Bruce Berkowitz - August 2010

2010 Semi-Annual Report

Over one-half of The Fairholme Fund’s assets are invested in securities of mostly hated financial services and real estate related companies. After all, “there is no job growth without economic growth; no economic growth without access to credit; no access to credit without a stable, functioning financial system.” Financials tend to lead markets into and then out of recessions followed by asset deflation and then inflation. Never being 100% certain as to events and timing, approximately 20% of the Fund’s assets are in relatively, short-maturity corporate debt and cash equivalents.
 

Bruce Berkowitz on Consuelo Mack Wealthtrack

CONSUELO MACK: Let me ask you about a recent Wall Street Journal article about you. It talked about how you were breaking Wall Street's rules and making other mutual fund managers look bad, by doing all the things they say can't be done. And this is your style. Can't time the market- do you time the market?

BRUCE BERKOWITZ: No. We don't predict. We price. So if timing the market means we buy stressed securities when their prices are way down, then yes. Guilty as charged. But, again, we're trying to compare what we're paying for something, versus what we think, over time, we're going to get for the cash we're paying. And, we try not to have too many predetermined notions about what it's going to be. And then we go, once we come up with a thesis about an idea, we then try and find as many knowledgeable professionals in that industry, and pay them to destroy our idea, and tell us--


*The author has a position in The Fairholme Fund (FAIRX). This is neither a recommendation to buy or sell any securities. All information provided believed to be reliable and presented for information purposes only. 

Longleaf Partners Q1 2010 Letter

The investment case for the Longleaf Funds overpowers macro concerns for several reasons:


• These macro predictions appear adequately discounted. We submit that they are baked into prices because so many investors share the same concerns. The magnitude of 2008 stock market declines was extremely anomalous, especially compared to previous bear markets associated with severe economic downturns, wars, or double-digit inflation. Prices reacted far more negatively than the recession’s meaningful impact on companies.

• We are not oblivious, however, to potential negative macro scenarios as evidenced by our investments. Core holdings such as DIRECTV, tw telecom, Yum, Fairfax, and Genting were “battle tested” in the first leg of the recession and demonstrated their ability to hold up if recession recurs. The majority of our companies have pricing power which would protect them in an inflationary scenario, and many would be net beneficiaries of inflation.


• The dread scenarios could actually help some of our holdings. For example, if governments continue to intervene heavily with infrastructure spending, Cemex, Texas Industries, ACS, and Hochtief will benefit. If the U.S. government gets serious about energy policy and its relationship to national security, Chesapeake’s natural gas and Pioneer’s domestic oil will gain additional advantage.

Leucadia National Corporation 2009 Letter to Shareholders

"Out of prudence we take a pessimistic view as to when this recession will end. To think otherwise would be a gamble that we are unwilling to make."

"America has had fifteen plus mostly fat years. Hopefully we will have less than seven lean years. We believe we are doing the correct things to protect shareholders’ capital and to begin cautiously expanding it. When this economic malaise will retreat, as the fog to the rising sun, we know not. Core and caution are the order of the times!!"

IVA Funds

We like the flexibility to invest in small, medium, and large companies, depending on where we see value.


We are willing to hold cash when we cannot find enough cheap securities that we like or when we find some, yet the broader market (Mr. Market) seems fully priced. We will seek to use that cash as ammunition for future bargains. 


In this environment, we try not to forecast but focus on valuation as well as risks. We are fond of Peter Bernstein's statement, "Risk is the only thing you can manage. You can't make your returns happen, but you can manage the degree to which your portfolio is exposed to to damage if things go wrong."


Being optimistic or pessimistic all depends on the price. 


The bursting of a credit-induced bubble is deflationary by nature, but may ultimately lead to inflation, depending on the policy makers’ response. We believe short term,that the deflationary forces are stronger than commonly perceived but remain agnostic longer term. The Funds’ portfolios, whilst built to a large extent from the bottom up, currently reflect that view, Both Funds have a high cash component which we believe is good under both short and long-term scenarios: a deflationary period means that cash has more purchasing power while an inflationary period would ultimately allow us to buy equities that could dc-rate (as they did in the 1970’s). The Funds both hold some gold, which did so well during the inflationary 1970’s but also during the deflationary 1930’s, The Funds both hold some high yield bonds, which we believe are of high quality (important if deflation spreads) yet not too long (important if inflation came back in a few years). Finally, both Funds have a moderate allocation to equities, with an emphasis on strong balance sheets, good competitive positions, decent pricing power (a huge advantage either during deflation or inflation) and not overly capital intensive business models (good under inflation)*.

*Understands the consequences of a macro-economic outcome on an investment.


We are particularly intrigued when credit markets, or segments of it, become disconnected from equity markets. Credit markets, filled with investors that worry about what can go wrong, do a better job at assessing risk than the equity market—filled with investors (or speculators) that, at times, fantasize mostly about the upside potential. During the spring and summer of 2008, we were intrigued by the credit markets, which were deteriorating faster than the U.S. equity market. The Lehman bankruptcy came along and the U.S. equity market finally capitulated. lnterestingly enough, the credit markets held up rather well in February 2009 while bank stocks were under severe attack. The huge rally since March appears to indicate that the credit markets were right again to be stabilizing while the broad equity indices were still declining lower. Over the past few months, however, we believe there may be a disconnect between the U.S. Treasury market—signaling slow economic growth and modest inflation for years to come—and both the high yield market (with lower spreads) and global equity markets — signaling a long-lasting V-shaped recovery.

US Debt Will Keep Growing Even With Recovery

Carmen Reinhart, an economics professor at the University of Maryland and a former IMF official, suggested the nation's fast-growing indebtedness may not have a visible impact at this point on ordinary Americans. But some day it will pounce.

"One thing we can say with a fair amount of certainty," she said. "We never know when the wolf will be at our door. The wolf is very fickle and markets can turn very quickly. And a high debt level makes us very vulnerable to shifts in sentiment that we cannot predict."

Nuggets of Wisdom from Charlie Munger (circa 2006)

Envy
"Harvard and Yale concentrated with venture capitalists that got the best calls and brainpower. Very few firms made most of the money, and they made it in just a few periods. Everyone else returned between mediocre and lousy. When returns happened, envy rippled through institutional money management. The amount invested in venture capital went up 10 times post-1999. That later money was lost very quickly. It will happen again. I don't know anyone who successfully resists this stuff. It becomes a new orthodoxy."


Risk 
"I know a man named John Arriaga. After he graduated from Stanford, he started to develop properties around Stanford. There was no better time to do it then when he did. Rents have gone up and up. Normal developers would borrow and borrow. What John did was gradually pay off his debt, so when the crash came and 3 million of his 15 million square feet of buildings went vacant, he didn't bat an eyebrow. The man deliberately took risk out of his life, and he was glad not to have leverage. There is a lot to be said that when the world is going crazy, to put yourself in a position where you take risk off the table. We might all consider imitating John."  

(Note: Made himself less vulnerable to the negative effects of a Black Swan)