Interview with Bruce Berkowitz
Consuelo Mack WealthTrack - October 12, 2012 - Full Transcript
Great investor and Morningstar fund manager of the decade, Bruce Berkowitz discusses his controversial concentration in financial stocks, and other unloved securities.
CONSUELO MACK: This week on WealthTrack, Fairholme Fund’s Bruce Berkowitz explains why he is ignoring the crowd and swimming with financial stocks while other investors flee! An exclusive interview with Great Investor Bruce Berkowitz is next on Consuelo Mack WealthTrack.
Hello and welcome to this edition of WealthTrack, I’m Consuelo Mack. “Ignore the crowd” is the motto of this week’s Great Investor guest, and Fairholme Fund’s Bruce Berkowitz has had his work cut out for himself defending it, especially in 2011.
The roar of the crowd was deafening as Berkowitz heavily invested in a handful of stocks left for dead by most investors. Fairholme’s largest holding by far is AIG, the global insurer brought to its knees and then resuscitated by the U.S. government. Next is Sears Holdings, the long out of favor retailer and corporate real estate behemoth. Fairholme is the second largest shareholder after Sears chairman, Eddie Lampert. The fund’s third biggest holding is Bank of America, which is still under legal assault related to its Merrill Lynch acquisition and mortgage business. The three companies account for over 50% of Fairholme’s portfolio.
That concentration in then declining unloved companies freaked out shareholders, who abandoned ship in droves last year. Assets under management had climbed to a high of $20.5 billion by early 2011, helped by Berkowitz being named Morningstar’s first ever Domestic Equity Fund Manager of the Decade and his exceptional 13.2% annualized returns for the period; assets have since fallen to the $7 billion range since. One of shareholders who has not fled is Berkowitz himself, who has much of his wealth invested in the Fairholme Funds. As with the vast majority of our Great Investors, staying with them through thick and thin has proven to be a profitable decision. The Fairholme Fund’s 10% annualized returns over the last decade place it in the top one percent of its large value category and have handily beaten the market.
Bruce Berkowitz is the sole owner of Fairholme Capital Management, its chief investment officer plus portfolio manager of the flagship Fairholme Fund, launched in 1999, and two much smaller and more recent ones. In addition to Manager of the Decade, Morningstar also named Berkowitz Domestic Equity Fund Manager of the Year in 2009. I began the interview by asking him why his fund remains so concentrated in so few companies.
BRUCE BERKOWITZ: It's the history of success. When you want to look at the Fortune 400 or those who’ve really succeeded well, they have focused on few activities. One could say well, they were running those activities, but I think we focused on companies that the managers could do a better job than I could. And that’s the reason. So the point being, why would you possibly want to buy your tenth best idea if you can buy more of your best idea?
So I understand if you're not confident or you feel ignorant about what you're doing, I could understand the need to have a lot of positions. But if you believe you've focused and you understand, and the facts are telling you that you're right, then I don’t believe there's a need for more than ten, and you could have a handful of significant positions and do quite well in this world. You only need a few ideas and a lifetime to do unbelievably well. And that's what we’re trying to achieve. That's what we’ve promised. We’ve kept our word and we’ve stayed the course. And no matter how shareholders may feel, after a decline, we’re going to keep to what we said we would do.
CONSUELO MACK: So let’s talk about the few good ideas. And of course your motto is ‘ignore the crowd.’ You certainly have done that, in spades, no question. And you've ignored the crowd to the extent where a large portion of your limited holdings are in financial stocks. Financial stocks which are hated and vilified by the crowd, no question about it. So why go looking for trouble? I mean, why invest in AIG and Bank of America, for instance? Why choose the financial stocks?
BRUCE BERKOWITZ: Well, the financials are just smack-dab in the middle of my circle of competence. The greatest performance I ever had was in the '90s when I invested in the late '80s/early 1990s in financials. It was a rocky road for a few years, and then we had—
CONSUELO MACK: So Wells Fargo, for instance, was one of your holdings back then.
