Fairholme Funds will file their Semi-Annual Report with the United
States Securities and Exchange Commission (“SEC”). The combined filing
contains information on the portfolio holdings of The Fairholme Fund
(NASDAQ: FAIRX), The Fairholme Focused Income Fund (NASDAQ: FOCIX), and
The Fairholme Allocation Fund (NASDAQ: FAAFX) as of May 31, 2012.
Fairholme Funds’ Semi-Annual Report will be available online to the
public on the SEC’s EDGAR database and is currently available at www.fairholmefunds.com.
The following Portfolio Manager’s Report as of June 30, 2012 is included
below and is also available at www.fairholmefunds.com.
FAIRHOLME CAPITAL MANAGEMENT, LLC
PORTFOLIO MANAGER’S REPORT
For the Six Months Ended June 30, 2012
Mutual fund investing involves risks including loss of principal.
Performance information quoted herein represents past performance and is
not a guarantee of future results. The investment returns and principal
values of investments in the Funds will fluctuate so that an investor’s
shares, when redeemed, may be worth more or less than their original
cost. Current performance may be lower or higher than the performance
information quoted within. The Fairholme Fund and The Allocation Fund
impose a 2.00% redemption fee on shares held less than 60 days.
Performance data does not reflect the redemption fee, which if imposed,
would reduce returns. Any questions you have regarding the latest
month-end performance can be obtained by calling shareholder services at
At June 30, 2012
To The Shareholders and Directors of Fairholme Funds:
Financial disasters start with great investment ideas taken to illogical
extremes. For example, what has been more beneficial to family wealth
than home ownership? Yet, we recently witnessed a near collapse caused
by residential real estate.
Great investment ideas start with disasters. Liquidity disappears.
Assets are marked to mayhem. Intangibles are written off. Companies with
fixable problems become unusually cheap and again profitable. Yet, they
remain hated for past sins and sell for less than assets minus
liabilities, reported as book value. They have little, if any,
This is when we focus on buying. This is also when we look dead wrong
and have periods of underperformance. This is also how The Fairholme
Fund has outperformed the S&P 500 Index in ten of the past twelve years.
In 1988, Warren Buffett wrote “…our marketable equities tell us by their
operating results – not by their daily, or even yearly, price quotations
– whether our investments are successful. The market may ignore business
success for a while, but eventually will confirm it.” Twenty years
later, the 2008 collapse of financial markets was caused by companies
ill-prepared for a national decline in home prices, the freezing of
credit, and knock-on effects. Today, they stand at polar opposites.
The Fairholme Fund (FAIRX)
The Fund gained 24.7% versus 9.5% for the S&P 500 Index in the first six
months of this year. A $10 investment in the Fund at its inception has
grown to $37.33 (assuming reinvestment of distributions) compared to
$11.74 for the S&P 500 Index. Cash and equivalents stand at $1.25
billion (17% of the Fund). The following chart compares The Fairholme
Fund’s unaudited performance (after expenses) with that of the S&P 500
with dividends and distributions reinvested, for the period ending
June 30, 2012.
The Fairholme Fund Performanceto 06/30/2012
Our best idea remains AIG common (35% of the Fund) with a reported book
value of $57 per share. There are few occasions when systemically
important franchises sell for half of book value and are profitable.
This is one of those times. AIG warrants held by the Fund (another 3% of
the Fund) provide the right to 21+ million shares at $45, or maybe more
shares at lower strike prices for the next 34 quarters if dividends
above $0.675 per trailing 12-month period are paid.
Bank of America is the Fund’s next largest financial holding (9% of the
Fund) affected by the great housing price collapse. The company’s
reported book value is over $20 per share. We believe that America’s
bank is returning to its retail roots (think of Wells Fargo) with a $1
trillion deposit franchise and that bank profits will skyrocket as
legacy real estate loans burn-off.
Sears Holdings (11% of the Fund) is one of the largest corporate real
estate organizations in the world, with a portfolio of retail locations
that is second to none. Generally Accepted Accounting Principles
(“GAAP”) mandate valuing their real estate at the lower of cost or
market. GAAP would force the Dutch settlers to value Manhattan today at
the 1626 purchase price of $23.70. The company’s reported book value of
$43 understates real values.
Warrants received by the Fund from General Growth Properties (7% of the
Fund) during its reorganization provide the Fund the right to “cash-in”
the difference between GGP’s market price and the current strike price
of $9.52 on now 45 million shares. For the next 22 quarters,
distributions by GGP will further reduce this strike price and increase
the number of shares.
The Fairholme Focused Income Fund (FOCIX)
The Fund seeks, among other things, current income. The Fund gained 6.5%
versus a gain of 2.4% for the Barclays Capital U.S. Aggregate Bond Index
(“Barclays Bond Index”) in this latest six month period. In its first 30
months, the Fund gained 17.5% versus 17.6% for the Barclays Bond Index.
MBIA senior, unsecured bonds maturing between 2022 and 2028 represent
the Fund’s largest holding (29% of the Fund). These bonds have an
average current yield of 10.1% and yield to maturity of 11.4% per annum.
MBIA surplus notes of 2033 (another 12% of the Fund) are the most junior
of MBIA bonds held by the Fund and have a current yield of 25.9% and
yield to maturity of 22.4%.
Sears Holdings’ 6.625% of 2018 and Emigrant Savings Bank’s 6.25% of 2014
(each 21% of the Fund) have respective yields to maturity of 8.9% and
10.6%. They compare quite favorably to equivalent U.S. Treasuries. Cash
and equivalents are at $30 million (12% of the Fund).
