Have Bruce Berkowitz And Fairholme Turned The Corner?

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 |  Includes: AGO, AIG, BAC, C, GS, HCBK, LLY, LUK, MS, RDS.A, RF, RRR-OLD, SAN, T, TEF, VOD, VZ, WFC
by: Davy Bui

Fairholme Capital's 2011 performance has been nothing short of horrific, with its flagship mutual fund losing 26% of value YTD (vs a flat S&P 500), largely due to out-sized bets on big-name financials like Bank of America (NYSE:BAC), Citigroup (NYSE:C), Jefferies Group (JEF) and Regions Financial (NYSE:RF). If that weren't enough, nothing seems to whet the media's appetite more than a good fall-from-grace story -- Barron's recently published a troubling piece detailing some behind-the-scenes drama that may have precipitated much of Fairholme's poor performance. The article implies Berkowitz may have driven out his long-time analyst team who were present for much of Fairholme's earlier success in order to install his cousin-in-law at the firm in 2008. After some initial triumphs, the firm has struggled mightily.

Studies have shown that mutual fund investors often mis-time their investments, opting to pile into a highly-rated fund when it is soaring and abandoning funds when they inevitably come back down. Perhaps investors should consider this as it pertains to Fairholme. After all, Berkowitz was named Morningstar's fund manager of the decade and he's given some indication of returning to a more traditional value investing strategy and abandoning strategies which veered toward activist investing. Now that the former Fairholme analysts have established their own fund and Berkowitz's cousin-in-law has abruptly retired from the fund, Berkowitz may finally be able to focus on righting the Fairholme ship.

Examining the third quarter, while other value investors like Seth Klarman seemed to do nothing but buy in Q3, Fairholme was a huge net seller, likely forced by investor withdrawals. The firm invested approximately $237M in purchases but sold off $1.5B in stocks.

Berkowitz made his name with big contrarian bets and some of his earliest successes were in the financial sector, so it's no surprise to see new Q3 buys reaffirming his bullishness on the financial sector that has hurt his fund this year, with new bets on AIG (NYSE:AIG) warrants, Banco Santander (STD), Bank of America warrants and Wells Fargo (NYSE:WFC). Despite my investment in Hudson City Bancorp (NASDAQ:HCBK), I am not interested in following Berkowitz's moves into the financials. HCBK, as a regional bank for affluent customers, has a much different business profile than the too-big-to-fail financials that Berkowitz has ... ahem ... bet the bank on.

Fairholme's other new positions are more interesting and may indicate a shift in Berkowitz's focus. The firm moved into telecom last quarter with Vodafone (NASDAQ:VOD) and continued that course with new purchases in AT&T (NYSE:T), Telefonica (NYSE:TEF) and Verizon (NYSE:VZ). I have discussed my bullishness on TEF in the past, most recently in this article. I continue to remain high on the name despite the euro troubles. The main point on Telefonica is that the biggest segment of revenues and profits originate from Latin America, mainly Brazil, which should dampen the negative impact of its Spanish home market.

Royal Dutch Shell (RDS) also appears on the list of new Fairholme stocks. Berkowitz's moves in the past have somewhat resembled sector rotation so it will be interesting to see if RDS is a precursor to more energy stocks appearing in the Fairholme portfolio. I am strongly bullish on energy stocks long-term, as evidenced by long positions in names like Devon Energy (NYSE:DVN) and Chesapeake Energy (NYSE:CHK). Even should a global recession hit, long-term oil supplies look increasingly scarce which should buoy prices and drive investment and consumption of other energy sources like natural gas.

As noted above, Fairholme was probably a forced seller in the third quarter but even so, it sold out of big positions in Morgan Stanley (NYSE:MS), Goldman Sachs (NYSE:GS) and Assured Guaranty (NYSE:AGO). Berkowitz also divested much smaller positions in Eli Lilly (NYSE:LLY) and RSC Holdings (NYSE:RRR-OLD).

Readers can view all of Fairholme's Q3 moves in spreadsheet format here.

Disclosure: I am long HCBK, TEF, CHK.PD, DVN.