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As far as equity funds go, the year has not been too kind to managers who have taken decisive positions on particular sectors and domestic equities. For some mutual funds, this has resulted in a huge shift from equity funds to bond funds or emerging market funds. But something tells us that investors of the high risk, high return Fairholme Fund (FAIRX) are wondering what everyone else is so nervous and upset about. Because this mutual fund continues to beat the S&P 500 and its respective category by big margins… margins that in many cases have meant doubling the performance of those indexes or categories.

A High Risk High Return Mutual Fund

One of the biggest concerns that investors have with their equity funds is the levels of risk they believe are present within the portfolio. While we like to find and share low risk, above average return funds at the Mutual Fund Site, we cannot say this mutual fund meets that difficult criteria. And the reasons will soon reveal themselves.

But first, this is 5-star rated by Morningstar and the Fund Manager, the notorious Bruce Berkowitz who has been with the fund since 1999 has been named Fund Manager of the Decade for domestic equity funds. A very honorable feat, no doubt. And of course his tenure (okay, he is Fairholme Capital) should make one feel pretty comfortable.

Looking back over the past 11 years, we see right away that there was only year where he underperformed the S&P 500 and his peers (that was in 2003). The rest of the time, he outperforms by as much as 55% (in 2000). Fast forward to the past three years and we see performance that beats the S&P 500 by 6.86% in 2007, 7.3% in 2008, 12.6% in 2009 and on a YTD basis, a better performance by a margin of 7.75%. That’s right, this domestic equity fund has a positive return of 3.15 as at September 1, 2010. Few domestic equity funds can lay claim on such performance.

What We Do Not Like About This Equity Fund

Remember that this domestic equity fund comes with its share of risks. Some would argue that in order to achieve high returns, you need to take on high risks, but we disagree. You can judge for yourself….

This fund has been able to purchase appropriately priced equities, with its average Price to Earnings Ratio being at roughly 13.25:1, about on par with the benchmark. But Top Holdings is what concerns us: 59% is in Financial Services! Wow, that is a bold position.

What strikes us as a little too risky for our tastes is that this is a primarily large cap value fund. While we definitely see value in large cap  financial services, our worry is that there is far too much growing that needs to get done in this sector for it to contribute to the fund’s short- and long-term goals.

For instance, Fairholme’s largest holding is Sears Holdings at 9.5% of the portfolio. Although the position has been shrinking, those assets have gone to other big financial services firms. Like Citigroup at 4.9%, Bank of America at 4.4% (we like BofA for its interest in regional mortgages) and CIT Group at 3%. These are bold holdings, big statements to make at a time where big financial companies like these are facing tremendous political and economical headwinds.

Overall, this is a tightly managed equity fund with just 24 equity holdings and $15.2 billion under management. Entry into this exclusive club comes at a cost though: you need to make a minimum $10,000 just to get access. And $10,000 seems like a lot of money to throw at such risk…

But here are the indisputable facts: Berkowitz has a track record of more than a decade of beating expectations and swimming against the current. While others (like the Mutual Fund Site) are afraid of giant- and large-cap financial services firms, he sees opportunity and has taken a huge, bold position. Also, this equity fund’s performance track record speaks for itself. You cannot argue with numbers and with just bum year in nearly 11 years, you have to trust that this actively managed equity fund is doing the right thing.

Investors with an appetite for big returns and a correspondingly big appetite for true risk will love this fund. Investors who want a safer way to simply above average returns will lose sleep between now and the time that this domestic equity fund proves everyone wrong with huge returns.