Bruce Berkowitz Discusses His Financial Investments

Posted on Posted in Bruce Berkowitz, Investment Philosophy, Superinvestors

Bruce Berkowitz is one investor that I like to study. I like to run an adequately diversified portfolio, taking advantage of what I consider to be numerous high probability situations. I imagine certain probabilities with each investment, and I look at diversification in two ways: one is through the various positions I currently have, and one is through the positions I will hold in the future. The latter refers to my thesis that over time, buying undervalued stocks over and over again will work. There will be some investments that don’t work out, but over time, on balance, it works.

I think some investors who are much more concentrated than I am focus more on the latter aspect of this type of thinking. Bruce Berkowitz is an example of a focused investor. Eddie Lampert, Mohnish Pabrai, and Allan Mecham are other investors who focus. They each own just a few stocks, and their top idea represents a major part of their portfolio. Perhaps this is part of the reason for their huge returns over time. I run portfolios that are more diversified, but these investors often provide me with great ideas to research.

13-F’s are Idea Generators

As Pabrai recommends, I look at 13-f filings each quarter to find out what the greatest investors are buying. I think of 13-f filings as idea generators. They are starting points… not ending points for investment ideas. I think of these 13-f’s as a way to leverage these larger firms’ vast resources, talent, and experience to source investment ideas. They are analysts, and I don’t have to pay them!

I think there is research out there that has concluded that following the best investors’ best ideas leads to significant outperformance. But I don’t think of these 13-f’s as an automatic investment system… I don’t run out and buy a stock because one of the investors I track just bought it. If I see an idea that looks interesting, I’ll look at it more closely and determine if it makes sense to me. More often than not, it doesn’t.

I go through my usual pre-inspection checklist:

  • Do I understand it? (Very basically, how do they make money?)
  • Is it cheap? (Big picture simple valuation metrics)
  • What are insiders doing?
  • What are the risks?
  • What’s the upside?

Most of the questions get answered along the way, but I like to immediately see if I can get a rough idea of what I’m dealing with. Sometimes, ideas are obvious, sometimes they aren’t. But it’s always interesting when the investor himself discloses some of his thought process behind his investments.

Bruce Berkowitz Discusses His Best Ideas

Last week, I caught this Bruce Berkowitz video where he discusses his new position in Fannie Mae and Freddie Mac preferred shares. The position represents about 5% of his portfolio, but have the potential to become much larger since they trade at 20% of their par value.

These Fannie and Freddie preferreds ares trading at about 20% of their liquidation value, and thus have significant upside. I took a look at these a few weeks ago, and after a quick look, decided that their fortunes were too tied to Congress. I don’t see an alternative to these GSE’s, and the residential housing market is too tied to these entities to simply remove them from the equation, but at the same time, I’m having a hard time determining how the government decides to play this out. And we know they play by their own rules… for example, they implemented a “sweep” amendment which simply allows them to take all of the profits from Fannie and Freddie (and these profits are huge-the GSE’s just had one of the most profitable quarters in their history).

I don’t quite see how this is possible/legal/Constitutional, but they did it, and now shareholders have to file suit just to try and protect their rights as owners.

Obviously this uncertainty is the reason that the preferreds trade at 20% of their par value, leaving a 5x possible return if this gets sorted out in Berkowitz’ favor. I decided to pass (it failed my first question: Do I understand it?) and will watch with interest to see how the situation resolves itself.

Berkowitz also discussed his ideas on AIG, BAC, and SHLD, his top 3 positions which represent a large majority of his overall assets. These ideas are much easier to follow… they’re cheap, selling well below book value (or in Sears’ case, below Berkowitz’ estimated value of their real estate assets).

It’s interesting to note that he’s very bullish on all three, even after huge runs by AIG and BAC.

Here is the video with Berkowitz discussing his ideas: 

24 thoughts on “Bruce Berkowitz Discusses His Financial Investments

  1. Honestly, sounds like you do have a good grasp of the GSE situation given your comments. Just assign probabilities to the outcomes you mentioned (tied into mkt vs. wind down, probability of positive legal ruling vs trampling of rights).

