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Fairholme Investors Face Huge Tax Bill On AIG Gains

The Fairholme Fund announced on Monday that it plans on paying out between $11 to $11.75 a share in capital gains to shareholders on Dec. 11th. This represents almost exactly one-third of the fund’s net asset value as of last Friday. Mutual fund firm Fairholme Capital Management noted that the distribution results from its long-term investment in AIG, the insurance giant that was bailed out by the feds in 2008.

Chris Dieterich of Barron’s and Daisy Maxey of the Wall Street Journal that many Fairholme investors are likely to be facing large tax bills as this is a taxable capital gains distribution. When mutual funds sell stocks, they must  distribute the net gains to fund shareholders, who must pay taxes on those gains if the shares are in taxable accounts. Accountants note that the long-term capital gain tax rate can be as high as 23.8%.

Bruce Berkowitz has managed large-cap value Fairholme Fund since it was founded in 1999.

Carl Icahn American International Group AIG Fairholme
Via S&P CapIQ

 

Fairholme made a bundle on AIG investment

Berkowitz’s Fairholme fund bought AIG common stock in 2010 and 2011 when it was still in deep financial trouble, and also received a large tranche of AIG warrants in 2011. As the U.S. and global economy improved, AIG shares regained much of their value and the stock and warrants eventually grew to represent close to 50% of Fairholme’s portfolio.

The investment in the insurer had led to over $2 billion in gains for Fairholme shareholders through June 20, Fairholme Capital Management said in a statement on its website. “We determined that it was an opportune time to realize the gain and began to reduce the position in AIG common stock.”

The Fairholme Fund tend to be highly concentrated. The fund held only 10 stock positions and 30 other holdings as of May 31st, based on data from Morningstar. Moreover, almost two-thirds of its assets were in its top five holdings, and a stunning 73.6% of its assets were in the financial-services sector, with almost 20% each in AIG and Bank of America Corp.

Mark Wilson, the CIO of Tarbox Group, a wealth-management firm that follows mutual fund capital-gains payouts, points out that it is quite rare to see a mutual-fund firm mention  the sale of specific holdings that resulted in capital-gains distributions.

“If you have really big bets like Bruce does, when you take profits and make money, it’s going to be really costly,” Wilson noted.

More on the tax issue can be viewed here and here.

However, investors are doing relatively well with Berkowitz compared to some other concentrated funds. FAIRX is down about 2% for the year, while many other concentrated value funds are down double digits amid “wrong” bets on sectors like energy and stocks like Valeant, Sune etc.