Fairholme distribution and its potential consequences for the fund

dryflower

Fairholme has declared an upcoming distribution equaling over 1/3 of the share value. It appears to me that for those who have purchased FAIRX over the past 5 years or so in a taxable account, they would save on taxes by selling the shares now and paying taxes on their capital gains which would be less, possibly significantly less than paying taxes on the $12 distribution. This is true especially because their tax basis includes distributions from prior years. (Then they can just buy the shares right back after the distribution if that's what they want to do.)

It seems a real possibility that just about everybody is going to realize this same thing and the assets of FAIRX are going to be significantly depleted. Meeting redemptions could possibly even put pressure on the market price of the fund's holdings, specifically SHLD.

Of course when the investor sees that pile of real cash money in his account, he may or may not decide to follow through on the original plan of investing all of it back into the Fairholme Fund.

Ted

@dryflower: FYI: 11/24/15 thread on FAIRX distribution.
Regards,
Ted
http://www.mutualfundobserver.com/discuss/discussion/24482/fairholme-fund-fund-s-successful-bet-on-aig-triggers-a-big-tax-bill-for-investors#latest

msf

While this game is usually played with funds having large distributions, it can also prove useful for a fund with slow, virtually inexorable declines in NAV, viz. RPHYX. Not to mention other cash-substitute funds. For example, ZEOIX has spent nearly its whole life except its first year above $10. It's now at $9.90.

It turns out that because this year has been somewhat flat, many funds (even with more reasonable size distributions) have shares whose NAVs will drop below purchase price after distribution. This is where specific share identification becomes so handy. You can sell just those shares that you purchased (or got via reinvestment) in the last couple of years, and recognize their losses without also recognizing gains on the other shares.

dryflower

I just checked. I have a capital gain of about $5,000 if I sell the shares vs. a distribution of about $19,000 if I keep them. It would simply be an incorrect decision to keep them. So I'm out at today's closing price. I'll buy FAIRX back, but the position will be smaller than the one I sold today.

PRESSmUP

I actually sold my shares in my taxable account for the same reasons as dryflower, but also sold in my IRA.

The hyper-concentrated portfolio can make this choice easy. Would you buy AIG? BAC? Sears? St. Joe? Fannie and Freddie?

If 4 of 5 are not yes, I don't see a reason to stay invested here.

Mark

If you're going to own it a Roth IRA account seems like the best place for it. Fairholme often hands out large capital gains.

msf

PRESSmUP said:

The hyper-concentrated portfolio can make this choice easy. Would you buy AIG? BAC?

Neither would Berkowitz - he wouldn't even hold (let alone buy) AIG, which is why the fund is paying out so much in cap gains. He's also dumped most of BAC. It will be interesting to see how his turnover ratio jumps for 2015.

As for the other four companies (SHLD, JOE, FNMA, FMCC), well ...

Baron's: Berkowitz's AIG Sale To Result In Huge Taxable Distribution

Bloomberg: Berkowitz's Fairholme Sold Almost All Its AIG Shares in Quarter; Also unloaded more than 60 percent of Bank of America position.

VintageFreak

I will not sell simply because I will not plonk down $25K if I have to repurchase. I will simply use HSGFX losses to offset FAIRX gain on my tax return.

msf

You can do a partial sale. Pick the shares that cost the most, sell those, retain the rest. Then you can repurchase as much or as little as you want by adding to your open account.

According to the prospectus you can add as little as $1K (min for a new account is $10K).

If you've got a lot of losses, it may be better not to offset all of them with gains. If you've got losses left over, you can use up to $3K of those extra losses to reduce ordinary income - a more valuable use of capital losses.

expatsp

@dryflower thanks for posting this. This distribution is crazy. FAIRX was supposed to be tax-efficient, at least that's what M* said when I bought it 9 years ago. And it was, for a while. What the hell?

I did notice recently that it's performance is no longer so correlated with AIG. Wonder what he's buying?