    Great analysis as always.

    1. Thanks for the comment Neil. Yeah it could be positioned as a quasi long term call option on Congress allowing the GSE’s to keep the profits. My hunch is that this investment will work out well for Berkowitz. It’s just hard to determine the odds when you’re playing with/against the guys who make the rules. But the situation certainly has some interesting game theory aspects to it. I will be following it closely.

  2. This website is joining all the dots for me.

    Where do you get the 13-F filings? Do you go to the investors website, or do you have access to the SEC database?

    1. Benny, I access them directly from the EDGAR filing system at the SEC site. They have to file each quarter by 2/14, 5/14, 8/14, and 11/14. Each quarter, I plug in the top 10 holdings for each manager into a spreadsheet so I can track them over time. Sometimes, it’s interesting to go back and see what they did in the past. Some good case studies in there…

      1. John

        You and your readers may find whalewisdom.com and dataroma.com very helpful for your 13-F data needs.

        I am not affiliated with either site.

        1. Thanks Allen. I haven’t checked those sites out. I usually just go to the EDGAR filings, but I’ll take a look at them. Thanks for the comment.

  3. Fannie and Freddie look very tempting.

    You say that you don’t understand what taking a position would entail… can you elaborate a bit more on that? Is it only congress that you don’t understand, or don’t want to pre-empt.

    Mortgage markets have had a good cleansing, and the CDOs are no longer about… to me it seems simple, they lend money out and take it at interest, what is important is the amount of actual working capital they have which could absorb future losses…. should congress let it go.

    I would be happy to get into that market at some point in the near future.

    1. Yeah I have a decent grasp of the business, and they actually have huge moats (Buffett and Lynch were at one time long time large Fannie Mae investors). They are essential to the health of the housing market, at least currently. If there is an alternative out there, it isn’t one without significant pain for middle income Americans that rely on the GSE’s for longer term amortization and lower downpayments (not saying large loan to value ratios (LTV’s) and 30-year mortgages are good for people to participate in, or even necessary in America, just that they likely wouldn’t exist without Fannie and Freddie… and without them, there would be some serious deleveraging going on in Main St). And if the alternative is replacing the GSE’s with something similar, that kind of defeats the purpose of replacing them in the first place.

      Basically, when I say I don’t understand the investment, it mostly means I don’t understand how to assign probabilities to the outcomes for Fannie and Freddie. At 20 cents on the dollar (for the preferreds), they look like great bargains, but it’s hard to figure out what Congress will do. One could view them as a call option with no real expiration date (not a bad way to view them maybe?)… but it’s more of a gamble to me because I really can’t figure out what I think Congress will do.

      Of course, once the uncertainty is lifted, these will likely be much more expensive, and that’s part of the investment scenario.

      Usually I like uncertainty. It typically causes mispricing, and usually works to my advantage as a value investor. But in this case, the thing I’m uncertain about (Congress) is the entity that ultimately can decide how my investment will work out (as opposed to normal market conditions, catalysts, revaluations, build up of profits, etc…).

      My hunch is that this investment will work out well, maybe extremely well for Berkowitz. But at this time, it’s just a hunch and I don’t like investing on hunches. I am still doing some research and a lot of thinking, and this could change if my thoughts change or more information comes about… but for now, I’m just watching with bated breath. 🙂

      1. Thanks for the replies above.

        The gambler in me wants to pull the trigger, but my rational side airs on the side of caution like you. The trouble with congress is that you don’t have a whole lot of lay people passing the votes, on the flip side investors have a pretty big lobbying wing.

        Hard to know.

  4. Hi John,

    I’m a bit ignorant concerning preferred shares. I was looking to see which pref. shares Berkowitz bought, as there are a number of different ticker symbols, and I couldn’t find anything on the internet other than he bought “preferred shares.” Then, I checked the EDGAR site, but didn’t see anything listed, which just added to my confusion — so maybe I’m looking at the wrong Edgar filing? ( http://www.sec.gov/Archives/edgar/data/1056831/000091957413005236/xslForm13F_X01/infotable.xml )

    Also, according to Morningstar there are a number of different ticker symbols, each with it’s own key ratios and such. So, is one type of preferred share better than another one? Or all they all basically the same (other than the yields)?

