Bruce Berkowitz on Portfolio Concentration & His Investments: WealthTrack Interview

Bruce Berkowitz of Fairholme Capital recently appeared on Consuelo Mack's WealthTrack to talk about his approach and his investments.


Berkowitz on Portfolio Concentration

Berkowitz said that, "The history of success, those who have succeeded well... they are focused on few activities.  He also went on to ask: "Why would you possibly want to buy your 10th best idea, if you can buy more of your best idea?"  He believes it makes sense to diversify more if you have less confidence in your picks though.

The Fairholme man doesn't think you need more than 10 stocks in a portfolio.  He said that you only need "a few good ideas" in a lifetime to do extremely well.  He likes to invest over the long-term and typically looks at investments with a five-year horizon.


Fairholme's Ideas

"Ignore the crowd" is Berkowitz's investing mantra.  At the time he made his AIG investment, he was definitely following that saying.  Nowadays, AIG is perhaps becoming more crowded as investors come around to the name and the government sells down its stake.  We've talked about how various hedge funds have been buying AIG this year.

We've posted up Berkowitz's AIG thesis as well as Glenn Tongue's presentation on AIG from the recent Value Investing Congress for more in-depth color on the name.

Berkowitz also has a large holding in Bank of America (BAC) as well, noting that many investors aren't touching it until "uncertainty" lifts.  Speaking about his financial purchases, he says he bought "systemically important companies at a fraction of their liquidating values."


Fairholme's Portfolio

Here's a look at Fairholme Fund's top three holdings as of the end of September:

1. AIG (AIG): 36.2% of fund
2. Sears Holdings (SHLD): 10.8%
3. Bank of America (BAC): 9.9%

Embedded below is the video of Berkowitz's interview:



For more on this investor, check out the following resources from Berkowitz himself:

- Berkowitz's MBIA investment thesis

- Berkowitz's Sears thesis

- Fairholme's presentation on Bank of America

Oak Value Fund Adds Activision Blizzard (ATVI) & Intuit (INTU): Investor Letter

We recently came across the fourth quarter 2009 investor letter from David Carr Jr's Oak Value Fund and thought our readers would enjoy it. After all, we like to track investment managers that employ fundamental research processes with a long-term time horizon. Oak Value certainly fits the bill, so let's see what they were up to in the fourth quarter of last year.

They made a few additions to their portfolio as they bought shares of Activision Blizzard (ATVI), Intuit (INTU), and XTO Energy (XTO). They added shares of ATVI because they believe this company is the industry leader in the subscriber-based revenue model of gaming. They were fond of Intuit because of its large consumer base, high operating profit margins, high returns on capital and significant free cash flow. Lastly, they purchased shares of XTO under the belief that natural gas is a viable energy alternative. Right after Oak Value's investment into XTO, Exxon Mobil came in with an offer to purchase the company.

Sales in their portfolio from the fourth quarter include Cadbury (CBY) and Syngenta (SYT). Their sale of Cadbury is notable because it appears they exited the position too soon as a potential deal has finally been struck between Cadbury and Kraft Foods. We've seen many hedge funds play both sides of this event-driven scenario as Bill Ackman's Pershing Square owns a lot of Kraft, as does legendary investor Warren Buffett. On the other side, we saw John Paulson's hedge fund Paulson & Co with a large Cadbury stake.

Oak Value sold their shares of Syngenta due to a decreased margin of safety as well as the fact that they saw more opportunistic areas to deploy their capital.

Here are Oak Value Fund's Top Ten Holdings as of December 31st, 2009:

1. Berkshire Hathaway (BRK.A): 6.75%
2. Avon Products (AVP): 5.5%
3. Coach (COH): 5.47%
4. American Express (AXP): 5.06%
5. Oracle (ORCL): 4.85%
6. Cisco Systems (CSCO): 4.57%
7. Praxair (PX): 4.56%
8. Republic Services (RSG): 4.54%
9. Diageo (DEO): 4.31%
10. 3M (MMM): 4.1%

Interestingly enough, one of their top 10 holdings is also on the list of most popular stocks held by hedge funds. Here is Oak Value Fund's fourth quarter 2009 letter to investors:




You can also download the .pdf of the letter here.

For background on Oak Value Fund, here's what you need to know: Taken from their website, they "approach investing with the philosophy, supported by a long historical background, that current market price is not always an accurate reflection of the true worth of a business. Our essential investing premise is that we can be successful over time by buying high quality companies with solid competitive advantages, run by capable, fair-minded management teams, purchased at sizable discounts from their intrinsic values."

