: Value Investing Forum - Singapore, Hong Kong, U.S.

Full Version: Bruce Berkowitz’s Interview with Bloomberg TV’s Erik Schatzker
You're currently viewing a stripped down version of our content. View the full version with proper formatting.

Bruce Berkowitz’s Interview with Bloomberg TV’s Erik Schatzker
February 1, 2013


Erik Schatzker: Bruce, you have used the word “horrible” to describe 2011. And in 2012, you crushed it, owning the very same stocks. It was a rough ride, no question. Do you feel vindicated?

Bruce Berkowitz: Not yet.

Erik Schatzker: Really?

Bruce Berkowitz: 2011 was horrible because of the price declines. The market declines in the companies that we owned didn't make sense to me in that the business trends of those companies were improving. In fact, these trends were in the second full year of improving. So I couldn't understand how our businesses were improving, but yet the prices were going down.

The reason, of course, is that people like to predict rather than price. Investors were predicting a double dip recession, the death of Europe, and so on. So as I'm watching business trends improve, profits going up, and the number of bad loans are going down. But, market prices went down. 2011 was horrible and 2012 was better.

Erik Schatzker: What will it take for you to feel vindicated?

Bruce Berkowitz: Three to five years. The thesis on the financials, whose prices were so decimated in 2011, is that we were able to buy them at half of their liquidation value and, as they recover, they're going to make money. We will regress to a more normal environment, that is, where stability and history have shown a reasonable profit.

Over the next five to seven years, as they recover, equity values will increase and market prices more so. That's what happened in the 1990s, when it was about a commercial real estate debacle with Wells Fargo and others. History doesn’t exactly repeat itself, but it does rhyme. And this is why we're all in with the Bank of America, AIG, and a few others. Of course, AIG was a much more unique circumstance.

Erik Schatzker: It sounds to me as though you want to beat the market by a much more significant margin than you have already in 2012 before you feel right about these investments, before they've paid off in full.

Bruce Berkowitz: Yes. Well, first of all, if you go down a third, you have to go up by more than a third to get back to where you were. We're long-term investors, so I was looking to make investments over a five-plus year period.

Erik Schatzker: And you're only, two years into it?

Bruce Berkowitz: Yeah, look at The Fairholme Fund. We've had about 97 five-year periods. At the end of every month, we go back five years to measure 5-year performance. We've beaten the S&P 500, significantly, 94 out of 97 times. We've had a few negative periods, but nothing near what the S&P has had.

We keep working to attract shareholders that will stay with us for at least five years. That's the reason why we're no longer accepting new shareholders at the end of February. I feel that shareholders that have stayed with us understand what we're about. And I don't want a lot of new money diluting the positions that we now own.

Erik Schatzker: Clearly, you're looking forward. But if you look backward, any regrets? Any lessons learned?

Bruce Berkowitz: Oh, there are always hundreds of mistakes.

Erik Schatzker: What would you have done differently?

Bruce Berkowitz: The lesson learned is that as bad as I expect something to happen, it could be worse. I didn't really fully understand how people overweight the near past. The last two years have been weighted more than the last 200 years. What I saw was a cycle repeating itself. What other people saw was something new that was going to continue to be bad forever. I seem to suffer from “premature accumulation.”

Erik Schatzker: Do you think that's a disease that's still infecting the markets or have people learned that same lesson, coming through it, realizing that focusing on the near past, isn't such a good idea?

Bruce Berkowitz: I haven't found the right technique or medication yet for “premature accumulation.” I see prices that are cheap relative to intrinsic values. And when I conclude, "This is too good to be true,” I buy. And then the price goes lower.

Erik Schatzker: But is it better to be in early than not to be in than to try and time the bottom of the market?

Bruce Berkowitz: Well, I have proven time and time again that I can't time the bottom of the market, but when I see $1.00 selling for $0.50, I buy and my feeling is if I'm early and the price goes down further, I have the chance to buy more. With being early, you look wrong until you're right.

Erik Schatzker: You talk quite often about having faith in the fundamentals of the equities that you own. Clearly heading into the financial crisis, fundamentals proved worthless in dozens of cases. Why have faith in the fundamentals now?

Bruce Berkowitz: Well, the fundamentals going into the crisis were quite weak. I'm a natural investor in financials. However, we were out of all financials and leveraged institutions until they were recapitalized by the government. We actually purchased financials a year after the recapitalizations/restructurings and after their business trends improved. But people continued to predict further demise in the face of positive factors.

Here was the arbitrage. The Graham and Dodd value school emotional arbitrage. We look at the facts. We go by the facts and we don't listen to the predictions of the crowd.

Erik Schatzker: Balance sheets are only worth as much, or at least, they're only trustworthy in as much as the people who value the assets and state the liabilities are trustworthy. Why have faith in balance sheets whose assets are still open to question?

