Fairholme: Not Just a Fair-Weather Fund

The stock market's recent gyrations may be making you a bit jittery. The recent upward spike in long-term interest rates caught even many of the smartest strategists, such as Pimco's Bill Gross, wrong-footed. With the economy surprisingly buoyant and concerns about inflation coming to the fore, Wall Street's seers are backing off on predictions that the Federal Reserve will soon cut short-term interest rates. If you can't figure out if this implies a bull or bear market ahead, you're not alone.

One thing you can do is purchase shares in a fund that performs well in either market. Fairholme (symbol FAIRX), a new member of the Kiplinger 25, is one such fund. Since its launch in December 1999, at the height of the market bubble, Fairholme has crushed Standard & Poor's 500-stock index in bear markets (2000-02) and also managed to whip its bogey in the good times of 2003-07. Overall, from its inception to June 1, 2007, Fairholme returned 19% annualized, compared with just 2% a year for the S&P 500.

Co-managed by Bruce Berkowitz, Larry Pitkowsky and Keith Trauner, this concentrated multi-cap value fund has succeeded using a series of techniques. When the managers put money to work, they require a large "margin of safety," meaning they want a stock's price to sell at a substantial discount to their estimate of the company's intrinsic value. They like to keep a large cash hoard -- generally 20% or more -- for the jewels on sale during inevitable market corrections. "Good companies only get cheap in difficult times," says Berkowitz.

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Fairholme's annual turnover is low (20%), as you might expect. The portfolio is extremely concentrated, with 64% of assets devoted to the top ten holdings. Interestingly, fund volatility is low, despite the non-diversified portfolio.

And the idiosyncratic fund is full of contrarian plays. For example, although many value investors shy away from oil plays because of the lack of certainty over a key variable in the business (energy prices), Fairholme is stuffed with oil stocks, such as Canadian Natural Resources (CNQ). The stock is up 25% year-to-date through June 8. And Fairholme bought beaten-down housing-related shares, such as Mohawk Industries (MHK; up 33% year to date), a leading carpet maker. "People walk on carpet," says Berkowitz. "It wears out."