Curtis Jensen is Chief Investment Officer and Portfolio Manager of the Small Cap Value Fund at Third Avenue Management. Third Avenue Management was founded by Guru Martin Whitman.
Mr. Jensen appeared on Steve Forbes’ weekly web show “Intelligent Investing”, where he discussed their investment philosophy, strategy and some of the characteristics of their funds.
Throughout the interview, Mr. Jensen used the pronoun “we” to refer to Third Avenue Management. I have used the same pronoun in my notes to maintain the interviewee’s intention.
Philosophy and strategy.
· Third Avenue fund gamut consist of five investment alternatives:
o The Value Fund. The flagship.
o The Small-Cap Value.
o Real Estate Value.
o International Value.
o Focus Credit.
· The Value Fund, the Small-Cap Value and the Real Estate Value have a portion of their portfolios invested outside the U.S. There are some great companies outside the U.S. When the war started in2003, we thought about the way money was being spent and what that could mean to the dollar, we decided to put some of our clients’ assets outside the U.S. Most of that money is invested in Asia.
· We are bottom up investors, we do not do macro forecasts internally, but we are cognizant of economic trends.
· We say that we are safe and cheap.
· Safety comes from the three criteria that constitute our philosophy:
o We look for companies which are extremely well financed. Conservatively financed entities can better cope with the hurdles that any firm faces throughout its life.
o We look for companies with good managers, whose interests are aligned with those of the shareholders over the long term. Managers should not only be competent operators but very good asset allocators as well. Ideally, managers own a lot of stock.
o We invest in businesses in which we can understand their economics and likely growth path.
· This philosophy is shared across all of our managers.
· When a company complies with our three criteria it must also come at the right price and valuation, and that is the “cheap” part. We strive to do a very conservative estimate of the business’ worth and buy it at a discount to that, protecting our downside is top priority. Once our downside is covered, then we can start asking: how much are we going to make?
· We are very price conscious, so we do not chase things. We do not believe in being fully invested for the sake of it. It is a good idea to have some cash at the ready. There is always between 5 to 10 percent in cash.
· We develop a range of value for an investment and for a company, business is dynamic, so value is dynamic, it oscillates. If we are doing our job right, value will grow over time, if that is happening we will hold that position.
· All of the portfolios tend to be concentrated in 40 – 50 stocks. We do not believe that you protect yourself by owning 300 or 400 stocks in a portfolio. Investors protect themselves by knowing more on fewer things and focusing on them. The greatest investors like Warren Buffett or Carl Icahn, do not own hundreds of stocks. They diversify with 6 or 10 stocks and focus on those stocks. That is what we try to do too.
· We own stocks for 4 to 6 years, which means low turnover.
· We try to get our clients focused on the long term.
· During the crisis we had some redemptions, saw a bit of panic. Unfortunately, people sold at a wrong time. Unless there was a depression, the prices did not reflect longer term fundamentals. We believed in the companies we owned, we held in there and tried to communicate our positions.
· We eat our own cooking; we are invested in our own products, alongside and under the same terms of our shareholders and clients.
· Because of our investment philosophy, we tend to zig when the markets zag.
· We have over 25 years investing in distressed debt and the debt of bankrupt companies. The 2008 – 2009 crisis offered plenty of opportunities, some fantastic bargains were found; some, the product of panic selling. Today, there are select prospects in the high yield market.
· There are 2 ways to win with small caps:
o Like medium and large caps, an investor can wait for the public markets to recognize an undervalued stock, fill the gap and make a profit.
o When public markets do not seem interested in the value and assets that we own, there is always the possibility of the private markets, strategic or financial buyers realizing the value. That does not happen if we owned Microsoft (NASDAQ:MSFT) or Pfizer (NYSE:PFE).
· The Sarbanes-Oxley Act has been troubling for companies of all sizes, but especially for small caps because they are spending the same amount that a big company would to comply with regulation. In Jensen’s view, this has pushed companies to think about going private or partnering with bigger companies so that they take care of those expenses. SarbOX has some positive elements though. The
regulatory environment has been more difficult since the last two years. Energy, health care, the financial industry. CEOs complain all the time on the uncertainty of a tax regime. In some instances, business have not hired or spent capital because of regulatory uncertainties.
Real Estate Value.
· The fund was invested in some high quality REITs. Nowadays, it is very hard to see bargains in the U.S. REITs market. The vast majority of the fund’s assets are outside the U.S. now.
· In the majority of cases, investors have protection where the stocks are listed; Hong Kong, Singapore, Europe. In accounting, most instances follow IFRS rules and conventions, so there is protection.
· It took some time to set up the Focused Credit Fund, mainly due to the development of the appropriate team. This fund differentiates from other high yield and credit funds in that it is focused. It has 60-odd holdings and has a mix of high yield and distressed debt.
· We have the capacity to short. There are no shorts at the moment, but risk premiums have shrunk and it is something to consider. We invested in some of the distressed debt of various real estate companies. The return profile would be around 20 to 30 percent.