“Secret Penny Hedge Fund”

By Travis Johnson, Stock Gumshoe, July 19, 2007

This one came in recently from Stansberry and Associates, it’s an ad for the S&A Penny Letter from Dan Ferris, who also does the Extreme Value letter. This newsletter focuses on what they call “Penny Stocks,” though personally I think they’ve got a pretty liberal definition of that term.

They say they are looking for the “safest and most profitable penny stocks in the market โ€“ safe stocks trading under $10 per share.” I think most folks would put the cutoff for penny stocks lower, and would exclude those companies that are over a certain market cap, but that’s neither here nor there because Ferris clearly does not — one recent “penny” pick of his, Abitibi, is, while low-priced at under $3 a share, a billion dollar+ company. So that’s what we’re working with as our investing universe for this pick, essentially any stock under $10 (that pick of Abitibi, by the way, is neither up nor down so far).

The ad says that this “Secret ‘Penny Hedge Fund’ Could Double Your Net Worth [and] It costs less than $7 to get into this opportunity … there’s no managements fees.”

No management fees! That doesn’t sound like any hedge fund I know, secret or not.

He goes on to say that this is, of course, not actually a hedge fund. He thinks it is “as close to being a hedge fund as you can get, considering it’s partly owned and managed by one of the most successful and under-the-radar investors in the world”

So who is this investor? We’ll start with those clues:

“He manages $4.6 BILLION for himself and a few of his super-rich friends.”

“He has trumped the S&P 500 stock index every single year for the past five years.”

He “loves” Echostar and Canadian Natural Resources and has held them for some serious profit.

The ad also includes a chart of this investor’s performance over the past five years or so (which is indeed very impressive), and that helps me to confirm that we’re talking here about the Fairholme Fund. It has beaten the S&P as noted, and the management number is pretty close — currently, FAIRX holds $4.9 billion.

So we’re done, right? Put your money in Fairholme? Not a bad idea, probably.

But not so fast — remember, we’re talking about this great investor who has some kind of involvement with some other thingamabob that itself could conceivably be considered to be something like a “penny hedge fund.”

And by the way, that “$4.6 billion for his rich friends” bit? Kind of misleading, Fairholme is a regular ‘ol mutual fund with a $2,500 minimum investment … I’m sure some rich folks own shares, but regular Joes like you and I might, too.

Take a breath. Step two.

It’s pretty clear that they’re talking here about Bruce Berkowitz, one of the advisers and probably the most public face of the Fairholme Fund. Fairholme holds large positions in both Canadian Natural Resources and Echostar (together they make up more than 20% of the fund), and the FAIRX chart is an exact match for the chart in the teaser ad.

Fairholme is a really good mutual fund, to be sure, and one that’s often considered to have a very similar investment strategy to Warren Buffett (whose Berkshire Hathaway is also a major holding of the fund — at 16%, the only holding larger than CNQ or DISH). They have beaten the S&P for five years running, though they’ve had an average performance compared with their “mid cap mutual fund” peers, according to Morningstar. I’ll certainly concede that Fairholme is worth investing in — it even has a somewhat reasonable expense ration of 1% — and that Berkowitz is a key player in the decisionmaking for this focused mutual fund.

But it’s nowhere near $7, and it’s a stretch to say it acts at all like a hedge fund, and it’s definitely not a stock. What on earth is this “Penny Stock” managed fund operation of whatever sort that we’re talking about here?

The ad says that “right now, he’s [Berkowitz, we presume] bought up more than a $14 million stake โ€“ with his own personal money โ€“ in the small $7 ‘Penny Hedge Fund’ I’ve told you about.”

Other clues?

Profits of “around $5 million” in 2004, “almost $50 million” in 2006.

And specific dividend numbers, too — this is great! “In 2004 and 2005, it paid out around $2 million…. Last year, investors got a whopping $16 million.”

I know — you’re saying to yourself, “but Gumshoe, this is way too hard. Just give up”

To which the Gumshoe, who has recently resumed referring to himself in the third person, responds with a hearty laugh … “Nonsense!”

So … a few seconds on spin in the Researchifilizationometer, and the Gumshoe can with some confidence tell you that this “Secret Penny Hedge Fund” must be …

Winthrop Realty Trust (FUR)

FUR? That’s odd, huh? The ticker’s left over from when it used to be called First Union Real Estate Equity.

And that’s right, it is a REIT. The hedge fund thing might be a stretch, but we’ll get to that.

Here’s the confirmation:

It is right around $7 — closed at $6.97 on Wednesday, when I first saw this email.

Gross profit matches — $5,066,000 in 2004 and $49,273,000 in 2006.

The total dividend payout for 2006? $16,069,000. And 2,064,000 in both 2004 and 2005, so that’s nearly an exact match. (I think they must not be counting special dividends here, because they did have a special dividend of near $4 million at the end of 2005 … but I won’t quibble.)

Berkowitz is not the Chief Investment Officer or anything akin to that as far as I can tell for Winthrop, but he is on the Board of Directors and personally owns well over two million shares, bought mostly last year in the $5-6 range, as far as I can tell with a cursory search. At today’s price of just a hair under $7 that does indeed put his holding at about $14 million. And it is his money, this isn’t Fairholme that’s invested in FUR (though they may own shares, too, for all I know).

And maybe that bears some investigation — if he likes it enough to pour tons of his own money in, why isn’t it a major holding of the Fairholme Fund? Is he shortchanging the fund, or does this stock just not fit its focus, or is he trying to save the fund from his personal folly? I don’t know.

