For most people, the answer seems clear. If it isn’t doing well, get rid of it.
This is, of course, the corollary to the opposite lesson — just because it is doing well does not mean we want to buy it.
It’s also related to questions about Morningstar “star” ratings, e.g. “why do I own this fund if it has only three stars?” or “why don’t I own this fund that has five stars?”
From First To Last
This all came to mind as I read an article about Bruce Berkowitz’ Fairholme Fund. Berkowitz may be familiar to many readers. He was named the U.S. domestic stock-fund manager of the decade in 2010 by Morningstar, a hugely prestigious award recognizing the best stock pickers of the previous decade.
Unfortunately, the following year, his fund finished in the last percentile (i.e. worst) among peers, losing 33% of value in a year the overall market was up.
Berkowitz, a value investor always on the lookout for under-priced assets, said he was willing to sit tight and wait for the market to come round to his way of thinking. Investors felt otherwise and voted with their feet. Assets flowed out the door. “Fairholme investors yanked an estimated $6.8 billion, which, combined with investment losses, reduced Fairholme’s assets from $21 billion to $7 billion.” Ouch.
Here’s the happy ending, at least for some. Berkowitz has been vindicated in 2012. His fund is up almost 30% year-to-date and back in the top percentile. Unfortunately, those investors who bought at the high and then sold at the low when the fund “wasn’t performing” are permanently out a lot of money. One commentator says Berkowitz’ experience shows “that diligent research, a contrarian mindset and a bit of courage can pay off (in the long run).”
A Concentrated Fund
Full disclosure: This is not a fund we have ever bought for clients. Nor are we likely to, with the utmost respect for Mr. Berkowitz. The reason is that the fund is extremely concentrated, meaning it holds very large stakes in a very few companies. According to a recent article, “more than three-quarters of the Fairholme Fund was invested in seven companies as of Aug. 31, with 37 percent of the portfolio in New York-based AIG’s common stock, 8.8 percent in Bank of America and 10 percent in retailer Sears Holdings Corp.” Investment concentration certainly has its place in many strategies, but it’s not a particularly good fit for our clients.
But our point here is that making long-term investment decisions based on short-term performance, good or bad, is always a mistake.
Buying based on past performance without fully understanding the strategy and level of risk of an investment is another mistake.
Buying or selling based on how many “stars” a fund has is a mistake.
Some fund managers clearly march to a different drummer. They have a clear investment vision, but are not always able to share it with others. Bruce Berkowitz, whose firm’s motto is appropriately “Ignore the Crowd,” is one of those managers.
Berkowitz’ style is not for everyone. His highly-concentrated aggressive value approach is suitable only for long-term investors with a strong stomach.
But his track record can teach us all an important lesson about patience, and not pulling the plug too hastily when a fund looks like it is struggling with performance.