Fairholme's Bruce Berkowitz Likes Healthcare Plays

We haven't covered Bruce Berkowitz on Market Folly before since we primarily track hedge funds here. However, there's no reason we shouldn't track him seeing how he is smart, an excellent stockpicker, and runs a concentrated portfolio. For those of you unfamiliar, Berkowitz runs the Fairholme mutual fund (FAIRX).

A $10,000 investment in his fund back in 1999 would today be worth almost $33,000. He founded Fairholme back in 1997 after a career as a managing director for Smith Barney. His Fairholme portfolio typically holds only 15-25 stocks, 20% cash, and employs a value approach. Berkowitz likes to see solid management teams coupled with undervalued companies. His concentrated portfolio allows him to 'bet big' on the stocks he sniffs out.

With this in mind, let's check out his latest focus: healthcare reform. In a recent publication from Money magazine, Berkowitz said he thinks the market is overestimating the impact that Obama's plans will have on healthcare companies. In fact, Berkowitz likes healthcare plays so much that he's put around 25% of Fairholme's portfolio in these sorts of companies. He doesn't think that healthcare reform will hurt profits for drug and hospital companies as much as others anticipate.

So, what companies does Berkowitz like? Here are his picks:

Humana (HUM) and WellPoint (WLP)

With both companies possessing P/E ratios of less than 10, they certainly fit Fairholme's undervalued focus. Berkowitz says that, "these insurers are both generating a significant amount of cash, and that's not reflected in their low stock prices. We don't believe the government will take over providing health insurance, despite fears otherwise."

Pfizer (PFE) and Forest Laboratories (FRX)

These companies also sport low P/E ratios and Berkowitz has taken notice. He says that, "a decade ago people overpaid for drug stocks because they were overly optimistic about earnings potential. Today that pendulum has swung so far the other way that some stocks are priced below their true value." Shares of Pfizer have been marching higher in stair-stepping fashion and trade at much lower multiples than they have historically.

We make special note of PFE because we've noticed many hedge funds buying shares over the past few quarters. After all, Pfizer was the second most popular stock held by hedge funds. Berkowitz is certainly not alone in his fondness for this name. John Griffin's hedge fund Blue Ridge Capital had Pfizer as their third largest US equity holding when last we checked. Whitney Tilson's hedge fund T2 Partners is long PFE. Also, David Einhorn's Greenlight Capital also has a sizable stake in Pfizer and has been bullish on their prospects. While shares have been marching higher, we'll have to see if they continue to do so given the large 'smart money' presence.

So, some interesting picks from Fairholme's Berkowitz. He certainly feels others have overestimated the impact of healthcare reform on these companies. After all, he has almost a quarter of his portfolio in this sector. Lastly, in other interesting news out of Fairholme, we saw earlier that Berkowitz would be opening a bond fund after enjoying success with his equity fund. We'll continue to track his portfolio going forward.

Hedge-like Strategy Mutual Funds (Again)

This really is starting to get ridiculous. Yesterday, we got word out of money manager Van Eck Global that they would be launching a Multi-Manager Alternatives Fund under the symbol VMAAX. It is an open ended fund and, wait for it, they are pursuing "hedge-like strategies." This is yet another offering for retail investors of the globe aiming to pursue strategies normally reserved for the high net worth crowd. Yet, despite their so-called hedge-like strategies, rest assured... this mutual fund will still adhere to the "same SEC regulations that apply to all similarly situated open-end mutual funds" Van Eck says.

For plenty of reading on the topic, check out our past post on QAI: a hedge fund ETF, on WisdomTree's hedge fund ETFs, or on mutual funds using hedge fund strategies. Overall, we don't see the point of these vehicles as they cannot truly replicate the investment process. Additionally, we've found that these ETFs and funds end up just investing in other ETFs in a fund-of-funds type of structure. And lastly, we'll have to truly reserve judgment until they can prove that they can even match the returns that they are targeting over time. Right now, they essentially have no track record. Money managers keep rolling these out as if they're all the rage. We really don't have anymore to say on the subject besides reporting this super-new and super-never-done-before development. That was sarcasm, by the way.

Yawn. Wake us up when all the offerings in this regard die down.

