After stepping down from the front-line of day-to-day operation of the firm, Investment Guru, Chairman of Third Avenue Management Martin Whitman wrote his first “Chairman’s Letter” to Shareholders. The responsibility for usual quarterly letter of Third Avenue Value Fund (TAVF) has been placed on co-manager Ian Lapey.
Martin Whitman: Chairman’s Letter
In his first letter, Whitman defended the case for the actively managed mutual funds. He first listed the benefits of actively managed mutual funds to investor in terms of protections; then he argued against index funds and Modern Capital Theory (MCT):
In MCT, there is a theory that the OPMI markets are efficient because information, when made public, impacts market prices. The problem is that most market participants don’t know what information is important, and they don’t know that they don’t know. The tendency is that what short-run speculators think is important is information. Such speculators tend to be extremely short-run conscious, overestimate the importance of reported earnings for most companies, especially short-run estimates of income; invest trying to pick market bottoms; have a technical-chartist approach; ignore balance sheets and net asset values; emphasize macro factors rather than details about an issuer or issue; and are more interested in figuring out what “the average opinion of the average opinion” might be rather than have an independent judgment about underlying value. To believe that the buy-sell actions of these market participants determine anything close to a universal price efficiency is to believe in the “tooth fairy”. It is simply unscientific to equate OPMI pricing with a universal efficiency; there just is no basis for concluding that there are rational reasons pointing to a relationship between OPMI pricing and other values such as the value of control.
Ian Lapey: Third Avenue Value Fund (TAVF) Quarterly Letter
In the letter, Ian provided a table showing the performance of TAVF for the past 10 years as compared to the S&P 500. During the period, the fund returned a decent 7.3% per year vs. S&P 500’s decline of 0.9% per year.
Among other things, Lapey highlighted the following stocks:
Under the leadership of Tom Gandolfo, who joined Third Avenue as a consultant in 2008 and a Senior Analyst in the beginning of 2009, Fund Management has been reviewing U.S. banks over the last several months. KeyCorp, headquartered in Cleveland, Ohio, is a bank holding company and the parent of KeyBank. The company has nearly 1,000 full service retail branches in 14 states and $93 billion in assets. While the company has struggled over the last couple of years with losses related primarily to commercial and residential real estate, its deposit base has remained strong, and it had a solid 12.7% Tier-1 capital ratio as of year end. Unlike some other banks that we reviewed, the company’s loss reserves, which totaled 4.3% of loans at year end, appeared to be reasonable, a favorable reflection upon management.
Shares were purchased at less than $6 per share, representing a significant discount to both tangible book value of approximately $8 per share and our estimated net asset value after adjusting for expected future loan losses and the offbalance sheet value of its healthy asset management business. Although the near-term earnings outlook is weak, future net asset value growth should be driven by an expanding net interest margin, reduced loan loss provisions and a return to a more normal level of demand for loans. The primary risk to the investment appears to be further deterioration in its commercial real estate loan portfolio and a dilutive equity raise to repay TARP and/or retain strong capital ratios. Fund Management would probably try to avoid dilution by participating in such an equity offering, particularly if it is at a discount.
BANK OF New York MELLON COMMON (BK)
Fund Management purchased an additional 500,000 shares of Bank of New York Mellon Common at approximately $27 per share during the quarter. The Fund’s original investment was in Mellon Financial Corporation common stock in 2006. Under the leadership of new CEO, Robert Kelly, Mellon merged with the Bank of New York in 2007. Although the merger created the largest global custodian ($22.3 trillion under custody as of December 31, 2009) and one of the largest asset management firms ($1.1 trillion under management as of December 31, 2009), it has been somewhat disappointing to date for shareholders. Despite healthy results in its cash generative core asset management and asset servicing businesses, the financial results of the combined company have been negatively impacted by numerous write-downs to its securities portfolio, particularly relating to Alt-A mortgage backed securities.
Nevertheless, the Bank of New York Mellon has fared better than most financial companies over the last couple of years as it has emerged from the global credit crunch and bear market with a strong financial position (12% Tier-1 Capital ratio even after repaying TARP) and only minimal shareholder dilution. Furthermore, the company’s recent fourth quarter results were healthy, as assets under management and custody increased 20% and 10%, respectively, compared to a year ago. The company also reported much improved results for both its securities and loan portfolios. The recently announced $2.3 billion acquisition of PNC’s asset servicing business appears to be an attractive strategic fit. Overall, the company now appears to be well positioned to generate the attractive net asset value growth that Fund Management envisioned when the Bank of New York merger was announced.