“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 – 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 – with his own personal money – 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”

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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 d