Steven Romick's FPA Crescent Fund Q3 Commentary
You should consider the Fund's investment objectives, risks, and charges and expenses carefully before you invest. The Prospectus details the Fund's objective and policies, sales charges, and other matters of interest to the prospective investor. Please read this Prospectus carefully before investing. The Prospectus may be obtained by visiting the website at www.fpafunds.com, by email at firstname.lastname@example.org, toll-free by calling 1-800-982-4372 or by contacting the Fund in writing.
** Annualized. A redemption fee of 2.00% will be imposed on redemptions of shares within 90 days. Expense ratio as of most recent prospectus is 1.26%.
Past performance is no guarantee of future results and current performance may be higher or lower than the performance shown. This data represents past performance and investors should understand that investment returns and principal values fluctuate, so that when you redeem your investment it may be worth more or less than its original cost. Current month-end performance data may be obtained by calling toll-free, 1-800-982-4372.
The Fund commenced investment operations on June 2, 1993. The performance shown for periods prior to March 1, 1996 reflects the historical performance of a predecessor fund. FPA assumed control of the predecessor fund on March 1, 1996. The FPA Crescent Fund's objectives, policies, guidelines and restrictions are, in all material respects, equivalent to those of the predecessor fund.
To view portfolio holdings from the most recent quarter end, please refer to the end of this document or at www.fpafunds.com.
Portfolio composition will change due to ongoing management of the fund. References to individual securities are for informational purposes only and should not be construed as recommendations by the Funds, Advisor or Distributor.
The discussions of Fund investments represent the views of the Fund's managers at the time of each report and are subject to change without notice. These views may not be relied upon as investment advice or as an indication of trading intent on behalf of any First Pacific Advisors portfolio. Security examples featured are samples for presentation purposes and are intended to illustrate our investment philosophy and its application. It should not be assumed that most recommendations made in the future will be profitable or will equal the performance of the securities. This information and data has been prepared from sources believed reliable. The accuracy and completeness of the information cannot be guaranteed and is not a complete summary or statement of all available data.
S&P 500 Index includes a representative sample of 500 leading companies in leading industries of the U.S. economy. The index focuses on the large - cap segment of the market, with over 80% coverage of U.S. equities, but is also considered a proxy for the total market. Russell 2500 Index is an unmanaged index comprised of 2,500 stocks of U.S. companies with small market capitalizations. Barclays Capital Government/Credit Index is an unmanaged index of in vestment grade bonds, including U.S. Government Treasury bonds, corporate bonds, and yankee bonds. Balanced Benchmark(60% R2500/40% BCGC) is a hypothetical combination of unmanaged indices comprised of 60% Russell 2500 Index and 40% Barclays Capital Government/ Credit Index, reflecting the Fund's neutral mix of 60% stocks and 40% bonds. Barclays Aggregate Index provides a measure of the performance of the U.S. investment grade bonds market, which includes investment grade U.S. Government bonds, investment g rade corporate bonds, mortgage pass - through securities and asset - backed securities that are publicly offered for sale in the United States. The securities in the Index must have at least 1 year remaining in maturity. In addition, the securities must be d enominated in U.S. dollars and must be fixed rate, nonconvertible, and taxable. The Consumer Price Index is an unmanaged index representing the rate of the inflation of the U.S. consumer prices as determined by the U.S. Department of Labor Statistics. Ther e can be no guarantee that the CPI of other indexes will reflect the exact level of inflation at any given time. The CPI shown here is used to illustrate the Fund's purchasing power against changes in the prices of goods as opposed to a benchmark which is used to compare Fund's performance. 60% S&P500/ 40% Barclays Aggregate Index is a hypothetical combination of unmanaged indices comprised of 60% S&P 500 Index and 40% Barclays Aggregate Index, the Fund's neutral mix of 60% stocks and 40% bonds. These indices do not reflect any commissions or fees which would be incurred by an investor purchasing the stocks they represent. The performance of the Fund and of the Indices is computed on a total return basis which includes reinvestment of all distributions. I t is not possible to invest in an index.
Investments in mutual funds carry risks and investors may lose principal value. Stock markets are volatile and can decline significantly in response to adverse issuer, political, regulatory, market, or economic developments. Certain funds may purchase fore ign securities, including American Depository Receipts (ADRs) and other depository receipts, which are subject to interest rate, currency exchange rate, economic and political risks; this may be enhanced when investing in emerging markets. Small and mid - ca p stocks involve greater risks and they can fluctuate in price more than larger company stocks. Short - selling involves increased risks and transaction costs. You risk paying more for a security than you received from its sale.
The return of principal in a bond investment is not guaranteed. Bond s have issuer, interest rate, inflation and credit risks. Lower rated bonds, callable bonds and other types of debt obligations involve greater risks. Mortgage securities and asset backed securities are subject to p repayment risk and the risk of default on the underlying mortgages or other assets; derivatives may increase volatility.
The FPA Funds are distributed by UMB Distribution Services, LLC, 803 W. Michigan Street, Milwaukee, WI, 53233
FPA Crescent returned 3.78% in the third quarter, and 14.55% year- to -date compared to the S&P 500's returns of 5.24% and 19.79%, respectively.