BRUCE BERKOWITZ: Wells Fargo, we made seven times our money. It was a decade of very good performance, abnormally high performance. And I was much younger, and I always promised myself if one day the financials would have another collapse, I hope I have enough money and I made enough money, to really take advantage of it. And this is exactly what I've done. We have bought systemically important companies at a fraction, say less than half of their liquidating values.
CONSUELO MACK: What’s the opportunity versus the risk that you saw in going into the financial companies that you did in 2011?
BRUCE BERKOWITZ: We went into the financials after they were recapitalized by the government, after their business trends turned positive, and they were still priced less than liquidation values. And today, they continue to be priced less than liquidation values. So we had the situation in 2011 where the businesses are all starting to improve, and we invest. But their prices plummet because investors did not believe the facts, what they were seeing reported by the companies. Obviously when you look back, you had the recent pain of these companies being decimated. You had the fear of the future, maybe a double-dip recession. And a lot of investors just couldn't go there. Even though when you can look back today and see how they performed since we purchased the companies, they've done very well. And they've made good money in a difficult environment. They're going to make great money in a more normal environment.
And this is what I do. This is what I've always done. I mean, a lot of people look at the fund and they say, oh the fund’s down. You know, we made a lot of distributions. We made almost two billion dollars in distributions. So when you take into account distributions. When we started out with ten dollars, we’re at $40 right now.
CONSUELO MACK: So you're talking about then, from inception.
BRUCE BERKOWITZ: From the Fairholme Fund, from the share. And if you compare that to the S&P, if you put $10 into the S&P Index, you'd have $12. Ten to 12; we’ve gone to 40. Now people say, oh, we’re very volatile, you've got to be careful. But you know what? You can pick any 60-month period you like during our existence, and the worst we performed over those five years, we were down seven percent.
CONSUELO MACK: So it's interesting. Since inception, there's no question, and also in the last five years, since inception especially, in the last ten years you've beaten the market handily, no question about it. The last three years, again, for the most recent investors, you've actually trailed the market. So let me just put it this way: from a recent experience, shareholders have not benefited by being investors in the Fairholme Fund. So what do you say, basically, to them?
BRUCE BERKOWITZ: I say to them that we invest for the long-term. We talk about a five-year horizon. We ask you to look back at our firm, at the Fairholme Fund, and look at any five-year horizon you'd like, any 60-month period. And we’ve crushed the S&P on the worst five 60 months, on the best 60 months; our best 60 months is 160% up. Multiples of the S&P. We ask you to look since inception, five years or longer, any five years. We had a very difficult 2011, so you have to understand the facts. The facts are we bought companies after they turned. Their values, their book values, liquidation values, bad debt ratios, ROEs, RIAs, whatever you want to look at, we’re improving.
CONSUELO MACK: Right, and you're talking about the fundamentals of the companies themselves.
BRUCE BERKOWITZ: The fundamentals, the facts.
CONSUELO MACK: You're talking about AIG and Bank of America.
BRUCE BERKOWITZ: AIG, Bank of America, CIT, all the financials that we’ve invested in. The ones we had before, that were some of the ones we had to sell because of liquidations. They were all turning. When we bought, it was half of liquidation value. And it went further down, which created more opportunity, which allowed us to focus more. That's my job.
CONSUELO MACK: Right, so as a value investor, a deep value investor, this is just par for the course, then, of what we should expect if I want to invest in the Fairholme Fund, just get used to the fact that you're going to be looking for deep values, which means that people don’t like them, they're shunned, they're vilified.
BRUCE BERKOWITZ: Right.
CONSUELO MACK: And people are going to think you're nuts for a certain amount of time.
