(/\)\s+([\,\;\.\!])/ig, ')$1')); }); $(".b").each(function () { $(this).html($(this).html().replace(/displayPTip\(.*/ig,'').replace(/\)\s+([\,\;\.\!])/ig, ')$1')); }); } var _gaq = _gaq || []; _gaq.push(['_setAccount', 'UA-16669347-1']); _gaq.push(['_setDomainName', '.morningstar.com']); _gaq.push(['_trackPageview']); (function() { var ga = document.createElement('script'); ga.type = 'text/javascript'; ga.async = true; ga.src = ('https:' == document.location.protocol ? 'https://ssl' : 'http://www') + '.google-analytics.com/ga.js'; var s = document.getElementsByTagName('script')[0]; s.parentNode.insertBefore(ga, s); })(); var Name = $('meta[name=DC.Creator]').attr("content").split(','); var Title = $('meta[name=DC.Title]').attr("content"); var URL = window.location.href; var Author = Name[1] + " " + Name[0]; var PubDate = $('meta[name=DC.Date]').attr("content"); _gaq.push(['_trackEvent', 'Article Title From Morningstar', Title, URL]); _gaq.push(['_trackEvent', 'Author Name From Morningstar', Author, URL]); _gaq.push(['_trackEvent', 'Article URL From Morningstar', URL, Title + "(by " + Author + " on " + PubDate + ")"]); _gaq.push(['_trackEvent', 'Publish Date From Morningstar', PubDate, URL]); _gaq.push(['_trackEvent', 'Article Title', Title, URL]); _gaq.push(['_trackEvent', 'Author Name', Author, URL]); _gaq.push(['_trackEvent', 'Article URL', URL, Title + "(by " + Author + " on " + PubDate + ")"]); _gaq.push(['_trackEvent', 'Publish Date', PubDate, URL]);

The fund made a similar bet with CIT Group . Fairholme bought a mix of equity, senior debt, and floating-rate loans after the small-business lender's bankruptcy. In the process, CIT shed liabilities, got new management, and has returned to profitability.

This isn't the first time Berkowitz has used this playbook. In late 2008, Fairholme did a recapitalization deal with auto lender  AmeriCredit displayPTip('ACF', 'ACF','YTD', '', '', '', '', '', '','msg','P'); , exchanging its debt for a pile of new common shares. AmeriCredit got credit relief in its time of need. Fairholme gained control of a quarter of the firm's shares at a rock-bottom price and created a self-fulfilling situation. Once it was clear that AmeriCredit had shored up its liquidity, the market bid up its shares fivefold.

Against the GrainBerkowitz is dodging the herd elsewhere. Save for  Berkshire Hathaway displayPTip('BRK.A', 'BRK.A','YTD', '', '', '', '', '', '','msg','P'); , he wouldn't touch banks or insurers in 2007 because of a lack of clarity on their liabilities. That was a big reason the fund lost less than nearly all its rivals when financials went off the rails in 2008's downdraft. But now the fund has half its assets in financials. In addition to Berkshire Hathaway, AmeriCredit, and CIT Group, the fund now holds  Citigroup displayPTip('C', 'C','YTD', '', '', '', '', '', '','msg','P'); ,  Bank of America displayPTip('BAC', 'BAC','YTD', '', '', '', '', '', '','msg','P'); ,  American International displayPTip('AIG', 'AIG','YTD', '', '', '', '', '', '','msg','P'); ,  Regions Financial displayPTip('RF', 'RF','YTD', '', '', '', '', '', '','msg','P'); , and  Goldman Sachs displayPTip('GS', 'GS','YTD', '', '', '', '', '', '','msg','P'); --a recent buy. Berkowitz says government scrutiny and Treasury audits have better illuminated the landscape, giving him a comfort level in the firms' balance sheets.

Berkowitz's case for Goldman Sachs typifies his approach. He bought the stock right after the SEC charged Goldman with trading improprieties. Not many managers joined him. But Berkowitz saw little merit to the SEC's case, saying Goldman was following standard operating procedures for investment bankers. And at any rate, he says the stock tumbled by a much greater amount than any lasting damage to its operations. The firm continues to generate strong returns, and downside is limited at his entry price, according to Berkowitz. The stock trades at a forward P/E of just 7.4.

What Could Go Wrong?The fund runs big issue-specific risks, but Berkowitz's skill as a security analyst has kept that risk from biting investors.