Bruce Berkowitz: Absolutely, especially when it comes to banks and insurance companies. However, when companies are under stress, they shrink. When companies shrink, it's awfully hard to cover up bad assets.
The problem years were 2006 and 2007 - six and seven years ago. Loans have a finite live, so do most insurance policies. They run off. More than 50% of 2006/2007 real estate loans are gone. There's a curing period. It's kind of like studying vintages of wine. You see how the 2006 year loans are developing or the 2007 year.

The third aspect to think about is when bad things happen to companies, after stress events, good business develops. 2008, 2009, 2010, and 2011 have been fabulous, profitable years for new business for surviving institutions.

Our portfolio companies have huge reserves, big cash flows. It's not a question of if they're going to recover, it's really a question of when they will fully recover. A huge margin of safety exists today. I believe market prices to be so low that you could have a wide gap in your estimates of how long they're going to get back to looking great – and still have a reasonable return.

Erik Schatzker: As a value investor, you're fond of asking a question we don't hear asked often enough. What's the worst thing that could happen to me and I still make money? What's the worst thing that could happen to you?

Bruce Berkowitz: The way we look at the financials is that, at some point, most will believe they are going to die and the worst possible event would be that I would have to run them. I would shut their doors, not accept new customers, and I would run them off. What would they look like in a slow run-off over time?

When we bought many of these companies, they were selling for less than the cash they owned in the bank. So we looked at the cash. We looked at all the liabilities. We looked at the reserves. [We then looked at the continuing earnings power] and came to the conclusion that I couldn't even screw up a run-off.

Erik Schatzker: Well, what's the worst case now, then?

Bruce Berkowitz: The worst case now, for The Fairholme Funds, would be an inflow of cash because we have developed outsized positions.

Erik Schatzker: You're the first money manager who's ever said that to me, anyway. Maybe others have felt similarly. Most money managers are dying for cash.

Bruce Berkowitz: I know, but at Fairholme we think less is more. Existing positions cannot be recreated. So if more money came in, I can't buy more AIG because we already are so concentrated. Our focus is already in AIG. Our focus is already in Bank of America. The rules of being a mutual fund would not allow me to buy more shares, so I do not want a lot of cash coming in that would potentially dilute those positions for existing shareholders.

Erik Schatzker: This is why you've closed the funds to new investors.

Bruce Berkowitz: This is why we're going to no longer accept new investors. We want to make sure that our existing shareholders get a full bang for their buck.

Erik Schatzker: Have you ever done this before?

Bruce Berkowitz: No, in the history of The Fairholme Funds, I have not. It's a little counterintuitive, I know. Most funds close when they have a lot of cash and not a good use for it. We have stayed open when we had a lot of cash, knowing that that cash would be a good cushion. And now we have a lot of cash - The Fairholme Fund is 20% cash – but I believe more cash will not help.

Erik Schatzker: You know, the cynic would say, Bruce, that you're just punishing the people who sold out of Fairholme and forced you to sell stocks into a bear market. You're saying to them, “Sorry, pal. You want to get in now? Tough luck.”

Bruce Berkowitz: We want to make sure to have a shareholder base that understands the long-term nature of what we do. In the past, we put $2 billion into the busted bonds of GGP during their Chapter 11 restructuring. We needed a shareholder base that's going to stay the course so that we could see the finale of the restructuring. In the case of GGP, we ended up making a profit of approximately $1 billion. And I can't use that kind of strategy when people aggressively withdraw from the fund.
Erik Schatzker: Why put up with mutual fund rules at all? Why not get some real patient capital? Why not raise five-year money, no redemptions or limited redemptions, and make it easier on yourself?

Bruce Berkowitz: A good question.

Erik Schatzker: And the answer is?

Bruce Berkowitz: Stay tuned.

Erik Schatzker: In all seriousness, is that what a partnership is all about?

Bruce Berkowitz: At this point, I can't talk about it, but stay tuned.

Erik Schatzker: Without getting into detail then, explain to me the appeal of an instrument like that versus the one that you're managing now.

Bruce Berkowitz: Well, mutual funds are great vehicles. They're transparent. They give investors daily liquidity and they’re highly regulated. But, there are also constraints that go along with those rules in terms of how much you can own of one industry, one company, one type. And it's fine. However, mutual funds have proven not to be the perfect vehicle for non-public companies or illiquid investments.

Erik Schatzker: Is the golden age of the mutual fund over?

Bruce Berkowitz: No.

Erik Schatzker: No, you think it's appropriate for other kinds of investment strategies, just maybe not your own.

Bruce Berkowitz: There's many ways to make money and we want to try and offer the maximum possible ways for our shareholders and existing clients to do reasonably well over a long period of time.

