Top manager Bruce Berkowitz is pouncing on financial companies he thinks are stronger after surviving the recession. By Andrew Tanzer, Senior Associate Editor August 6, 2010 Bruce Berkowitz, manager of Fairholme Fund (symbol FAIRX), doesn’t mince words. In his latest shareholder letter, Berkowitz discloses that he has loaded up on “mostly hated” financial-services and real estate–related companies. The new portfolio features large new positions in American International Group (AIG), CIT Group (CIT), Goldman Sachs (GS), Morgan Stanley (MS), Bank of America (BAC) and MBIA (MBI). More than half of Fairholme’s highly concentrated portfolio is now devoted to financials.Berkowitz is a bit like a graceful boxer with a fine sense of rhythm. When he smells danger, he feints and plays defense. When he spots opportunity, he pounces and stings like a bee. Fairholme shareholders have enjoyed the match. Year-to-date through August 4, the fund gained 10.2%, eight percentage points ahead of Standard & Poor’s 500-stock index. Over the past decade, Fairholme -- which is a member of the Kiplinger 25, our favorite no-load mutual funds -- returned an annualized 12.6%, more than 13 points per year better, on average, than the index. We asked the Miami-based Berkowitz why he is jumping feet first into financials these days. KIPLINGER’S: Bruce, why have you loaded up on financial stocks? BERKOWITZ: Financials are going to play the key role in rebuilding the balance sheets of individuals, corporations and municipalities. Without a strong financial-services market, the country will not have the necessary credit to move forward. Our financials’ balance sheets are solid. In fact, they’ve never looked better in terms of capital and reserves. We bought at prices reflecting pessimism in the economy. I do not believe that we are going to lose money at the prices we paid. If the economy just sputters along, we’ll do fine. If the economy recovers, we should do reasonably well. Absent a severe double-dip recession, I don’t see how our shareholders can get hurt. Advertisement In previous conversations, we don’t recall you ever being so enthusiastic about the financial industry. Why the newfound interest? I didn’t have any financials in 2007 or 2008 -- no banks or brokers on the way down. As you get older, one of the nice things in the investment world is that you’ve seen a few cycles already. I made my name [at Lehman Brothers] in the financials in the early 1990s, when people said Wells Fargo and Citibank were finished. Yogi Berra said it right: ‘It’s déjà-vu all over again.’ But many of these companies made disastrous mistakes. What makes you so sure they’ve changed their stripes? Whatever doesn’t kill you makes you stronger. We’re at the point where the institutions that survived are stronger than they were before the recession. They’re tougher, leaner; expensive lessons learned are instilled in them. Now it’s just a question of when the economy advances to a more-normal upswing as opposed to this nascent recovery. So the banks have learned how to make better loans? Banking usually swings from one side to the other, from extreme optimism to extreme pessimism. Enough time has gone by that a huge amount of capital has been injected into the system, and there has been a curing period. Loans made during difficult periods, such as we’ve had the past two years, are good loans; credit standards are tighter and fees are better. When you’re shrinking as an institution, you’re much more selective. And we’re getting to the point where we’re in the second half of digesting all of those poor loans -- the pig in the python -- that the banks extended in those optimistic years. What about Wall Street? Goldman, Morgan Stanley -- they’re a big part of the answer of rebuilding the balance sheets of individuals and the country; improving the rates of savings and investment and overall credit. We need a strong Wall Street for the country to prosper. And we need strong banking and insurance sectors.