A couple of other factors keep things on an even keel. First, Berkowitz loves cash. The fund nearly always has 20% of its assets in cash, so Berkowitz can quickly take advantage of unexpected opportunities without liquidating existing holdings. And the big cash hoards on the balance sheets of most holdings, including Berkshire Hathaway, WellCare Health Plans displayPTip('WCG', 'WCG','YTD', '', '', '', '', '', '','msg','P'); , and  Sears displayPTip('SHLD', 'SHLD','YTD', '', '', '', '', '', '','msg','P'); , have a stabilizing effect as well. As Berkowitz is fond of saying, "Cash is worth an awful lot of money when others don't have it."

Berkowitz has a good record of averaging down in stocks. He did so in 2008 and early 2009 when Sears' shares dropped by two thirds. He backed up the truck near the stock's lowest point ever, citing the firm's solid balance sheet and nearly 25% free cash-flow yield. Sears shares have since tripled, but the firm still generates a double-digit free cash-flow yield.

An area of small concern is the fund's structure as a 1940 Act mutual fund. Berkowitz is increasingly doing hedge-fund-type deals, such as the recent General Growth Properties transaction, that require patience and can be illiquid. If a rough patch leads to redemptions, Berkowitz might lose some ability to do the creative deals that are becoming his hallmark. It's a minor quibble, and it would take a landslide of redemptions to eat into the fund's gargantuan cash reserves, but it's worth monitoring.

ConclusionOnly time separates luck from skill, and this fund's risk/reward profile since its 1999 inception is no fluke. Even so, Berkowitz will stub his toe at some point. It is matter of when, not if. But expect him to remain adept at carving his own path over time.

A version of this article appeared in Morningstar FundInvestor.

Return to Discuss Submit your articles to Morningstar. Comments 1"“- of - Comments Oldest First | Newest First     1"“- of - Comments Oldest First | Newest First Add a Comment Please login or register to post a comment. Log In Register E-mail me new replies. Post Cancel Securities mentioned in this article Ticker Price($) Change(%) Morningstar Rating Morningstar Analyst Report With Morningstar Analyst reports you can get our expert Buy/Sell opinions on over 3,900 Stock and Funds Michael Breen does not own shares in any of the securities mentioned above. Find out about Morningstar's editorial policies. Video Reports How Berkowitz Got Comfortable... More Videos... Most Popular Related News Also in Fund Spy Weitz Funds Follow a Predictable PathMorningstar Fund Analyst Picks' Batting Average ImprovesA Rough Patch for Flexible Allocation FundsSome Target-Date Funds Are Grossed Out Sponsored Links Buy a Link Now Sponsor Center Please Wait... var title = $("#mstarTitle h1").text(); showAddToThisLink = function(){return addthis_open(this, '', location.href, $("#mstarTitle h1").text());}; document.getElementById('titleLink').href = document.location.href; document.getElementById('loginLink').href += escape(document.location.href); document.getElementById('addToThisLink').onclick = showAddToThisLink; if (document.referrer.toLowerCase().indexOf('discuss')>0 || document.referrer.toLowerCase().indexOf('socialize')>0 || document.referrer.toLowerCase().indexOf('peanut')>0) $(".adiscuss").show(); //Henry added code to highlight the header tab $(".h_tab1On").each(function(){ $(this).attr('class','h_tab1'); }); var colName=$("#mstarColName").text(); var fundRegx=new RegExp('\\bfund\\b', 'gi'); var stockRegx=new RegExp('\\bstock\\b', 'gi'); var etfRegx=new RegExp('\\betf\\b', 'gi'); var marketRegx=new RegExp('\\bmarket|markets\\b', 'gi'); if(fundRegx.test(colName)) { $("a[title='Funds']").attr('class','h_tab1On'); } else if(stockRegx.test(colName)) { $("a[title='Stocks']").attr('class','h_tab1On'); } else if(etfRegx.test(colName)) { $("a[title='ETFs']").attr('class','h_tab1On'); } else if(marketRegx.test(colName)) { $("a[title='Markets']").attr('class','h_tab1On'); } else { $("a[title='Investment']").attr('class','h_tab1On'); } var articleId = 350818; var title = $("#mstarTitle h1").text(); var email='michael.breen@morningstar.com'; OAS_AD('Bottom'); Content Partners Site Directory Site Map Our Products Corrections Help Advertising Opportunities Licensing Opportunities Glossary RSS Mobile Portfolio Affiliate Careers Company News International Sites: Australia Canada China France Germany Hong Kong Italy The Netherlands Norway Spain U.K. Stocks by: Title Ticker Popularity Interest Funds by: Title Symbol Popularity Interest Articles by: Title Date Popularity Interest Stock Groups by: Popularity Interest Favorites Title Fund Groups by: Popularity Interest Favorites Title Article Groups by: Popularity Interest Favorites Title Premium Stocks by: Title Ticker Popularity Interest Premium Funds by: Title Symbol Popularity Interest Premium Articles by: Title Date Popularity Interest Independent. Insightful. Trusted. Morningstar provides stock market analysis; equity, mutual fund, and ETF research, ratings, and picks; portfolio tools; and option, hedge fund, IRA, 401k, and 529 plan research. Our reliable data and analysis can help both experienced enthusiasts and newcomers. © Copyright 2010 Morningstar, Inc. All rights reserved. Please read our Terms of Useand Privacy Policy.Dow Jones Industrial Average, S&P 500, Nasdaq, and Morningstar Index (Market Barometer) quotes are real-time. Russell 2000 quote is 10 minutes delayed. var HeaderBox = initBoxQuote("AutoCompleteBox","AutoCompleteDropDown"); HeaderBox.IdleDisplayMsg = ""; HeaderBox.LocalRegion="USA"; HeaderBox.SetPreference('USA','EN',32); var FooterBox = initBoxQuote("AutoCompleteBoxFooter","AutoCompleteDropDownFooter"); FooterBox.IdleDisplayMsg = ""; FooterBox.LocalRegion="USA"; FooterBox.SetPreference('USA','EN',32); //clears all content/image boxes-------------------------------------------------------------------------------------- var imageIDs=new Array('siteDirectoryContent', 'siteMapContent', 'productsContent'); //content boxes .mi_row3{display: none} Fund Spy The Secret of Fairholme's Success