    Concerning Fairholme’s investment in the preferred stock v.s. the common stock — I think I understand this, but I just want to make sure — Berkowitz bought the preferred stock, rather than common stock, for the yield, but also because he views (whichever) preferred stock he bought as more even undervalued than the common stock?

    And my apologies for all of these questions. I really appreciate this blog. Personal finance is something that was never discussed in my family growing up (other than pinching pennies from paycheck to paycheck), so I’ve learned quite a bit in the past year by following this blog as well as many of the links and books you’ve recommended (I am a graduate student at a state university and have access to an extensive library, as well as databases like Morningstar and Value Line — which I never would have looked at if I hadn’t seen your blog post on idea generation and screens — so thanks for that, too).

    Best,
    RW

    1. Thanks for the comment Ryan. All good questions.

      The first one regarding Fairholme. I went directly to Fairholme’s site and read the latest letter to shareholders along with the latest report. However, he seems to have taken the letter down for some reason. Maybe it’s still there somewhere but I didn’t see it at first glance. I copied each of the tickers he owns and put it in my notes, but he really just owns the most liquid of the Fannie and Freddie preferreds. He owns 5 or 6 of the series of each Fannie and Freddie (so it looks like a total of 10 or 12 positions). Some are cheaper than others due to liquidity and future dividends, etc… but basically, it looked to me like he just bought a bunch of them, buying the most of the liquid ones simply because that was the easiest for him. I actually think the two liquid securities: the Freddie Mac Z Series (FMCKJ) and the Fannie Mae S Series (FNMAS) are probably the most expensive, but because Berkowitz has a lot of capital to put to work, those are the two securities that make it easiest for him to build a big position. He also owns many of the less liquid ones as well.

      He has about 6% of his assets in these preferreds (many have misinterpreted the size of his position saying that he has a $2.4 billion bet on Fannie and Freddie. This isn’t true as of now. It’s only about $500MM or so. The articles that have said that are referring to the par value of the securities-which are about 5 times the current market value).

      Look for his next semi annual report for details and they’ll be on his next 13-f I would assume as well.

      As for the symbols, I checked the Fannie and Freddie sites directly. I also read through a few of the prospectus when they came out which are also posted there. You can get a list of symbols http://www.fanniemae.com/portal/about-us/media/financial-news/2010/5086.html and http://www.freddiemac.com/investors/preferred_stock.html.

      And re: the question about preferreds vs common. Berkowitz’ decision there really had nothing to do with the dividend, but rather the seniority that the preferred shares have over the common. In the event of a bankruptcy or other unforeseen government action, the preferred shareholders stand in front of common shareholders, making the preferreds much less risky.

      Hope that helps. Thanks for reading and glad you found some of the links and material useful.

  5. Berkowitz’s investment thesis simply says that Congress will act out of political pressure, fiduciary duty and greed. I agree with the commentators so far that investing money that depends on Congress to act rationally is not a sure thing. However, these kinds of investments may come under Whitney Tilson’s “lottery ticket” approach. You invest a small portion of your portfolio. If you lose, you lose a small portion of your capital. If you win, you win big. And the odds are much better than state lottery games, which I avoid. Also, FNMA and FMCC are both financial stocks, which are well within Berkowitz’s circle of competence. Predicting how a committee like Congress will act, however, is not within anyone’s circle of competence, IMHO.

    1. Good point… the absolute risk reward of the position on its own merit is very difficult to determine. But position sizing and portfolio management could allow you to take a specified risk. The preferreds have 5x upside if they sell at par at some point. So it’s 5:1. It’s just determining the probability… I don’t typically like getting into that type of mindset regarding lottery tickets, because it can lead to a justification of taking risks that you can’t properly underwrite and if you have too many situations at one time, the portfolio begins to take on too much risk. However, with proper discipline, it probably wouldn’t be a problem to risk a small given amount of portfolio basis points. I’m staying away for now but will continue to study and read more about the details of the situation.

