What a horrible year for performance! Market prices plunged in many of our Funds’ core holdings in spite of strengthening book values with huge reserving for legacy issues. Using the positions held in The Fairholme Fund, weighted for the Fund’s composition at the end of 2010 and 2011, the line graph on the next page illustrates this divergence in market prices to book values in the last two calendar years using the most recent, publicly available information for 2011 book values.
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If the yearly change in The Fairholme Fund’s NAV reflects investor perceptions of future performance and if changes in underlying book values of portfolio companies approximate current economics, then markets in 2011 expected disaster in the midst of strength. Improving book value levels and ratios show companies recovering from tough times, prepared for uncertainty, and capable of profits without excess leverage. The Fund’s performance last year makes little sense in light of such positive trends and we can only hypothesize from public comments that investors did not fathom our financials’ assets. There appears little understanding of how loan and insurance contracts age and run-off, bad begets good over time, and how U.S. Generally Accepted Accounting Principles (GAAP) create undue quarterly volatility in book values.