BRUCE BERKOWITZ: I think that's true. If I see a dollar bill on the floor, and I can buy it for 20 cents or 30 cents, and I know that dollar bill is real; in fact I believe that dollar bill will eventually be two dollars and three dollars, and I can get it for a fraction, I’m going to buy as much as I possibly can within the rules being a mutual fund.
CONSUELO MACK: Okay. Your motto is ‘ignore the crowd.’ But the crowd that did come into the Fairholme Fund, because you've had this superb track record, you were named Morningstar’s first-ever Manager of the Decade. And so people basically flocked into the fund, and then in 2011 they just fled the fund, so you lost over half of your assets.
BRUCE BERKOWITZ: Yes.
CONSUELO MACK: In retrospect, would you have handled anything differently? Or were there lessons? What was the takeaway of that, for you?
BRUCE BERKOWITZ: Well, if I knew the future, I would have waited, I would have held onto the healthcare companies longer. I would have waited for the financials if I knew what the prices were going to be. But I don't have the crystal ball. All I can judge are the facts. That companies turned the corner. They were not going to die. They were unbelievably cheap. We had a huge opportunity and over a five-year window, we were going to make a lot of money. This is what happened to me in the late '80s, and through the '90s, and I thought this was a replay. And it is turning out to be a replay.
CONSUELO MACK: That's the question. So it is turning out to be a replay, then.
BRUCE BERKOWITZ: It is, and we’re back. Our performance, when you take into account distributions, we are 10, 12% from our all-time high. We’re getting there. And based upon, we’re up, what, 32, 33% right now?
CONSUELO MACK: Right, year-to-date.
BRUCE BERKOWITZ: Got about twice the S&P. And our companies, many of our companies are still dirt cheap. That dollar bill may be $1.50 now, and they're not even 75 cents on $1.50. So we have a long run ahead of ourselves. And the facts, the evidence, the quarterly reports are showing that it's going the way we thought it would. And for those, you know, you go back three years, see what I had to say, five years, a couple of years ago. I believe our thesis is correct.
CONSUELO MACK: It's starting to be reflected in the market.
BRUCE BERKOWITZ: Right, and the facts, and quarterly reports, it's proving it and the facts are proving it. And I wish I could figure out how prices go up and down in a six-month period, or 12-month, but I don't have that ability. So we look at book values, we look at more stable measures. We look at performance ratios and we know eventually the facts cannot be ignored. You could only ignore certain issues, like making a ton of money for so long. It's right there, it's cash you can count in the bank.
CONSUELO MACK: And I know cash is very important to you. Give me the quick executive summary for AIG, you're largest holding by far, and you really have these terrific case studies that you have in the Fairholme Fund website. We’ll probably a link on our website as well. So AIG, give me the rationale.
BRUCE BERKOWITZ: AIG, a victim of a set of circumstances, from Hank Greenberg leaving to two little small divisions that were no longer being watched by a smart manager, almost blowing up the entire company, because of liquidity issues. If Hank Greenberg was there, it would not have happened.
CONSUELO MACK: And the government ended up owning like 90%, right?
BRUCE BERKOWITZ: Ninety-two percent. A very smart government. So we’re the largest owner after the government. So you look at the company. I mean, growing up in the insurance world, being on the boards of insurance companies, you drooled about AIG. At one time, it was five, six times book value. And all of a sudden the price goes down to near zero. And you still have a very valuable global franchise, large U.S. domestic life insurance. Huge amount of assets. You're buying tangible assets for less than 50 cents on the dollar and you're becoming a large owner of a systemically important company that has to exist. After it's been refurbished.
CONSUELO MACK: So right now, AIG still your largest holding, still a terrific buy?
BRUCE BERKOWITZ: Terrific buy.
CONSUELO MACK: And so when do you decide to get out? I mean, what’s the decision that you start trimming back?
BRUCE BERKOWITZ: Well, I think the book value is near 70. It's going to continue to grow. The price, less than 35, will eventually reach book value. Maybe that happens in the 70s or the 80s, I don't know. But it gets about there, we’ll see. But companies such as AIG can trade at a multiple of book value. But I don't want to go there yet. Just getting to book value will be a very nice return for shareholders. It's a similar case for Bank of America. It's a very similar case in Sears.