The Fairholme Allocation Fund (FAAFX)
The Fund seeks long-term total return. We have typically sought
investments for the Fund that are too small to make a big impact on a
larger fund. The Fund gained 11.3% while the Barclays Bond Index and S&P
500 earned 2.4% and 9.5%, respectively, in the past six months. In its
first 18 months, the Fund is down 4.3% versus a gain of almost 10.4% for
the Barclays Bond Index and 11.8% for the S&P 500. Cash and equivalents
are at $11 million (4% of the Fund).
MBIA common (32% of the Fund compared to 3% of FAIRX) has a reported
book value of $10 per share. GAAP mandates no value attributed to
unearned premiums and mark-to-market reversals estimated to be worth $20
per share. Since 2008, the company has paid $35 per share on faulty real
estate-backed bonds. Management expects to receive at least half back of
the $35 from the issuers of the bonds and to restart the municipal bond
insurance business with the cash proceeds.
AIG common (18% of the Fund) is our second largest idea for the Fund
given valuations and liquidity.
Long-dated warrants on AIG, Bank of America, Wells Fargo, J.P. Morgan,
and Hartford Financial held by the Fund (in total 16% of the Fund) are
unique in that strike prices decline and conversion share amounts
increase with dividends paid above threshold levels. The following table
summarizes each warrant’s current strike price and conversion ratio,
expiration date, and quarterly dividend threshold. Estimated returns are
attractive, if as assumed below, underlying common share prices meet
book values growing at 10% per annum and exercised shares can be sold at
* Assumes trailing 4-quarter cumulative dividends of 67.5 cents.
** There can be no guarantee that these assumptions will occur.
Liquidity and Concentration of the Funds
Fund share redemptions have forced the Funds to raise liquidity. Rather
than selling across the board, we have learned not to sell our best
ideas. Again, Mr. Buffett: “The strategy we’ve adopted precludes our
following standard diversification dogma. Many pundits would therefore
say the strategy must be riskier than that employed by more conventional
investors. We disagree. We believe that a policy of portfolio
concentration may well decrease risk if it raises, as it should, both
the intensity with which an investor thinks about a business and the
comfort-level he must feel…”
Bruce R. Berkowitz
Fairholme Capital Management
As reflected in its current prospectus dated March 29, 2012, The
Fairholme Fund’s Expense Ratio is 1.02%, which includes acquired fund
fees of 0.02%. Acquired fund fees and expenses are those expenses
incurred indirectly by the Fund as a result of investments in shares of
one or more investment companies, including, but not limited to, money
The following chart compares The Income Fund’s unaudited performance
(after expenses) with that of the Barclays Bond Index with dividends and
distributions reinvested, for the period ending June 30, 2012.
The IncomeFund Performanceto
As reflected in its current Prospectus dated March 29, 2012, The
Income Fund’s Expense Ratio is 1.01%. The Manager contractually agreed
to waive a portion of its management fees and/or pay The Income Fund’s
expenses (excluding taxes, interest, brokerage commissions, acquired
fund fees and expenses, expenses incurred in connection with any merger
or reorganization and extraordinary expenses such as litigation) in
order to limit the expenses of The Income Fund to 0.75% of The Income
daily average net assets for the period of March 30, 2011 through
March 29, 2012.
The following chart compares The Allocation Fund’s unaudited
performance (after expenses) with that of the S&P 500 and the Barclays
Bond Index, both with dividends and distributions reinvested, for the
period ending June 30, 2012.
The AllocationFund Performanceto
As reflected in its current Prospectus dated March 29, 2012, The
Allocation Fund’s Expense Ratio is 1.01%. The Manager contractually
agreed to waive a portion of its management fees and/or pay The
Allocation Fund’s expenses (excluding taxes, interest, brokerage
commissions, acquired fund fees and expenses, expenses incurred in
connection with any merger or reorganization and extraordinary expenses
such as litigation) in order to limit the expenses of The Allocation
Fund to 0.75% of The Allocation Fund’s daily average net assets for the
period of December 29, 2010 through March 29, 2012.
This Portfolio Manager’s Report is not part of the Fairholme Funds
Semi-Annual Report. The Semi-Annual Report contains a Management
Discussion and Analysis section covering the period ended May 31, 2012.
Opinions of the Portfolio Manager are intended as such. Unless otherwise
specified, any references in this Portfolio Manager’s Report to a
portfolio holding of a Fund is at the latest public filing of Fairholme
Funds, Inc. with respect to such holdings at the time of publication.
Portfolio holdings are subject to change at any time and are subject to
risk. There can be no guarantee that undervalued securities will
appreciate as anticipated.
Expense ratios for the Funds stated in the current Prospectus dated
March 29, 2012 may differ from the actual expenses incurred by the Funds
for the period covered by the Fairholme Funds Semi-Annual Report.
The S&P 500 Index is a widely recognized, unmanaged index of 500 of
the largest companies in the United States as measured by market
capitalization. The Barclays Capital U.S. Aggregate Bond Index is an
unmanaged market-weighted index comprised of investment grade corporate
bonds (rated BBB or better), mortgages, and U.S. Treasury and government
agency issues with at least one year to maturity. Investors cannot
invest directly in an index.
Investors should consider the investment objectives, risks, and
charges and expenses of a Fund carefully before investing. The Fund’s
prospectus contains this and other information about the Fund. To obtain
a copy of the Fund’s prospectus, please visit www.fairholmefunds.com
or call 1-866-202-2263. Please read the prospectus carefully before
Fairholme Capital Management, L.L.C.Brian Ehrlich, 305-358-3000
Source: Fairholme Capital Management, L.L.C.