Well, I will sell, then decide whether to put some of it back into FAIRX, or FAAFX, or finally fulfull the vows I keep making and postponing, and put money into index funds. But I have a feeling that after striking out so much recently, he's going to start hitting home runs again.

expatsp

Oh, I see what he's buying: http://www.gurufocus.com/StockBuy.php?GuruName=Bruce+Berkowitz
Interesting.

bee

Isn't a taxable distribution just an accountant's way of saying, "You made a profit...now you need to pay your taxes on that profit."

As Mark mentioned, I own this fund in my Roth IRA.

claimui

bee said:

Isn't a taxable distribution just an accountant's way of saying, "You made a profit...now you need to pay your taxes on that profit."

True, except in this case, the "person" that made the profit is the fund, and not necessarily the investors. FAIRX was down 2.72% in 2014 (compared to +13% for the S&P 500). So far this year, it is down another 2.39% (compared to +3% for S&P). So folks who bought into FAIRX during the last two years are probably not feeling all that "profitable" with their FAIRX taxes.

VintageFreak

msf said:

You can do a partial sale. Pick the shares that cost the most, sell those, retain the rest. Then you can repurchase as much or as little as you want by adding to your open account.

According to the prospectus you can add as little as $1K (min for a new account is $10K).

If you've got a lot of losses, it may be better not to offset all of them with gains. If you've got losses left over, you can use up to $3K of those extra losses to reduce ordinary income - a more valuable use of capital losses.

Too complicated. I always do fifo and my gain on earlier shares is 30℅. Minimum is 25k I thought. Just saying everyone's situation is different, and people have enough excuses to sell fairs and don't need another one.

Valet

Some additional considerations when a fund has a large capital gain distribution:

1. If folks are not reinvesting their distributions, that'll mean the fund has to sell to meet those "redemptions". If half of Fairholme's shareholders are not reinvesting, this means 15%+ of the fund is going to be redeemed. Forced selling is never a good thing for a fund.

2. If you like the fund and have a gain that's less then the distributed gain, you can sell just before the record date and buy back just after to minimize the time you are out. (No wash sales on gains.)

3. If you like the fund and have a taxable loss, you can still sell use the "sell just before and buy just after" strategy. You'll have a wash sale, but this simply means you start off where you were with an embedded loss - not a big problem. Of course, you can get out for 30 days and get the benefit of the loss this year.

4. Remember that a distribution is simply a pre-payment of taxes. You might pay more tax this year, but (because of your higher basis) you'll pay less in the future. I'd prefer to control when I pay my taxes, but pre-paying is not a disaster.

5. If a fund is distributing long-term capital gains, you can sell the fund after the distribution (in the same tax year) and end up with the same tax consequences. This might help if you were surprised by the distribution.

I hope these aren't too obvious and are helpful.

Personally, I think funds that have 30%+ distributions have several things going on and they are all headwinds. Giving them a break as they regroup might be a good strategy.

VintageFreak

IMHO, we are seriously at the point of overthinking this. "Forced Selling" is more of an issue when market is falling (which of course could always happen).
One can also make argument manager can then buy shares cheaper subsequently.
M* is showing 23% cash for FAIRX. The true cash stake might be larger and that can be used to "weather redemptions" from those investors who will not reinvest distributions (yours truly, as a rule)

Finally, two more things.

First, let's debate about the dangers of FAIRX more in terms of how Berkowitz invests. What were people expecting? That he will keep AIG stake at 40% forever? Money is made when investment is SOLD. Else it is paper gain. Just one reason I don't reinvest distributions - it is a healthy way to take gains and diversify across your holdings buy re-deploying in another fund.

Second, of all the faults one thinks Berkowitz is (I include infatuation with Fartiromo which has gotten my goat in the past), he is hardly an idiot. I would like to think he has planned this out a little bit more than what people are giving him credit for, If you purchased FAIRX in June 2015 and are now complaining, I have no sympathy for you.