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management company is focused on in-vestment, not sales and marketing. It hasan expense ratio of just 1%.

A graduate of the University of Massa-chusetts Amherst, Berkowitz worked atLehman Brothers and Smith Barney be-fore launching Fairholme. Mutual friendsintroduced him to Pitkowsky, but theirprofessional relationship was cemented ata Berkshire Hathaway annual meeting.Berkowitz met Trauner at an annualmeeting of Leucadia National (LUK),which investors regard as a small-scaleversion of Berkshire. The fund boughtLeucadia in the single digits; it nowtrades in the low 30s.

Berkowitz, Pitkowsky and Traunerhave long shared the same investmentapproach: Buy good management andgood businesses at low prices relative toestimated free cash flow and intrinsicvalue. Berkowitz says Fairholme has

been buying Berkshire stock since thefund’s inception, including recently. Hethinks the company’s intrinsic value is“somewhere around $140,000 per share,”well above its current quote, $108,600.

Fairholme has had exceedingly lowturnover of around 20% a year, reflectingits long-term investment horizon. “Selling

a stock is like getting di-vorced,” Berkowitz says,noting the Fairholmeteam tracks five or six

years of speeches, filings, Webcasts andreports produced by the companieswhose shares it buys. It sells if the priceof a stock climbs to a level at whichfuture returns are likely to be no betterthan risk-free investments like Treasur-ies, or if management changes.

“We spend a lot of time trying to un-derstand the psychology of the CEO’stoys—the trains, the planes—and theirthinking,” he says. “We are very much

about the jockey. If you want to under-stand owner-managers, you have to fig-ure out how they managed through adifficult time, during an industry or gen-eral recession.”

Fairholme’s stable is filled with Buffett-like owner-managers, including lawyer-turned-financier N. Murray Edwards, 47,part-owner of the Calgary Flames hockeyteamandamemberofnumerousoil- andgas-company boards. Edwards built CanadianNatural Resources (CNQ) from scratch; itnow boasts a market capitalization of morethan $33 billion.

The fund started buying shares in2004 at around 20 apiece. The stock nowtrades for 63 and accounts for almost15% of Fairholme’s assets. “Within a cou-ple of years, free cash flow per sharecould approach $10, assuming somewhatlower commodity prices than exist today,”Berkowitz says.

Canadian Natural Resources recentlyrenewed a share-repurchase program forup to 5% of its outstanding stock.

Fairholme also has money on anothercompany Edwards helped found andgrow: Penn West Energy Trust (PWE).Edwards recently left the board after thetrust merged with Petrofund EnergyTrust. “We started buying [Penn West] inlate 2003 and early 2004, at prices be-tween 10 and 15 a share, and made it abigger holding in 2005 at higher prices,”Berkowitz says.

Heestimates the trust’s net asset value issomewhat higher than its current marketvalue, and contends that “investors are notgiving it enough credit for two large off-bal-ance-sheet assets that are just starting to bedeveloped.” Seal, a 300,000-acre oil-sandsproperty, is believed to hold 6.8 billion bar-rels of oil, while Pembina is a mature lightsweet oil field fromwhich the company couldrealize between 150 million and 400 millionbarrels.

Charlie Ergen, 54, chairman of Echo-Star Communications (DISH), is anotherowner-manager of the sort Berkowitz loves.Fairholme bought EchoStar in the high-20sper share from mid-2005 to early 2006, atime of great uncertainty for pay-TV distri-bution companies, especially those in theDBS/Satellite industry. The stock nowtrades for about 49. Berkowitz wagers thecompany’s free cash flow could approach $5a share after taxes “in a couple of years,” upfrom around $3 now.

Fairholme also was attracted to cop-per giant Phelps Dodge despite concernsabout management. “We got it at an in-credibly cheap price, and [the presenceof] activist shareholders gave us confi-dence that shareholders would be pro-tected,” Pitkowsky says. The company

was purchased in March for $26 billion,or $128.68 a share, by Freeport-McMo-Ran Copper & Gold (FCX).

Fairholme picked up most of its PhelpsDodge shares in the spring and summer of2006, at prices ranging from the high-70sto mid-80s. At the time, says Berkowitz,the company’s “unhedged cash flow pershare was approaching $20.”

The Fairholme team plans to hang on tothe Freeport-McMoRan shares it receivedin exchange for its Phelps Dodge stock. “Itlooks attractive to us because of demandfromChinaand20yearsofunderinvestmentin new copper facilities,” said Trauner.

Freeport-McMoRan said last week that

its first-quarter profit came close to dou-bling, due to rising metals prices and the ac-quisition of Phelps Dodge. If commoditiesprices hold at current levels, the company’sfree cash flow could climb to more than $7pershare fromacurrent$6,Pitkowskysays.