CONSUELO MACK: But talk about, so in the next case of Bank of America. Stick with the financials. And again, you keep seeing these headlines, the New York State Attorney General’s going to sue them as well, after J.P. Morgan Chase. So you keep getting this drumbeat of mortgage exposure and who-knows-what.
BRUCE BERKOWITZ: The big uncertainty with Bank of America, the legal issues, are related to mortgages. Clearly they have to work as hard as they can to resolve that uncertainty. That's the catalyst, though, the uncertainty. Bank of America has a $20 book value. It has 16, $15 billion of reserves against these issues. They have earnings power of $20 billion a year. They are burning through their issues. They're more than halfway through now. But no one’s going to really touch Bank of America until the uncertainty diminishes.
But I look at it as you could have a wide range of uncertainty and they can handle it. And they have. And you can see the results of settlements and you can see where it's heading. You've had a long period of time now, so you see how it's sort of the tenure, you see how the vintage, you see how it's aging. And they're making money. Their book value’s going up. So here you have a company less than, last time I looked, nine dollars that has a book of 20. There's trading for less than the cash they own in the bank. What am I missing?
And a company that is just a huge pot of the system, the financial system of the United States. So what more can an investor ask for? If it's hated, I mean, it's absolutely hated. But it's like going to a restaurant with a new chef, and you won't go to a restaurant with a new chef because of the bad meal you had with the old chef. I mean it doesn't make any sense how people are behaving to a situation that no longer exists.
CONSUELO MACK: All right, so this is definitely vintage Bruce Berkowitz strategy, there's no question about it.
BRUCE BERKOWITZ: This is what we look for.
CONSUELO MACK: The third case study I’m going to ask you about is Sears. It's not a financial stock. It's considered to be an old, mature retailer, and you've owned it for about five years.
BRUCE BERKOWITZ: Right.
CONSUELO MACK: Hasn’t been a great investment, right, for you?
BRUCE BERKOWITZ: Absolutely.
CONSUELO MACK: And so what’s the rationale for sticking with Sears? You're the second-largest shareholder of Sears.
BRUCE BERKOWITZ: Yes, I've tried to explain this a bunch of times.
CONSUELO MACK: Maybe this time it’ll take.
BRUCE BERKOWITZ: And I’m trying a new way now.
CONSUELO MACK: Okay.
BRUCE BERKOWITZ: The largest mall operator, I believe in the United States, is Simon. Sears owns more, or leases, very long-term lease, which is the equivalent of ownership, owns or long-term leases, more square footage than Simon. And if you compare the values of the two companies, Sears is about one-tenth the enterprise value of Simon. Now, what’s wrong with the picture, how can Sears be valued, the equity and debt be valued one way, and Simon, which has less space, be valued at almost ten times that value?
CONSUELO MACK: Well, I’ll tell you how it can be valued differently, and it's because Sears is a retailer and it's not trading properties like Simon is. So people have a very different view of Sears, because these are retail brand spaces.
BRUCE BERKOWITZ: If you look at what’s happened in the past year, and you see how Sears has sold properties and they've closed stores down, and how they've made money by closing stores, and pulled in huge amounts of cash, the facts tell you that it's true. They have tremendous value in the real estate. Look at it another way. Today’s market price of Sears is equivalent to the liquidation value of just the inventory within Sears and Kmart. So there's the inventory, there's the real estate. We haven’t even talked about the brands, Lands’ End, or the insurance company, it's Canada. So any way you look at it, it's worth a multiple of what we paid for, of where it's trading today, and there's a fact set that shows that’s correct.
CONSUELO MACK: So shouldn't Sears be doing more, I mean, here you are the second-largest shareholder. Shouldn't it be doing more to unlock the values that you’re talking about?