Michael Breen is a senior fund analyst with Morningstar.

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This isn't the first time Berkowitz has used this playbook. In late 2008, Fairholme did a recapitalization deal with auto lender  AmeriCredit , exchanging its debt for a pile of new common shares. AmeriCredit got credit relief in its time of need. Fairholme gained control of a quarter of the firm's shares at a rock-bottom price and created a self-fulfilling situation. Once it was clear that AmeriCredit had shored up its liquidity, the market bid up its shares fivefold.

Against the GrainBerkowitz is dodging the herd elsewhere. Save for  Berkshire Hathaway displayPTip('BRK.A', 'BRK.A','YTD', '', '', '', '', '', '','msg','P'); , he wouldn't touch banks or insurers in 2007 because of a lack of clarity on their liabilities. That was a big reason the fund lost less than nearly all its rivals when financials went off the rails in 2008's downdraft. But now the fund has half its assets in financials. In addition to Berkshire Hathaway, AmeriCredit, and CIT Group, the fund now holds  Citigroup displayPTip('C', 'C','YTD', '', '', '', '', '', '','msg','P'); ,  Bank of America displayPTip('BAC', 'BAC','YTD', '', '', '', '', '', '','msg','P'); ,  American International displayPTip('AIG', 'AIG','YTD', '', '', '', '', '', '','msg','P'); ,  Regions Financial displayPTip('RF', 'RF','YTD', '', '', '', '', '', '','msg','P'); , and  Goldman Sachs displayPTip('GS', 'GS','YTD', '', '', '', '', '', '','msg','P'); --a recent buy. Berkowitz says government scrutiny and Treasury audits have better illuminated the landscape, giving him a comfort level in the firms' balance sheets.

Berkowitz's case for Goldman Sachs typifies his approach. He bought the stock right after the SEC charged Goldman with trading improprieties. Not many managers joined him. But Berkowitz saw little merit to the SEC's case, saying Goldman was following standard operating procedures for investment bankers. And at any rate, he says the stock tumbled by a much greater amount than any lasting damage to its operations. The firm continues to generate strong returns, and downside is limited at his entry price, according to Berkowitz. The stock trades at a forward P/E of just 7.4.

What Could Go Wrong?The fund runs big issue-specific risks, but Berkowitz's skill as a security analyst has kept that risk from biting investors.

