Of Mutual Interest Star fund manager trips as bank stocks skid

By Mark Jewell AP Personal Finance Writer BOSTON (AP) -- Would you entrust a sizable piece of your portfolio to a renowned stock-picker who's beaten the market 10 of the last 11 years? Until recently, many have been saying "yes" to Bruce Berkowitz. His Fairholme Fund possesses that enviable record. But those investors now face tougher questions: Are they patient enough to stick it out through a performance slump that's dimming Berkowitz's star reputation? And do they have renewed faith in bailed-out financial companies like American International Group and Bank of America that Berkowitz is counting on to get his mojo back? Some have already hit the exits -- $2.5 billion has been withdrawn in the past three months, leaving Fairholme with $14.6 billion in assets. And at last week's Morningstar Investment Conference in Chicago, Berkowitz didn't inspire much hope that a turnaround is near for Fairholme, or for the banks and insurance companies whose stocks are in another rough patch. In a presentation to more than 1,000 financial advisers, Berkowitz joked about why his voice was raspy from laryngitis: "I'm having an extreme case of premature accumulation in financial services companies." "We are going through a painful period right now," he said. "And a year from now, we'll see." It hardly inspired the confidence one might expect from a man Morningstar honored in January 2010 as the past decade's top stock fund manager. Fairholme investors earned an average return of 13 percent a year last decade -- 14 percentage points ahead of the Standard & Poor's 500 index. Berkowitz has a knack for finding stocks whose prices have fallen further than justified by the company's performance. Historically, he's been able to capitalize. He holds a small number of stocks in his 11-year-old fund; at latest count, it had just 20. A concentrated portfolio can be risky, yet the 53-year-old's accomplishments can make the most skeptical investor take a look at Fairholme (FAIRX), and many have. Investors deposited a net $4.3 billion last year, according to Morningstar. But their recent rush to the exits is depleting the amount of cash the fund maintains. If investors continue to withdraw, Berkowitz may be forced to sell some of his financial stock holdings before they've fully recovered. Redemptions may continue because Fairholme has lost nearly 13 percent this year, compared with the S&P 500's 1 percent gain. The fund ranks in the bottom 1 percent of its peer group. A coveted 5-star rating from Morningstar was lost last month when the fund researcher demoted Fairholme to four, due to the performance slump. Blame Berkowitz' recent bet on financial stocks. At latest count, 74 percent of the fund's stock holdings were in financial services. Five of the top six stock holdings were among those hardest hit in the financial crisis. The No. 1 holding is insurer AIG. Then there's Bank of America, Morgan Stanley, Goldman Sachs, and Citigroup. Bank stocks have been among the worst performers in the market recently. An index of major U.S. bank stocks is down 10 percent this year, while the S&P is up 1 percent. Investors continue to worry about banks' complex balance sheets. Banks are more vulnerable than most stocks when the economy is in trouble and financial activity slows, and recent indicators point to a weakening recovery. Banks also face increasingly strict regulations, and investors worry that U.S. and European banks could come under stress if Greece defaults on its debt. At the Morningstar conference Berkowitz suggested banks will eventually come back, but he offered no timeline. "Every five or 10 years, the financial services companies get themselves into a pickle," he said. "It just seems to be the nature of capitalism, and it's one of the side effects of capitalism." He says bank prospects are improving, with profits likely to rise once interest rates climb. The Federal Reserve is keeping short-term rates near zero to stimulate the economy, so rates have nowhere to go but up. Once that happens, banks will again be able earn decent returns on their investment portfolios. Berkowitz also argues that bank loan portfolios are looking better now that many defaulted loans have been written off as losses. Fewer than 40 percent of the loans that were in banks' portfolios in 2007 are still on balance sheets, he said. His favorite example of a stock that's been punished too much is Bank of America. Because it bought troubled mortgage lender Countrywide during the financial crisis, the bank has been "kicked every day for being the evil empire," Berkowitz says. But now, "they have an extra 30,000 people working through the problems. They are doing everything in their power." Other investors haven't liked Berkowitz' stock picks lately. AIG, for example, is down 52 percent this year, and Bank of America 21 percent. Still Berkowitz isn't alone. Two other star fund managers of the past decade are also in slumps. This year, Ken Heebner's CGM Focus Fund (CGMFX) has the worst year-to-date performance among more than 1,700 large growth stock funds, with a 14.6 percent loss, according to Morningstar. Bill Miller's Legg Mason Capital Management Opportunity Fund ranks in the bottom 1 percent in the mid-cap value category, with a 12.4 percent loss. All of these recent disappointments illustrate the perils of investing based on a fund manager's star reputation. A manager may have taken big risks to beat the market. When things shift -- say, bank stocks rise after they're bailed out, only to drop when the rise appears to have been unjustified -- star stock-pickers can suddenly look like also-rans, or worse. Many investors who put money into Fairholme in recent years probably had no business doing so, said Morningstar fund analyst Kevin McDevitt, "because this fund will be volatile." McDevitt's advice: "Rather than focusing on past returns, you want to look at a fund's strategy, and how volatile it can be, and whether you're comfortable with it." Published: Mon, Jun 20, 2011