A Superstar Stock-Picker Moves to Bonds

The Fairholme Fund (FAIRX) has the kind of superstar track record that every manager dreams of. And now, the fund's lead portfolio manager, Bruce Berkowitz, is relying on his stock-picking expertise to break new ground for Fairholme.

Over the past five years, Fairholme has outpaced nearly 99% of all large-cap blend funds and has posted nearly a 13% annualized gain since its late 1999 inception, compared to an annualized 1.6% loss for the S&P 500 Index. Berkowitz has truly accomplished something that few of his peers have.

Bond-ing with the best
Berkowitz recently filed paperwork to start a brand-new bond fund, the Fairholme Focused Income Fund. The fund will invest across multiple fixed-income sectors, including government and corporate bonds, as well as convertibles and preferred shares. The interesting thing about this fund, as its name would imply, is that Berkowitz plans to apply a concentrated approach to selecting bonds. This is different from the majority of bond funds, which take a more conservative approach and attempt to diversify away the risk of a single-issue blowup. As such, this fund may prove to be more risky than many bond investors would like.

Of course, the Fairholme Fund has employed a concentrated approach throughout its existence, and the results have been superb. The fund held only 20 stocks as of May 31, mainly in just a few sectors. Top holding Pfizer (NYSE: PFE  ) soaks up 14.3% of assets, while other health-care names like Forest Laboratories (NYSE: FRX  ) , WellPoint (NYSE: WLP  ) , and Humana (NYSE: HUM  ) account for another 26% of assets.

Berkowitz has a focused approach, but he does spread his money into other sectors as well. For instance, industrials make up another 20% of fund assets, with stocks like Spirit AeroSystems (NYSE: SPR  ) , Leucadia National (NYSE: LUK  ) , and Boeing (NYSE: BA  ) among its holdings. Nevertheless, the fund remains strongly concentrated, and Berkowitz has deftly shown how profitable taking that approach can be.

Talent is as talent does
In most cases, I would be skeptical about a stock manager's expertise translating into success in the fixed-income arena. However, Berkowitz does have one important thing working in his favor -- he has essentially been doing the legwork of researching bonds all along. In doing his due diligence on potential stocks for the Fairholme Fund, Berkowitz has made a habit of looking at every aspect of the capital structure of every company he invests in. So the new bond fund will simply capitalize on some of the work that Berkowitz and his team have long been performing.

That kind of organic cross-functionality is definitely a point in the new fund's favor. As such, I think this fund could have a greater chance of success, as compared to a bond fund that was a completely new effort for a stock manager. It can be tricky to get a move into new territory right. No less a firm than Bill Gross's Pimco is grappling with the same issues as it mulls a move into stocks, coming from a solidly fixed-income investment culture.

I admit that the focused nature of Berkowitz's new bond fund gives me some pause. After all, fixed income is typically where investors like to play it safe, and this fund may not provide as smooth a ride as many might expect.

Wait and see
So should you take a chance on Fairholme's new bond fund? Well, many investors may not have a choice, since the fund will come with a hefty $25,000 minimum, placing it out of reach of many average Joes and Janes. However, even if you're one of the lucky individuals who could meet this minimum, I'd recommend taking a wait-and-see approach. As talented as he is, Berkowitz has made his name in picking stocks, and it's not a given that his talent will automatically translate into skill at picking bonds. I'm not saying he won't succeed, but you should demand to see proof of that success before committing your money to this new venture.

Truthfully, my gut says that this could end up being a pretty decent fund. But more than one talented manager has been blindsided by the difficulties of venturing outside of his or her comfort zone. Fairholme Focused Income could turn out to be a good thing, but I'd let someone else test the waters first.

For more insider investing and personal financial planning tips, take a look at the Fool's Rule Your Retirement service, which provides top-notch retirement and mutual fund advice. You can start your free 30-day trial today.

Amanda Kish is the Fool's resident fund advisor for the Rule Your Retirement investment newsletter. At the time of publication, she did not own any of the funds or companies mentioned herein. Leucadia National is a Motley Fool Stock Advisor recommendation. Pfizer and WellPoint are Motley Fool Inside Value recommendations. Spirit AeroSystems Holdings is a Motley Fool Hidden Gems pick. Try any of our Foolish newsletters today, free for 30 days. The Fool has a disclosure policy.


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