GivenFairholme’s evident talent forpick-ing winners, why the side bet on cash? Typi-cally cash averages 20% of the portfolio,though it currently accounts for 24%. “Wethink cash is a strategic asset for the fund,”Berkowitz says. “Though we would eagerlybecome fully invested under the right cir-cumstances, shareholders have benefited todate from holding some cash.”

Twenty-fourpercent isn’t “some,” but it’shard to argue with Fairholme’s sterlingrecord. n

J.R. BRANDSTRADER, a free-lance writer,contributes frequently to Barron’s.

*Annualized **As of 2/28/07 Sources: Fairholme and Morningstar***Acquired in March by Freeport-McMoRan Copper & Gold

% OfTop 10 Holdings Ticker Portfolio**

Berkshire Hathaway BRKA 14.30%

Canadian Natural Res. CNQ 12.19

EchoStar Commun DISH 9.60

Mohawk Industries MHK 4.74

Sears Holdings SHLD 3.59

Leucadia National LUK 3.47

Ensign Energy Services ESVIF 3.27

IDT IDT 2.66

Phelps Dodge*** N/A 2.04

Berkshire Hathaway BRKB 1.92

Total: 57.8

Fairholme Fund866-202-2263

Scoreboard: Edging Out the S&PzEquity-income funds have gained 17.72% in the past year, a little ahead of the S&P 500’s16.67% total return, according to Lipper, the fund-tracking arm of Reuters. These funds havenotched a three-year annual gain of 14.42%. Top performers in the last year include AllianzNFJ Dividend Value, up 20.28%.

One Week Year-to-Date

U.S. STOCK FUNDS 0.20% 7.22%U.S. BOND FUNDS 0.11 2.19TOP SECTOR / Latin American Funds 1.94 14.32BOTTOM SECTOR / Real Estate Funds – 1.00 4.24

THE WEEK'S TOP 10Fund Investment Objective One Week Year-to-Date

United States Nat Gas Natural Resources 4.58% NAProShares Ult Indust Specialty & Misc 3.77 NAPowerShares DB MS BMtl Specialty & Misc 3.75 NAClaymore MAC Oil Dn Tr DSB 3.47 – 2.46ProFunds Telecomm Inv Telecommunication 3.03 14.90Direxion LA Bull 2x Inv Latin America 2.94 26.03BlackRock Comdty Str C Spec Dvsfd Equity 2.92 7.39ProShares UlS Rl Est DSB 2.89 NAProFunds Industrials Inv Specialty & Misc 2.86 12.93Oppenheimer Intl Sco A ISMG 2.74 15.89

THE WEEK'S BOTTOM 10Fund Investment Objective One Week Year-to-Date

American Heritage Growth Multi Cap Core – 6.71% – 7.36%Turnaround Fund Multi Cap Value – 4.62 3.17ProShares UlS Indust DSB – 3.63 NAPowerShares WldHill CE Small Cap Core – 3.03 12.46ProShares Ult Rl Est Real Estate – 2.91 NAFirsthand Tch Val Inv Technology – 2.85 9.56Firsthand Tch Inn Inv Technology – 2.83 2.49Claymore MAC Oil Up Tr Natural Resources – 2.81 3.80IPATH ETN GSCO TR IDX A Specialty & Misc – 2.80 NAUnited States Oil Fund Natural Resources – 2.80 – 4.90

THE LARGEST 10Net Assets 3-Year* 1-Week YTD

Fund (billions) Investment Objective Return Return Return

American Funds Gro A $85.087 Multi Cap Growth 13.85% 0.40% 6.88%American Funds ICA A 74.191 Large Cap Value 12.89 0.43 6.12Vanguard 500 Index Inv 70.353 S&P 500 Funds 12.35 0.59 6.51Fidelity Contrafund 68.713 Multi Cap Growth 15.50 0.32 6.37Dodge & Cox Stock 68.489 Large Cap Value 16.92 0.33 6.65American Funds CIB A 68.387 MTAG 16.83 0.51 7.04American Funds Wsh A 68.272 Large Cap Value 12.47 0.65 6.79American Funds CWGI A 66.846 GMLV 21.51 0.51 8.54American Funds Inc A 63.539 MTAG 14.21 0.54 6.54PIMCO Tot Rtn Inst 62.602 Intmd Inv Grade 4.45 – 0.10 1.49

*Annualized. Through Thursday. Source: Lipper

continued from page 37

Total Returns1-Yr 3-Yr* 5-Yr*

FAIRX 15.48 19.21 15.51

S&P 500 17.06 12.42 8.91

Fund Scope,page M47

38 B A R R O N ' S May 7, 2007