This past June I attended the Morningstar Conference here in Chicago. There were a number of well-known and notable speakers. One of the featured lunch speakers was Bruce Berkowitz. Mr. Berkowitz is the manager of the Fairholme Fund and was named Morningstar’s Domestic Stock Manager of the Decade. In short, Bruce Berkowitz is a rock star.
Fairholme had an amazing run from 2000 through the end of 2010. An investment of $10,000 held throughout this period would have grown to $43,376 (including the reinvestment of all fund distributions), a return of almost 334 percent (or 14.27 percent per year). By comparison, that same $10,000 investment in the Vanguard 500 Index fund would have grown to $10,361 over the same time frame and using the same assumptions.
The story is different so far in 2011. Year-to-date through September 30, the fund has lost 32.49 percent, versus a loss of 8.68 percent for the S&P 500 Index. In spite of this drop in performance, the fund still ranks in top 1 percent of all Large Cap Value funds over the 10-year period ending September 30.
Early investors in the fund are still way ahead of the game. Folks who made their initial investment in 2008 or after likely have an unrealized loss in the fund at this point.
The question an investor should ask is whether this decline is an opportunity to buy into a top-notch fund, or if Berkowitz’s best days as a fund manager are behind him?
Over the years there have been a number of funds with superstar managers like Berkowitz that did quite well for a number of years then faded out. One explanation is that the funds started out with a low asset base. As the funds became successful, more investors bought in. This, combined with the funds’ investment gains, led to a tremendous growth in the funds’ asset bases, conceivably making the big gains the funds enjoyed early on harder to replicate going forward. The growth in assets has followed this pattern with Fairholme. At the end of 2004, the fund had $264 million in assets; by March 31, 2011, the fund’s assets had reached $19.27 billion.
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With any potential fund investment, the starting point should be to determine if the fund fits your investment criteria. Using Fairholme as an example, this is by all accounts a riskier-than-average holding. Case in point is the fund’s outsized decline so far in 2011. As an investor, can you stomach a decline of this magnitude?
Will Danoff has managed the Fidelity Contrafund for 20 years and has by and large been able to maintain the fund’s top-flight performance over his tenure. However, any number of other managers have failed to keep their funds on top after an initial period of out-performance.
The lesson for investors is to do your homework before investing in any mutual fund, but most especially a “hot” fund. Ask yourself:
- What caused the fund to do well?
- Can the manager continue to produce out-sized returns with a larger asset base?
- Was the fund’s success a product of certain market conditions?
- Can this fund and this manager do well in all types of markets?
Nothing in this article should be construed as investment advice in any way. The use of actual fund and manager names is for illustrative purposes only and is not a recommendation of any kind. You should consult your financial advisor before making any investment decision.
Roger Wohlner, CFP®, is a fee-only financial adviser at Asset Strategy Consultants based in Arlington Heights, Ill., where he provides advice to individual clients, retirement plan sponsors, foundations, and endowments. He recently cofounded Retirement Fiduciary Advisors to provide direct investment and retirement planning advice to 401(k) plan participants. Follow Roger on Twitter and LinkedIn. Roger also blogs at Chicago Financial Planner.