Bruce Berkowitz isn't the kind of manager whose moves make headlines, but they've paid off remarkably well for his investors.
Berkowitz, Morningstar's domestic-stock fund manager of the decade, has headed the now-$11.2 billion Fairholme Capital Management since its founding in 1999. Fairholme earned a 13.2% 10-year annualized total return through Dec. 31, according to Morningstar, soundly beating the Standard & Poor's 500 Index.
"The bottom line is he has been an exceptional stock picker," said Karen Dolan, director of mutual fund analysis at Morningstar. Berkowitz's strategy is simple. He looks for companies with strong cash flow at low prices, setting him apart from the standard "price to earnings" approach. It also makes him a contrarian investor, but only by default.
"We want to buy a company where we think we're getting double-digit cash-flow yields," Berkowitz said. "If we're right, we'll do quite well, and if we're wrong, hopefully we bought with enough margin safety where we won't get hurt."
Cash flows, as Berkowitz sees it, are the end result, the final product. "Companies need cash to run and survive, and with that, they have a choice to pay out a dividend, profitably grow their business or make an acquisition."
The strategy may be simple, but execution is difficult. Berkowitz does it with a lot of cash on his part, skirting the leveraged purchase, which has enabled him to avoid volatility-related problems. "It gives us liquidity and flexibility that hasn't hurt our performance yet," Berkowitz said.
He quipped that during an economic crisis, cash is like Xanax. "People that have it are calm, and people who don't, have to sell to get that calm, and that brings about the bargains."
His average cash position through the last decade was 18.3%, while his position at Aug. 31 was 22.4%, far more than in most funds. "It's an absolute cushion he's looking for, but his picks have been strong enough to where the cash hasn't held him back," Dolan said.
Looking back at the decade, it's easy to see how and why Berkowitz made his investment decisions. However, rare is the fund manager with the strength of character and tenacity to say one thing while the rest of Wall Street is saying something else. Berkowitz isn't just extra confident, though. "He knows as much, if not more, about his companies than its own insiders," Dolan said.
"It's much easier to come up with a scenario on how to make a lot of money, but it's better to look at how an investment is going to be bad," Berkowitz said. "We spend most of our time quantifying the downside.
"When you've worked every day of your life for the last 30 years, there's a lot of pressure on you not to lose," Berkowitz continued. "It's easier to handle a bunch of people out there making more money or doing better than you do than it is to lose your 30 years of hard work."
Berkowitz is also emphatic about the support he receives from Fairholme's investors, of which he is the largest. Over the past few years, a lot of good fund managers have lost capital because of shareholder departures, while Fairholme has been more able to hold on.
"It's important to attract the right shareholders for the fund," Berkowitz said. To dissuade traders and market timers, the fund charges a 2% penalty if an investor pulls out during the first two months.
The trick now is to maintain the fund's strong numbers even though it's a larger fund. Berkowitz said the fund's size has helped in many ways, at least in a difficult market environment when there's plenty to do, but that will change when things start going well again, and he might have to consider closing the fund to new investors. "If I don't realize first that the fund is too big, I promise you I'll hear it from our shareholders."
Berkowitz said the next decade may feel familiar. "There's an inability to predict the future, but you can expect bouts of fear and greed, probably at least one low-frequency, high-severity event — natural or man-made — and lots of high-frequency, low-severity bumps in the road."
Berkowitz said an investor can approach the future in two ways. He can try to predict it or time it, or he can react and price it, which gets into his investment process. "We tend to look at stressed sectors, industries, markets, and from there, see if there's anything interesting," Berkowitz said. "When everyone is optimistic about something, you pay a price for that optimism."