Though we have lagged equity markets in general, our returns continue to meet our goal of delivering equity- like returns over the long-term, taking less risk than the market while avoiding permanent impairment of capital. As we have written in the past, when putting capital at risk (as opposed to at "work" ), we worry about defense first and offense second.
Nevertheless, a recent report would indicate that we have found a happy medium between both preserving and compounding your capital. Specifically, Morningstar evaluated the " investor r eturn" that shareholders have received for each of the Morningstar 500 Funds over the last 15 years and we ranked in the top 20 . 1 As we explained in our Q1 2007 commentary, investor return is the money you actually earned in Crescent. 2 In contrast, fund return, which does not take into account shareholder redemptions and contributions, is the published figure you see, for instance, in a newspaper's mutual fund tables .
Few funds actually have investor returns larger than fund returns, though Crescent is one of them. The credit for this accomplishment goes to our patient shareholders who have responded rationally to market dislocations, maintaining or increasing their positions rather than selling. This accrues to your advantage in two ways: You avoid selling at market lows and you allow us to focus on taking advantage of investment opportunities that those lows present. 3 We are fortunate to have such thoughtful shareholders and hope this trend continues in the future. For our part, we will continue to communicate our process and positioning, so that you will be comfortably able to keep your wits about you when others are losing theirs.
Turning to the third quarter, nothing out of the ordinary drove the portfolio's performance. The market's continued move upward in 2013 has been broad-based and the price action of the Fund's quarterly top five winners and losers derived little from company specific news. The third quarter's winners listed below added 1.44% to the Fund's quarterly return, while the losers detracted just 0.30%.
Per custom, our first and third quarter letters avoid a redundant discussion of the economy as the world spins slowly on its axis – albeit with a bit more than the usual tilt these days.
We would prefer that some of the lunacy we see out there translate into fear as that generally causes investors to sell assets without regard to value. Many of you would probably agree that people nowadays are anxious about both the economy and federal governance. And yet, the Federal Reserve's QE (Quantitative Easing) policies continue to support asset prices, despite slower economic growth and myriad other uncertainties.
This can be seen in the returns of more speculative stocks. As a proxy for shares of that ilk, we turn to the most heavily shorted companies at the start of 2013. The top 100 most-heavily shorted stocks in the Russell 3000 returned 44.6% for the nine months ended September 30, dwarfing the index's return of 19.52%.
4 , 5 With a reluctant nod to obliging central banks, the stock market seems to be the only game in town so equities continue their unabated rally , regardless of quality. It seems a lot of people share CNBC's Jim Cramer's view that, "We all know it's going to end badly, but in the meantime we can make some money." 6 If you believe this trend will continue, you will most likely be better served having your capital with a manager who is more fully invested. As Morningstar analyst Dan Culloton observed in his most recent commentary about Crescent, " The past 10 years included two bear markets and were fraught with volatility, which plays to the fund's strengths." 7 Absent volatility, we are like an automobile whose gas gauge is nearing empty. That doesn't mean w e are stuck in idle. We continue to read, speak to executives, visit companies, and then read some more. We 'd like nothing more than to shift to a higher gear and increase our exposure , but given the lack of securities offering a genuine margin of safety 8, we're content to stay out of the fast lane for now.
In the meantime, we've taken advantage of the kindness of others who seem to have plenty of petrol and have bid up many of our investments to a point where we find the risk/reward unattractive. To remain intellectually honest and clinically dispassionate, we have found ourselves with little alternative but to make some sales. The number of equity positions now number 46 as a result – 7 fewer than our 2012 peak. 9 Each of the eleven companies purged from the portfolio in 2013 were profitable investments, posting an average gain of 64 %. 10 Fewer names and little in the way of attractive opportunities have caused our gross long equity exposure to shrink to 54.2%, down from 63.8% at 2012 year-end. Individual security exposure has not declined ratably, however, as some companies have seen their stock prices perform better than others, and not always justifiably. The net result is that Crescent's available liquidity has increased to 39.4%. As has occurred in the past, we expect that liquidity will inevitably be our friend again once opportunity returns.
Although little excites us, we have made some small purchases. Since we are in the process of building these investments while hoping for lower prices, it would be premature - and to our collective economic disadvantage - to discuss them now. For the most part, these positions are aggregated in the "Other" category in the Portfolio Holdings shown on our website, www.fpafunds.com
We naturally care about making money for our clients. As committed investors ourselves, we' ve put our money right alongside yours . Over any short- term period, we don't worry – or expect – that our returns will exceed or trail the market. Short-term does not mean one quarter or even one ye ar . It could mean a few years. Admittedly, the way we invest requires patience as only time will prove us correct. Rabbi Shlomo Riskin pointed out the fine and portable line between smart and dumb. "When you're one step a head of the crowd, you're a genius. When you're two steps ahead, you're a crackpot." 11 The only way we know to invest comfort ab ly in the present is to look down the road, knowing at some point that there will be a place to refuel.
October 18, 2013