In considering the best mutual fund of the year 2008 (so far), I concluded that the best risk-adjusted return belongs to an actively managed, focused fund. While I'm a big proponent of low-fee index funds as a base investment, if you're looking to outperform the market, there's no sense in paying higher expenses for sub-par performance, which is generally what you get with actively managed funds when considering higher expenses and tax liabilities due to turnover.

I took a look at some common popular funds, as well funds that have catchy strategies like 130/30 long-short, "socially responsible", quant funds and more. I even went back and looked at the returns of the fabled Sequoia Fund, which just opened its doors to new money...but to no avail. The award for best fund of 2008 goes to Fairholme (FAIRX). Here's why:

• The Fairholme Fund outperforms its peers and the S&P500 over time in both up and down markets. As of August 19, 2008, the following historical returns are:

6 Month Return: Flat vs. -6% for S&P500

YTD Return: -1% vs. -13% for S&P500

5 Year Return: 91% vs. 29% for S&P500

• It's a Morningstar 5 star-rated fund.
• Beta is less than 1, yet it achieves market beating results. Usually a fund with lower volatility can match market returns at best (before fees). In this case, Fairholme beats the market net of fees.
• It is a focused fund holding 25 stocks. Top holdings include Warren Buffet's Berkshire Hathaway among others. This focused approach allows for the fund to distance itself from the "over-diversification" that generally occurs when you get into the 50-500 positions your typical actively managed fund holds. This generally results in herding, forced mediocrity pre-expense, and a market loser net of fees and tax consequences.
• According to this article, the fund started scaling back its energy holdings pre-July. Great timing! This is while all the hot money was still piling in hoping the commodity bubble would never burst.
• It's a no-load fund with a 1% expense ratio. For this performance, that's more than fair.
• Reasonable initial investment criteria of $2,500 at all major brokerages.

Top 10 Holdings:

Berkshire Hathaway Inc. A (BRK.A) 15.71%

Canadian Natural Resources, Ltd. (CNQ)14.87%

Sears Holdings Corporation (SHLD)9.11%

DISH Network Corporation Class A (DISH)6.99%

Mohawk Industries, Inc. (MHK)4.44%

Leucadia National Corporation (LUK)4.43%

Miscellaneous Investments 4.21%

St. Joe Corporation (JOE)4.20%

Bristol-Myers Squibb Company (BMY)3.34%

USG Corporation (USG)3.23%

What's Fairholme buying now? Healthcare. I find it tough to argue on the valuation front. Many of these pharmas and health care stocks have wads of cash, steady dividends and cash flow and are for the first time, not exhibiting the typical "defensive" strength in a market downturn. Berkowitz (fund manager) may just be on to the next trend now that Solar, China and Commodities have fizzled.

In summary, I really don't see any reason why Fairholme (FAIRX) shouldn't be a part of every investor's portfolio. In fact, I don't know why it's not a part of mine yet (disclosure - no position).

What's your favorite fund with great criteria like
this? And Why?

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