Chou Associates Fund

Analysis: Most mutual funds are pretty easy to classify. They typically have a relatively narrow mandate and tend to stick to it. The same cannot be said for many of the funds offered by Chou Associates. For example, the Chou Associates Fund is definitely hard to classify. If we look strictly at its holdings, it would be a global small cap fund. The reality of it is that manager Francis Chou runs it as a global equity fund with a go anywhere mandate and the ability to invest in companies of any size.

His management style is a high conviction, deep value approach that produces a portfolio with 25 to 35 names. He follows a fundamentally driven, bottom up approach that focuses on balance sheet strength, cash flows, management and future growth potential. Valuation is critical; Mr. Chou won’t even consider adding a position unless it is trading at a discount of at least 40% to his estimate of its intrinsic value.

He sticks to his beliefs and is not afraid to hold significant cash balances if no suitable investment opportunities are available or he feels that volatility is too high. He is not afraid to take big bets on stocks he feels are cheap. For example, in March, he held 10.4% in Sears, 8.5% in Level 3 Communications and 8.4% in Berkshire Hathaway. The top 10 holdings made up more than 60% of the fund. When evaluating a stock, he takes a long term view, putting less emphasis on shorter term market factors. As a result, portfolio turnover tends to be low. For the most recent five year period, turnover has been less than 20%.

Given this approach, the fund has the potential to be very volatile. It will also tend to zig when other funds zag. Over the long term, we believe that it has the potential to deliver decent returns.

There are risks with this fund. Along with the volatility, nearly one quarter of the fund is held by Fairfax Financial. If they were to redeem their holdings, the manager would have to raise cash, which could have a negative impact on the fund. Further, this is largely a one man show. If anything were to happy to Francis Chou, the funds would be negatively affected until a suitable replacement were found.

We like this fund but would be reluctant to recommend it as a core holding. In our opinion, it is best used as a component in a well diversified portfolio. Our rationale is based on two factors. First is the key person risk. Second is the deep value style that is employed. While we believe that investors will be rewarded over the long term, there is a good chance of high volatility in the short term. As long as investors are aware of these risks, we feel it can play a part in an investor’s portfolio.