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I have been deliberately following up on a number of articles I wrote last year to see how many of the stocks I wrote about have performed in recent months. A discussion over the weekend drew my attention back to the Fairholme Fund (FAIRX), and the concentration of financial stocks in the fund. This gave me pause to reflect, and once again pushed me back to revisit old ground.

To that end I have revisited positions in PNC Financial Group (PNC), Citigroup (C), American International Group (AIG) and Morgan Stanley (MS). The end result of that analysis led me to decide to exit my position in Citigroup soon and replace it with MS for reasons that will be detailed below.

I first wrote about Bruce Berkowitz in October 2011. At that time AIG was trading at $26.34 with a 52 week high of $62.87. Fast forward to 6th February and the stock is trading at $26.80 with the 52 week high sitting lower at $43.20 (the 52 week low remains unchanged at $19.18). The prior article made reference to Berkowitz's substantial stake in AIG, his value on it as a distressed asset, and his belief that the stock had future capital growth of significance. He later acknowledged that the US government may unwind its position at a loss (in the $27 - $30 price range) which would incur a significant loss for Fairholme's Fund. AIG's 12 month performance is illustrated below:

click to enlarge

In taking a reflective look back, it struck me that the share price for AIG had not moved dramatically, but its EPS had improved from -0.49 in October 2011, to 14.97 in February 2012. But without delving too much further into AIG, it also struck me that if AIG is such a large position within FAIRX (21.69%), what else is making up the portfolio, and how diverse is the fund across different asset classes? Not very diverse it would appear, as you will see below:

  1. Financial Services 84.19%
  2. Industrial Materials 7.39%
  3. Consumer Services 6.84%
  4. Healthcare 0.93%
  5. Business Services 0.65%

How is this fund composition affecting performance? See below for the FAIRX fund's 12 month performance chart:

To me it appears to be an over concentrated holding of financial stocks, which is understandable if seeking large capital gains from currently undervalued assets, but are those assets truly undervalued, or are they valued correctly given the amount of exposure to the European debt crisis? Are they sufficiently diversified to weather the fluctuations in global financial markets? Have we seen a definitive rally out of the ongoing financial crisis, or is the European debt crisis being unduly ignored?

In addition to its exposure to AIG, FAIRX is heavily invested in Citigroup, Goldman Sachs (GS), Morgan Stanley and Bank of America (BAC). I have previously rated Citigroup, but having looked at it in more detail recently I think I could retain consistent banking exposure through PNC Financial Group for moderate growth in capital and dividends, and gain a more valuable position in Morgan Stanley from an investment banking perspective.

I sought readers' thoughts on Citigroup vs Morgan Stanley in my recent article on 2 Feb 12, but in recent days I have reached my own conclusion. I need to exit the Citigroup position in my Sun Tzu Portfolio, and replace it with Morgan Stanley. Why? I see better intrinsic value in MS, and I don't need to worry about a substantial shareholder (Prince Alwaleed) wading in to direct management on how it should or shouldn't deliver value to investors.

So in choosing between Berkowitz's FAIRX, or mimicking its positions in AIG, BAC, C, MS and GS, I will exit C and choose my own path and take a position in MS. There is enough 'doubling down' on risk being generated within FAIRX's portfolio structure to make even the most aggressive of growth investors nervous. But then again, I refer to my earlier assessment of Berkowitz - that he didn't get to where he is by being conservative (but then again, he has a lot more capital than me to take the positions he does). I'll leave FAIRX with the conundrum of a prince to solve.

Source: Looking Beyond Citigroup, American International Group And The Fairholme Fund