Fairholme Fund loses half its value and its co-manager

October 20, 2011, 10:46 PM UTC

FORTUNE — Struggling Fairholme Fund, which has shed half its value this year as investors yank money amid losses, added another victim this week: Bruce Berkowitz’s partner Charlie Fernandez.

Fernandez was a restructuring hotshot Berkowitz hired in 2007. They met after Fernandez dated, and later married, Berkowitz’s younger cousin. Fernandez moved into the mansion next to Berkowitz’s outside Miami, and the two walked the neighborhood streets before dawn to talk investments. Berkowitz joked that it took him a lifetime to find his own Charlie — a nod to Charlie Munger, Warren Buffett’s longtime partner.

But lately the deals Fernandez specializes in have dried up. Fairholme has shriveled from $18 billion in January to $9 billion today, according to Morningstar, evaporating the cash reserves the fund had hoarded in anticipation of a huge restructuring wave over the next few years. Fernandez says he left for other opportunities, although he declined to elaborate on them. “I’m saddened,” Berkowitz says of the move. “Shocked, no.”

It’s a notable turning point for Fairholme. Berkowitz hired Fernandez, and as late as last year aimed to grow Fairholme to $25 billion size, because he wanted to invest more private transactions, like Fairholme’s stake in bankrupt mall operator General Growth Properties. Fairholme quickly took in billions, and Berkowitz knew investors could pull money at any time. When shares in his biggest investments, including AIG (AIG), Citigroup (C), Bank of America (BAC), and Goldmans Sachs (GS), plummeted this year, they did. Now Berkowitz has forgotten about private transactions; he’s betting completely on the big financials. “We’re staying the course,” he says.

Last fall, Fernandez was fresh off a string of hits that earned Fairholme about $2 billion. First he saved subprime auto lender AmeriCredit. Fernandez worked consecutive sleepless nights around Thanksgiving 2008 to put together a deal so the desperate lender—close to filing bankruptcy— could sell a tranche of loans into the frozen credit markets. (In those harried days of 2008-09, Fernandez gained about 40 pounds.) Then in 2010, he sorted through one of the largest—and almost everyone agreed, the most complex—real estate bankruptcies in U.S. history. In a matter of two months, he had bought $1.8 billion worth of securities of General Growth Properties (GGP), the country’s second-largest mall developer. In short order, a committee led by hedge fund manager Bill Ackman resurrected GGP and turned those securities into riches for Fairholme. It was Berkowitz who saw opportunity. It was Fernandez who hit the phones for two months straight to execute.

Now the deals are gone. But there’s still been plenty of action down in Miami. Fairholme’s top holding, AIG, has been disastrous this year, falling 60%. Berkowitz misjudged the price at which the Treasury would sell its bailout stake in the insurer. They guessed it would sell shares at book value, north of $45 a share; instead Treasury sold it near its “break-even” price, below $30.

Add in the lagging stocks of banks like Citigroup, Bank of America, and Goldman Sachs, which represent huge positions for Fairholme, and the fund has been pinched this year. Berkowitz has sold half his stake in Regions Financial (RF) and no doubt wound down many other holdings as investor redemptions add up to $5 billion, according to Morningstar.

Fernandez’s departure provides fodder for another ongoing saga. Berkowitz and Fernandez spent months shaking up the Florida real estate company St. Joe (JOE) after hedge fund manager David Einhorn, best known for his short positions, criticized the company’s accounting. Fairholme drove out Joe’s CEO earlier this year. Berkowitz took over as chairman and Fernandez also joined the board in the spring. Fernandez is now out, and after a new Joe CEO has assumed office, Berkowitz might soon leave the board too.

It’s not difficult to understand why Fernandez left Fairholme for better opportunities. Fairholme shareholders could be asking if they should too.

Clarification: An earlier version of this story stated that Charlie Fernandez left for another job. He left for other opportunities.