Larry Pitkowsky and Keith D. Trauner have their own money in their Fairholme Fund and invest in companies whose executives do the same, including billionaire Warren E. Buffett.
Fairholme's biggest holding is shares of Berkshire Hathaway Inc., 38 percent-owned by Buffett. The mutual fund's second-largest investment is Leucadia National Corp., whose founders own about 24 percent of the company. Pitkowsky and Trauner, along with Fairholme Capital Management LLC President Bruce R. Berkowitz, have a combined $5 million in the fund.
"When management owns a big block of stock, if things go well, they will do extremely well, and if things go poorly, they will suffer," Pitkowsky said from his office in Short Hills, N.J. "It's very helpful to have management interests aligned with our interests."
The $1.4 billion Fairholme Fund rose at an annual rate of 15.2 percent during the past five years, outpacing 90 percent of competing funds and the 0.4 percent advance of the Standard & Poor's 500-stock index. The top-performing fund of the past five years that has a similar strategy of investing in companies whose stock prices are low relative to earnings growth is the $345 million Delafield Fund, data compiled by Bloomberg show.
The Fairholme Fund opened with $100,000 in 1999 and has grown by "trying to buy dollar bills for 50 cents," Pitkowsky said. The initial minimum is $2,500.
"All of our investments outside of our homes and a little cash are in the entities we manage," said Pitkowsky, 41, a former broker from Paine Webber Group Inc., now owned by Zurich-based UBS AG. "Everything is here one way or another." Fairholme employees have "personal wealth of many tens of millions of dollars invested in the vehicles we manage," Trauner said.
Buffett, 75, has a stake worth about $50 billion in Berkshire Hathaway, the insurance and investment company based in Omaha. Joseph Steinberg and Ian M. Cumming own Leucadia shares valued at more than $1.2 billion, according to U.S. regulatory filings.
Pitkowsky joined Fairholme Capital Management, which oversees about $2.5 billion, six years ago. He has a bachelor's degree in accounting from Rutgers University in New Brunswick, N.J. Trauner, 48, who's chief financial officer of Fairholme Capital, was hired in 1999. He has a bachelor's degree in history from Middlebury College in Middlebury, Vt.
The Fairholme Fund owns shares of 15 to 25 companies. Cash and Treasury bills make up almost 30 percent of its assets.
Pitkowsky and Trauner also invest in securities of bankrupt companies. The fund bought bonds of WorldCom Inc. when the U.S. telephone company went bankrupt. The bonds were converted into shares of MCI Inc. after the company emerged from bankruptcy last year.
They like "companies that can be bought at a discount through special situations including bankruptcies and reorganizations," said Ronald A. Sugameli, who owns a stake in the fund through his New Century Alternative Strategies Portfolio. "Patience is key with that style of investment, and they have the underlying philosophy to back that up."
Sugameli, based in Wellesley, Mass., manages $350 million, which he invests in more than 60 mutual funds.
Fairholme has had one losing year, dropping 1.6 percent in 2002 when the S&P 500 tumbled 22 percent. This year, Fairholme has risen 13 percent, more than three times the advance of the market benchmark. It closed Friday at $25.89 a share.
The managers have invested in Berkshire Hathaway since the fund opened. Berkshire Hathaway made up 18 percent of the Fairholme Fund as recently as August. The shares reached their low for the year on Sept. 21, three weeks after Hurricane Katrina slammed into the Gulf Coast and just days before the arrival of Hurricane Rita. Since then, they have gained 9 percent. Fairholme's managers view Berkshire as "significantly undervalued."
Insurance costs "will be up sharply in the next year or two with much higher terms and conditions and much higher deductibles," Trauner said. Berkshire Hathaway has "the ability to take enormous advantage of the current insurance problems," he said. Its Class A shares ended the week at $90,900 each.
Fairholme's second-biggest position, Leucadia, is a company with businesses ranging from banking and lending to a winery. Steinberg is the company's president and Cumming is the chairman.
"A lot of studying has given us a certain comfort level that we're dealing with smart and honest people," Trauner said.
Leucadia has been a Fairholme holding since the fund's first few months, Pitkowsky said. The shares have tripled since the end of 1999, including a 12 percent gain since Oct. 31, when Level 3 Communications Inc. agreed to pay Leucadia $680.5 million for WilTel Communications Group LLC. Leucadia's stock closed Friday at $47.40 a share.
Fairholme jumped 25 percent last year, helped by a surge in MCI shares. The fund more than quadrupled its holdings in the second half of 2004, and the shares surged 40 percent from June through December. The managers have since trimmed their stake. MCI shares ended the week at $19.95 each.
Fairholme this year was among the MCI shareholders who protested the board's decision to accept an $8.4 billion takeover bid from Verizon Communications Inc., arguing it wasn't high enough. The dissenters failed. The deal is scheduled to close this month or in early January. "We were quite vocal about trying to maximize value," Trauner said. "We thought it was worth a lot more."