BRUCE BERKOWITZ: When it comes to real estate, you can't push on a string. When you're in a real estate cycle, there's a time to sell, there's a time to buy, there's a time to do nothing. And I think Eddie Lampert will figure out at what point it makes more economic sense to close down a store and sell it to a company that needs it, whether it's European outlets or a chain store, whatever. Malls are doing quite well. Rents are up, occupancy is up. And if you understand the history of malls in America, and what it is to be the anchor and the kinds of deals that you receive, to be an anchor, in terms of owning the property, rights of first refusal, the price of long-term leases, when you look at all of it, you have to come to the conclusion that the kind of stock price doesn't make any sense.
CONSUELO MACK: So looking at Fairholme, what place do you play in my portfolio, if I want a well-diversified portfolio, and I want Fairholme to be part of it?
BRUCE BERKOWITZ: I believe it's dependent upon your sort of emotional attitude towards the markets. And how you feel in terms of what fraction Fairholme should be, of an overall portfolio. And it's really up to the individual. I can't tell you.
CONSUELO MACK: Right.
BRUCE BERKOWITZ: I’m all in, I can tell you that, but...
CONSUELO MACK: You're all in. So what is it that it's going to deliver for me, as an investment? What is it that I can expect if I stick with you for five years or more?
BRUCE BERKOWITZ: Before 2011, we had high teens performance.
CONSUELO MACK: Annualized performance.
BRUCE BERKOWITZ: Annualized performance. And now we’re down to a measly 10%, 11% compared to zero for the S&P 500. But we’re bums. I think we’re going to get back in everyone’s good graces because of the positions we have now have the ability to make a 10% return on equity, on shareholder’s money. And if they're at half of equity price, at half of book value, that means we should be able to make 20% per annum. So I see us getting back to that high teens performance.
CONSUELO MACK: One Investment for a long-term diversified portfolio.
BRUCE BERKOWITZ: Our largest position, by far, is AIG. Rumors of AIG’s death were greatly exaggerated a few years back. The government is pretty much out. You're paying 50 cents on the dollar of tangible book. The company will grow, the franchise is still there. They're back. They're back, we’re back, the economy’s getting back. It's happening. I know it's been a long time and people are still traumatized from the past few years. But eventually you have to get over it and take a look and see the reality of what’s actually happening.
CONSUELO MACK: You heard it here first. Bruce Berkowitz, the Fairholme Fund, are back. So, Bruce, thank you so much. You certainly are back on WealthTrack, and we really appreciate you being here.
BRUCE BERKOWITZ: Thank you.
CONSUELO MACK: At the conclusion of every WealthTrack, we give you one suggestion to help you build and protect your wealth over the long term. This week’s interview with Bruce Berkowitz reminded me of a timeless message that we have delivered to WealthTrack viewers since our launch eight years ago. It is: avoid the underperformance trap!
There have been numerous studies done comparing mutual fund performance with that of the shareholders who invest in those funds. Investors underperform even top funds they invest in by a huge margin because time after time they pour money into funds that have had a stretch of exceptional performance, as they did with the Fairholme Fund, and they bail out when the fund underperforms, thus missing any subsequent rebound: the infamous buy high and sell low mistake.
The solution: once you have chosen your funds based on their management, culture, long-term track records and just as important, matched their risk profile with your tolerance level, stick with them. We want you to beat the underperformance trap!
Next week we’re going to be joined by another contrarian Great Investor. Steven Romick of the FPA Crescent Fund will explain why he’s low on conviction and high on “compounders.” We’ll find out what those are. To see our interviews again, please go to our website, wealthtrack.com. Advanced viewing is available to Premium subscribers and additional material can be seen on our new and improved WealthTrack Extra feature. And that concludes this edition of WealthTrack. Thank you for watching and make the week ahead a profitable and a productive one.
Copyright © Wealthtrack.com