Erik Schatzker: You like to say, "Why would I own my tenth best idea when I can own more of my best idea?" People complain that you're too concentrated. Why not be more concentrated? There's a lot of Bank of America stock you could own.

Bruce Berkowitz: Right.

Erik Schatzker: Maybe there isn't much more Sears stock that you could own.

Bruce Berkowitz: We have kept our promises as to being a focused fund and staying the course with our very best ideas, rather than investing in lesser ideas. In the case of Bank America, we would love to own much more, but mutual funds can't invest more than 5% of their assets in a company that has a significant broker dealer. So we’re limited. Only because fund shareholders left did Bank of America became a bigger position than 5% of The Fairholme Fund.

Erik Schatzker: Would you want to own more Bank of America if you could?

Bruce Berkowitz: Yes.

Erik Schatzker: You would. So maybe a new kind of a vehicle would afford you that opportunity.

Bruce Berkowitz: It's always good to be flexible and have more degrees of freedom.

Erik Schatzker: Should I assume, looking at your holdings, Bruce, that these remain your best investment ideas, that you have scanned the market, you have scanned the globe, perhaps, and not found anything better than AIG, Sears, Bank of America, MBIA, the list goes on.

Bruce Berkowitz: You only need a few good ideas to make a significant difference in a lifetime.

Erik Schatzker: But you like to say, “I want to buy stocks that other people hate.” People, up until recently, hated Dell Computer. They can't stand Hewlett-Packard. Look at what's going on with Apple. Do those stocks appeal to you?

Bruce Berkowitz: It's not within my circle of competence. What I'm doing now is, I believe, is a replay of what I did in the '90s, so I understand the strategies and underlying models. You buy something at half its liquidation value. Problems are fixed. A more normal environment develops. The equity values rebound. Price eventually surpasses equity values and you have an above average performance return for a number of years.

Erik Schatzker: People, though, wonder. If you've made 50% on AIG, like you did last year, why not sell? Why not take the easy money off the table and go and find something that is similarly underpriced, perhaps within your circle of expertise and knowledge?

Bruce Berkowitz: Well, we do rank order. I still consider the holdings within our portfolio to be cheaper than anything else I can find and understand. I can't kill them. Overall, I'm very optimistic about their futures.

Erik Schatzker: And you want to wait around until they've surpassed one times tangible book? And you talk about buying them at a discount to liquidation value. Let's call that tangible book value. Why not sell at one times tangible book?

Bruce Berkowitz: Well, then a company can make a 10% return on equity, which these companies have done before and history says they can do again, and you see reasons why there may be some significant growth potential in these companies, why sell at tangible book? For example, as government-sponsored enterprises Fannie Mae and Freddie Mac run off / wind down, who will take their essential roles? Could it be the big banks that at one time funded 100% of home loans? Could it be AIG to insure residential mortgages?

Real estate lending is a huge market. Banks could have significant growth. I'm not counting on this catalyst, but when you go through the history books on these replays, you start to remember what happened in the past and understand future possibilities.

Erik Schatzker: If you really want to position yourself to take the place of a Fannie Mae and a Freddie Mac, why not own the biggest mortgage originator in the country in, Wells Fargo?

Bruce Berkowitz: I believe Bank of America once had this position with Countrywide.

Erik Schatzker: Sure, but they're running as hard as they can to get out of that market.

Bruce Berkowitz: Bank of America decided they want to only serve their core customer, which makes sense. Wholesale mortgage lending is very good right until it causes a blow-up. Brian Moynihan is going to make Bank of America more like Wells Fargo than Wells Fargo.

Erik Schatzker: Do you believe that owning Bank of America is like a bet on America?

Bruce Berkowitz: It is America's bank.

Erik Schatzker: So you'd rather own Bank of America than make a bet on globalization and emerging markets with Citigroup, which is also priced very cheap.

Bruce Berkowitz: Right. Citi doesn't have the retail element of Bank of America in the United States, which I know the best. And Wells Fargo is a fine institution. But investing's all about what you give versus what you get. And Bank of America gave you the chance to get an awful lot for very little.

Erik Schatzker: Bruce, anybody who knows your track record shouldn't be surprised by what you're doing now. How will you surprise us?

Bruce Berkowitz: I hope I don't. I hope that our traditional record of outperformance clearly shows again. We have outperformed over a significant period. We had a bad 2011, which confuses a lot, but that's business. Business is a lumpy process. And for those companies and fund managers that have shown business to be a very smooth process, it hasn't worked out real well in the end.

Berkshire Hathaway can have a 50% decline in price. Charlie Munger in the early days with his partnership had two years of 30% plus declines and still, in the end, did reasonably well. Who am I to think that I am going to miss a 30% plus declining year? That would be awfully arrogant of me, wouldn't it?