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Bruce Berkowitz on the Keys to Success for the Fairholme Fund

January 12, 2010

by Robert Huebscher

Recognizing that you don’t make macro forecasts, what key macro thinking leaks into your analyses at Fairholme? 

What happens if a small nuclear device goes off in a city? Or what happens under extreme conditions of inflation?  The idea is to think of the worst and hope for the best.  That is why we hold, on average, significant cash.  Cash becomes extremely valuable under extreme adversity.

With approximately $11 billion in assets under management in your equity fund, do you expect to earn similar returns as in the past? Is there a chance you would close the fund to new investors to stop the fund from getting too large?

Size has helped to date and when it doesn’t we will close the fund.  I’m going to pride myself by seeing this first.  But I know we have great shareholders and, if I don’t see this, I know they will. 

Cash has been helpful and size has allowed us to buy in scale. Of course, it has hurt in smaller investments.  It takes longer to deploy.  In a difficult environment, that is fine. In a very good environment, size hurts.

The big issue is not going to be whether or not we have inflows.  It is our success.  If we continue to perform, $11 billion will become $22, and $22 will become $44 without any inflows.  That’s a bigger issue than closing the fund.

Closing the fund is a very high class issue.  Keeping my feet in the shoes of shareholders, I hope to make the right decision when the time comes.

My last question is an unusual one: Since you are obviously in a very competitive business, why do you do interviews with people like me?

We have no marketing. Our shareholders are wired for wealth creation.  They are well-informed by using channels such as yours.  Whatever I say here becomes public.  It’s a great way to communicate with existing shareholders.

I can make points to you that I would be uncomfortable making to shareholders, because what you do is in the public domain.  We don’t talk to that many people.  You are an extremely efficient channel for our existing shareholders.  It’s not cheap to reach 80,000 readers. 

It’s also important for Fairholme to attract the right shareholders.  For example, if someone called me up for the five-minute timing digest, we are not going to have a chat.  The same would be true with the technical analysis channel.

If I can communicate with our shareholders and with other great potential shareholders, then it is very effective, because there is a natural ebb and flow.  People leave us during difficult times.  We want to keep in touch with our shareholders and keep a high-quality shareholder base. 

This is why we charge a flat 1% fee with no loads and have never used a 12(b)1 fee and actually abolished the ability for us to use such a fee. 

Last year, there were outstanding managers who had significant amounts of capital withdrawn, who were unable to execute their strategies.  Fairholme did not have significant net outflows.  It’s hard for me to remember if we had even a month of net outflows.  That is a huge weapon and a big advantage – having the right shareholders who will stick with us while others are running for shelter.  Without that we couldn’t execute.

I have to find ways to talk to smart people who can present our concepts to the kinds of people we would like to have as shareholders.  That’s why we do it.  I’m not giving anything away.  I would never talk to you about what I am going to do today, what we plan for the future or what is not in our public reports.

The real service is for our shareholders, to let them know who we are, how we behave, how we maintain our level of integrity, how we perform during difficult times and whether we eat our own cooking.  That is what’s important.  Now that we’ve finished our tenth year, it’s good that people can look back and see what we had to say every six months and how we behaved during very difficult periods.  They can stress test us.

At the end of the day, however, I know talk is cheap.  You’ll know in three to five years whether I had anything interesting to say today.