I don’t see any indication that he has bought more shares recently, or that he is particularly active in investment decisions for the company, though as a director he may well be (and I expect it’s likely that Dan Ferris has delved significantly deeper than I on this — I haven’t even listened to the conference calls).

So … color me convinced, the “Penny Hedge Fund” looks to be Winthrop Realty Trust.

Now … is it anywhere near being a hedge fund? Well, maybe kinda sorta. They are somewhat nontraditional in the REIT space — they invest in property, in debt, they have lots of partnership agreements, and they’ve stated that they do not intend to be restricted, except to the extent legally required by their REIT status, in the types of investments they consider. They don’t just buy buildings and collect rent, nor do they just lend money to developers or homeowners, and most REITs fall into one or the other of those categories pretty perfectly.

From their webpage: “Our principal business activities include investing and making loans secured by real estate, joint venture investments with local real estate partners and acquiring equity and debt securities where the underlying assets consist of real estate.”

Check out the “Our Assets” page on the company’s site, and you’ll be convinced that they are much more diverse than the typical REIT. So that’s kind of interesting. All kinds of properties, investments in other REITs and partnerships and joint ventures, mezzanine real estate loans, etc. etc. etc.

There are certainly some hedge funds with a similar focus, so I guess if we’re feeling charitable we can let S&A get away with calling this a hedgie. Of course, after Bear Stearns’ little problems, hedge funds that get anywhere near mortgages are not all that popular these days. I have no idea whether Winthrop has anything in their portfolio that could conceivably be tarred with the “sub-prime” brush, but if they did focus on that area at all I expect we would have seen a dramatic fall this year in the stock price (and we have not).

They’re a decent size at just under a half billion dollar market cap, and are in the S&P REIT index. The indicated yield is not terribly impressive, as with most REITs these days, at about 3.5% — I have no idea if it’s likely to go up in the near future. It has recently gone down, but that’s not particularly fair to say because it has generally been quite uneven in the past and there have often been “special” dividends, including last fall.

They do have a nice profit margin; their debt is not all that high for a REIT; with Berkowitz and management it has pretty massive insider ownership of about 25%, so some smart people who should know the company certainly own shares. I ain’t that smart, and I don’t own shares, and I’d love to hear more about this firm if anyone wants to delve deeper. This is, I think, the third real estate related company I’ve looked at in recent months, and all of them have pretty massive insider ownership (and often, recent insider buying).

Given the volatility in real estate, it’s interesting to see that shares in this one are virtually unchanged on the year (though they did have a good year in 2006), so the $7 price you can buy it for today is not far off the price it changed hands at in January … which means there might not be any rush to do your research here. As of their last quarterly earnings report, earnings were up a tiny bit but funds from operations, a more typical measure of REIT performance, were down a bit. It looks like there’s only one analyst covering this one, and they’ve got a buy and a $7.50 price target.

I must say, I’m intrigued … but I still want to learn more about why I should buy this over any of the other high-insider-ownership REITs we’ve looked at here, including some other pretty sophisticated financial REITs that work with debt as well as buildings. I’m also kind of curious why, if it’s the investment expertise of Bruce Berkowitz I want, I should buy this company that he is a part owner of over shares in the much more diversified, nicely performing Fairholme Fund for which he clearly makes investing decisions.

And really … a little bit off the point … are individual investors still fascinated enough with hedge funds to bite on a “penny hedge fund” teaser? Haven’t we all seen enough evidence yet that the majority of hedge funds are underperforming, extremely high cost, illiquid investment vehicles? Just because rich people and institutions still seem eager to invest in them, doesn’t mean I aspire to.

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6 Comments on "“Secret Penny Hedge Fund”"

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Thanks for the analysis,,,FUR is technically not a buy and seemed to hit the wall @ $7.30 this July. Trading today @ 6.95, it appears to have stopped it’s drop. I would imagine that the fact that news of two hedge funds from Bear Stearns going bankrupt has not helped the likes of FUR and other funds. Of course, a fund like this pays out dividends from time to time that affects the stock price. Has that happened recently? Thanks for the info, super sleuth!


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It is indeed FUR – I have been passed the Penny Letter itself by a friend. The analysis is quite convincing, but looking at the FUR website, “no management fees” is a bit misleading, because FUR pays “FUR Advisors” (who are the same guys who are FUR itself) significant fees, plus they get 20% of the dividends from each common share!!


I overstated that a bit. They will get 20% of all dividends if they ever reach a specific dividend total sometime in the future. The target number compounds every year, so it will be a while before it is ever reached, but it’s still bothersome if you want to be a long-term investor in this company, and just when you’re ready to retire using the dividends for steady income, the bigwigs start taking a 20% chunk for the rest of the company’s existence.

12/28/07 FUR continues to be down, along with lots of stuff that has any exposure to real estate. They also have a CDO as part of their portfolio, which may be scaring people off, but the CEO sounded quite postitive about it in the last conference call so it doesn’t look have the same weaknesses as other CDO-related investments. It’s all commercial real estate for one thing – no subprime housing speculators.Stock price is at $5.29 at the moment, but FUR has had 31 cents deducted from that price for dividends in the last two quarters, so that’s in shareholders… Read more ยป

The CDO also appears to be something that FUR itself put together (?) and knows/is associated with all of the components involved. They didn’t put it together to sell it off but rather to make money themselves, and they didn’t buy it not knowing what was/is lurking inside it.Maybe it’s what a CDO should be, rather than the plethora out there that were abused and are now terrifying investors.