Fairholme Will Soon Close Its Doors to New Investors

Fairholme announced in a filing on Tuesday that it would soft close its three funds (Fairholme (FAIRX), Fairholme Focused Income (FOCIX), and Fairholme Allocation ) to new investors on Feb. 28. Existing shareholders still will be allowed to invest in the funds. What's unusual is that these closings are not being driven by big inflows. In fact, despite rebounding with a category-leading 35.8% return in 2012, the flagship Fairholme fund still endured $2 billion in net redemptions. Outflows are the norm these days for many actively managed U.S. equity funds, but Fairholme got hit harder than most after a dreadful 32.4% loss in 2011. Investors pulled an estimated $6.5 billion in 2011 after years of top-quartile returns. But many of the same stocks, such as AIG (AIG) and Bank of America (BAC), that laid it low in 2011, drove its recovery in 2012.

Nevertheless, this move is not a surprise. Manager Bruce Berkowitz has alluded to this possibility a number of times over the past 18 months, feeling burned by the massive outflows of the past two years. He says he would now rather have a smaller, core group of long-term shareholders who have a thorough understanding of his deep-value process and are less likely to bolt during periodic bouts of underperformance.

It's possible that the timing also is partly being driven by current equity valuations. Berkowitz has given no indication that this is the case, but presumably he would be more open to inflows if there were bargains to be had. Instead, he has continued to consolidate the portfolio, trimming Fairholme to just six core names as of August, led by a whopping 37% position in AIG. Meanwhile, he built cash throughout 2012 despite funding $2 billion in outflows. Cash increased during the year from just above 4% in February to nearly 14% in August, which is closer to its historical norm. This plumper cushion makes it less likely that Berkowitz would have to trim existing holdings to meet any further redemptions. Plus, it gives him available funds should buying opportunities present themselves. But given a market that's considered fairly valued by many, that cash may not be burning a hole in Berkowitz's pocket.