Bruce Berkowitz and Fairholme Fund’s Alpha

Bruce Berkowitz launched Fairholme in 1999. It earned him the title of “Stock Manager of the Decade” from Morningstar and is now a $19 Billion mutual fund. Berkowitz’s Fairholme Fund managed to return 1.02% per month since September 2000. This compounds to an average annual return of 12.9% for the past 10 years. In 2010, Fairholme Fund returned 25.5%, beating the SPY by more than 10 percentage points. In fact, Berkowitz managed to beat the market every year except in 2003.

FAIRHOLME (FAIRX) Bruce Berkowitz

Bruce Berkowitz had hired two stock pickers, Larry Pitkowsky and Keith Trauner, when he launched Fairholme in 1999. Keith Trauner is a value investor. Berkowitz himself is a value investor too, investing in Berkshire Hathaway earlier in his career on behalf of his clients. Trauner and Pitkowsky quit Fairholme after the arrival of Charlie Fernandez, though they kept providing consulting services until last year. In January, the duo announced that they’re in the process of launching their own mutual fund. Their first client and minority shareholder of the new company is Tom Gayner’s Markel Corp.  WSJ reports the following about the new fund:

The GoodHaven fund will be highly concentrated, like Fairholme, with roughly 15 or 20 holdings, the managers say. And it will follow Fairholme’s example of looking for bargains among companies that are under stress. “We’re the kind of people who want to run toward a fire, instead of away from it,” Mr. Trauner says. At Fairholme, Mr. Berkowitz has lately loaded up on financial-services firms such as American International Group Inc. and Citigroup Inc. that were beaten down during the financial crisis.

But Messrs. Pitkowsky and Trauner won’t stick strictly to the Fairholme playbook. One difference: They are eager to look at smaller companies, whereas Fairholme has generally gravitated toward larger-cap holdings.

Insider Monkey, your source for free insider trading data, will keep an eye on Pitkowsky and Trauner, but our main interest is whether Bruce Berkowitz has a statistically significant alpha or not. We downloaded Fairholme’s monthly returns from Yahoo! Finance and used Carhart’s four factor model to calculate Berkowitz’s alpha. Between September 2000 and November 2010, Berkowitz generated a monthly alpha of 50 basis points. His market beta was 0.7 and value effect beta was 0.59. His investment style for the entire period was much closer to value investing and since anybody who purchased value stocks during the past decade achieved significantly better results than the SPY we don’t give any credit to Berkowitz for this. (If value stocks performed badly during the past decade, he wouldn’t have been penalized for this either).

One might argue that Fairholme was a much smaller fund during the first five years of its existence, so we should only consider its performance since 2005. When we did that his alpha went down to 44 basis points per month. Still a great performance. However, we’ve been calculating alpha for most hedge fund managers starting from 2008. The past three years have been an exceptionally challenging time for fund managers. That’s why we like to use this time period to determine more accurately whether a hedge fund manager has alpha. Unfortunately, Bruce Berkowitz’s monthly alpha goes down to 22 basis points per month. It isn’t as high as 6%, but it’s still nearly 3% per year. Whitney Tilson and Daniel Loeb had higher alpha during the same time period, whereas Warren Buffett didn’t have any alpha for the 2000-2009 period (see Warren Buffett‘s latest stock picks).

Overall, Bruce Berkowitz still manages to generate a positive alpha for his investors even though he now manages nearly $19 Billion. Mutual fund investors should consider investing with him because there aren’t many mutual funds that can generate a 3% alpha per year.

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