A couple of other factors keep things on an even keel. First, Berkowitz loves cash. The fund nearly always has 20% of its assets in cash, so Berkowitz can quickly take advantage of unexpected opportunities without liquidating existing holdings. And the big cash hoards on the balance sheets of most holdings, including Berkshire Hathaway, WellCare Health Plans displayPTip('WCG', 'WCG','YTD', '', '', '', '', '', '','msg','P'); , and  Sears displayPTip('SHLD', 'SHLD','YTD', '', '', '', '', '', '','msg','P'); , have a stabilizing effect as well. As Berkowitz is fond of saying, "Cash is worth an awful lot of money when others don't have it."

Berkowitz has a good record of averaging down in stocks. He did so in 2008 and early 2009 when Sears' shares dropped by two thirds. He backed up the truck near the stock's lowest point ever, citing the firm's solid balance sheet and nearly 25% free cash-flow yield. Sears shares have since tripled, but the firm still generates a double-digit free cash-flow yield.

An area of small concern is the fund's structure as a 1940 Act mutual fund. Berkowitz is increasingly doing hedge-fund-type deals, such as the recent General Growth Properties transaction, that require patience and can be illiquid. If a rough patch leads to redemptions, Berkowitz might lose some ability to do the creative deals that are becoming his hallmark. It's a minor quibble, and it would take a landslide of redemptions to eat into the fund's gargantuan cash reserves, but it's worth monitoring.

ConclusionOnly time separates luck from skill, and this fund's risk/reward profile since its 1999 inception is no fluke. Even so, Berkowitz will stub his toe at some point. It is matter of when, not if. But expect him to remain adept at carving his own path over time.

A version of this article appeared in Morningstar FundInvestor.

Return to Discuss Submit your articles to Morningstar. Comments 1"“- of - Comments Oldest First | Newest First     1"“- of - Comments Oldest First | Newest First Add a Comment Please login or register to post a comment. Log In Register E-mail me new replies. Post Cancel Securities mentioned in this article Ticker Price($) Change(%) Morningstar Rating Morningstar Analyst Report With Morningstar Analyst reports you can get our expert Buy/Sell opinions on over 3,900 Stock and Funds Michael Breen does not own shares in any of the securities mentioned above. Find out about Morningstar's editorial policies. Video Reports How Berkowitz Got Comfortable... More Videos... Most Popular Related News Also in Fund Spy Weitz Funds Follow a Predictable PathMorningstar Fund Analyst Picks' Batting Average ImprovesA Rough Patch for Flexible Allocation FundsSome Target-Date Funds Are Grossed Out Sponsored Links Buy a Link Now Sponsor Center Please Wait... var title = $("#mstarTitle h1").text(); showAddToThisLink = function(){return addthis_open(this, '', location.href, $("#mstarTitle h1").text());}; document.getElementById('titleLink').href = document.location.href; document.getElementById('loginLink').href += escape(document.location.href); document.getElementById('addToThisLink').onclick = showAddToThisLink; if (document.referrer.toLowerCase().indexOf('discuss')>0 || document.referrer.toLowerCase().indexOf('socialize')>0 || document.referrer.toLowerCase().indexOf('peanut')>0) $(".adiscuss").show(); //Henry added code to highlight the header tab $(".h_tab1On").each(function(){ $(this).attr('class','h_tab1'); }); var colName=$("#mstarColName").text(); var fundRegx=new RegExp('\\bfund\\b', 'gi'); var stockRegx=new RegExp('\\bstock\\b', 'gi'); var etfRegx=new RegExp('\\betf\\b', 'gi'); var marketRegx=new RegExp('\\bmarket|markets\\b', 'gi'); if(fundRegx.test(colName)) { $("a[title='Funds']").attr('class','h_tab1On'); } else if(stockRegx.test(colName)) { $("a[title='Stocks']").attr('class','h_tab1On'); } else if(etfRegx.test(colName)) { $("a[title='ETFs']").attr('class','h_tab1On'); } else if(marketRegx.test(colName)) { $("a[title='Markets']").attr('class','h_tab1On'); } else { $("a[title='Investment']").attr('class','h_tab1On'); } var articleId = 350818; var title = $("#mstarTitle h1").text(); var email='michael.breen@morningstar.com'; OAS_AD('Bottom'); Content Partners Site Directory Site Map Our Products Corrections Help Advertising Opportunities Licensing Opportunities Glossary RSS Mobile Portfolio Affiliate Careers Company News International Sites: Australia Canada China France Germany Hong Kong Italy The Netherlands Norway Spain U.K. Stocks by: Title Ticker Popularity Interest Funds by: Read Full Article »