(click to enlarge)

Mutual Funds Using Hedge Fund Strategies

Typically, most vanilla mutual funds don't short stocks. They are usually long-only funds aimed at matching or beating certain benchmarks. But, over the past few years, we've seen an evolution in the arena of money management and actively managed portfolios. Case in point: We've just learned that $14 billion Turner Investment Partners is launching the Turner Spectrum Fund which aims to earn similar returns as hedge funds by employing those strategies. The fund will have two share classes: an Institutional class charging a 1.95% fee (minimum investment of $100,000) and a Retail class which will charge a 2.2% fee with a $2500 minimum. However, unlike hedge funds, these mutual funds will not charge a performance fee. (Hedge funds typically charge a flat management fee of around 2% and then a performance based fee of 20% of all profits).

Essentially, Turner is relying on their managers to create six other long-short equity strategies including: market-neutral, a financial sector, a healthcare sector, and other sector strategies. It will be interesting to monitor their progress and their performance. They've launched these funds as a way to capitalize on those investors hesitant to invest in hedge funds themselves given how the Bernie Madoff saga has scarred the industry. Keep in mind that this is not a new development on the scene. Instead, they are merely taking the ball and running with it.

Both Legg Mason and AQR Capital have mutual funds using similar hedge fund-like strategies. Also, there are many individual mutual fund managers that are shorting stocks in their mutual fund portfolios. One of the most well-known would have to be Ken Heebner, of CGM Funds. Heebner runs a very active book, turning over the portfolio numerous time within each year. And, his use of shorting definitely draws him closer to a long/short equity hedge fund strategy. He correctly shorted Washington Mutual among others in the turmoil of 2008. However, his small short portfolio was not enough to stave off massive losses in his longs. After having a rampantly successful year in 2007, Heebner came crashing down in 2008. His CGMFX mutual fund was down over 48%. Even though he was using hedge fund-like strategies, he could not avoid losses either. Interestingly enough, we've also noted that Heebner himself will be starting a hedge fund, Wayfarer Capital.

Another example of possible flaws in these hedge fund vehicles came to light when we highlighted QAI, a hedge fund strategy exchange traded fund (etf). We had numerous criticisms of that vehicle and questioned it's ability to truly replicate hedge fund performance. Instead of operating like an individual hedge fund, it seems to be more like a hedge fund of funds that combines various strategies into one collective portfolio. We'll have to check out the fine details of the Turner Spectrum Fund as well.

As a whole, the rough market of 2008 has definitely highlighted the benefits of being truly hedged to downside risk. As such, there's definitely demand from investors for vehicles that can protect them from losses and generate returns in any market. But, the aforementioned mutual funds and ETFs aren't necessarily "hedged vehicles," but rather vehicles seeking hedge fund returns. And, in 2008, hedge funds as a whole didn't perform that well, as they too suffered losses. Well, that is, except for a select few (as we highlighted in our 2008 full year hedge fund performance numbers).

Another major problem here is that they won't be able to truly replicate hedge fund strategies to their fullest extent. And, they aren't really even trying to replicate the strategies as much as they are trying to replicate just the returns. This is mainly due to the limitations and restrictions of the only vehicles they can really provide to investors: mutual funds and exchange traded funds. Sure, they are shorting like a hedge fund would. But, are they using options, bonds, notes and other means to take advantage of unique situations? Are they trading currencies or commodities? Are they turning activist on management teams to institute change? Are they running quantitative algorithms with proven performance? Surely they cannot be that precise. And, they won't be. Their goal of 'earning returns like hedge funds' is so broad and vague that it's pretty much open for interpretation. In the end, it doesn't seem like it matters how they get to the end result. As long as they 'generate returns like hedge funds,' they'll deem the vehicle a success.

While these hedge fund replication vehicles mean well, they are far from perfect. They may prove us wrong and come directly in line with hedge fund benchmarks and performance metrics. But, only time will tell and that's why we intend to monitor them. As is often the case with Wall Street, investments can be marketed differently than what they truly are. And, right now, it seems like the phrase 'hedge fund-like returns' is all the rage. Obviously a distinction will have to be made between the terminology of 'using hedge fund strategies' versus 'aiming for hedge fund returns.' The catchphrase of 'using hedge fund strategies' would more likely attempt to replicate their actual portfolios. 'Aiming for hedge fund returns,' on the other hand, is vague and implies that they will invest however they please, as long as they match the numbers they are attempting to duplicate. In the end, these vehicles are not nor will they ever be truly like hedge funds. But, given the bad year hedge funds had and the overall crazy environment, maybe that's not such a bad thing.

Mutual Funds Getting Killed

The Stock Market is kicking ass and taking names (of fund managers everywhere).

"Out of almost 2,100 diversified retail U.S. stock mutual funds that are open to new investors, just 17 have positive returns for both the past 12 months and year-to-date, according to investment researcher Morningstar Inc."

Source: MarketWatch