  6. Yes it is hard to decide especially if you have spent a lot of time doing homework on AIG. However, it is easy if you just realize that… all things being equal if a guy is waiting for the politicians to make a decision that will yea or nay your “investment” then in all realism it is wiser to avoid it.

    An example from my own portfolio… Last year I did some homework on YPF as it was going through its political crisis. It was a cheap blue chip that showed up because of its… cheapness. And there will always be a very good reason why a blue chip is cheap. Well, in this case it was the Argentine national govt. deciding to “nationalize” the company which really meant they would majority shareholder the thing and keep it running as a public company. It is my personal belief that the thing was mispriced to the downside because the market feared an outright nationalization and delisting. The fear of the unknown went on for so long that it went lower than the ’09 crisis price of $16+ and went even as low as ~$9.50. I was lucky to get it at $10+. However, I am lucky but I am right at the same time. The right is that I knew the Argentine govt. would do the wisest thing and keep the company running publicly as a justified entity (ie a profitable company). Therefore, with their stated goal of increasing oil production I knew that this company has nowhere to go but up.

  7. By the way… Fairholme just put out (or I just noticed it at least) their case study on Fannie and Freddie. I might take a look through it today… or this weekend. Might be interesting. Check his site for the link.

  8. Actually, I just started looking through it and realized the case study is really just a very short powerpoint with a few facts. Not really anything new there…

  9. Hi John,

    Could you explain a bit more about AIG’s business model and their relation to Congress? I thought AIG was a global insurance company that got bailed out by its home territory’s federal government. How much does it owe Congress? Is it making money? Does Congress have an incentive to see a rising share price? I think if we can ask a lot of these focused questions, there is a better picture of how good a speculation or investment it is.

    Are you surprised it is still paying dividends?

    Thank you for your expertise.

    1. Also, how would AIG compare to a similar beaten-up financial company across the waters over in Europe: AEG? Aegon looks even more undervalued at 0.38 price-to-book.

      These were both first-class (supposedly) blue chip companies before the financial crisis.

      1. Not sure about AEG but it does appear cheap. Many other insurance companies and other financials are still in the post crisis “valuation hangover”. Some really nice profitable small banks sell at 70% or less of tangible book. That historically is rare. But the market takes a long time to forget an event like 2008.

    2. Hi Cory, I will put a post up on AIG at some point. AIG is no longer owned by the government. The government exited their position over the past couple years through a series of offerings. Their investment turned out to be profitable to the tune of over $20 billion. The vast majority of the shares are now in the public’s (and insiders’) hands. The government did bail it out, and helped see AIG through the crisis. But the company that has emerged is completely different (in terms of their business model) than the old company. Far fewer derivatives (CDO’s, etc…), and far fewer business lines. It’s basically a life insurance business and a P&C business. It has a third business that does mortgage insurance, but that is tiny relative to the other two.

      AIG is making money and just started paying a dividend. I own the common and the warrants for AIG, and I think the new business is extremely streamlined and is valued very cheaply by the market. I think eventually there is a good possibility that it gets revalued to book value or even a slight premium, but time will tell.

  10. What do you think about investing in countries like Japan, Greece, and Spain. These countries are having difficult times, but there’s a lot of super cheap companies over there. Nate from oddballstocks has made a lot of money in Japan. Would you recommend investing in countries such as Greece, Spain etc? The thesis being is that all the problems are reflected onto the market price and you can pick some super cheap companies.

    1. Sure…. value investing is simply figuring out what an asset is worth and buying it for less. I’m not necessarily recommending going overseas, but certainly value investing principles apply everywhere. I have traditionally stayed home simply because I find enough ideas and I understand the laws better. But some guys have done very well owning net net baskets in Japan, etc… it’s not a bad idea and I applaud their results. I didn’t participate simply because I have a hard time gauging the risks of businesses in other countries (I suppose if you can understand the balance sheet and you’re buying net nets, that doesn’t really matter). Nevertheless, my first priority is to not lose money and I’m more comfortable at home. Perhaps this will change as I gain more experience and knowledge of foreign businesses and their reporting…

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