FPA Crescent Fund Commentary: First Quarter Preliminary Update

Executive Summary

• Due to elevated valuations in many of the equities we own and a lack of distress or adequate yields in the credit markets, the FPA Crescent Fund (“the Fund”) began 2020 with a net equity exposure of ~57%

• Given better risk/rewards in many securities, we have recently increased it by ~1000 bps to ~67%

• We have removed some market hedges, selectively added to existing names and purchased new companies with strong balance sheets

• The S&P 500 is now back at December 2018 levels1

• Unless one wants to make a call on energy prices, travel or financials, we do not think there is much at “throw away prices” – yet

• We have yet to materially increase the Fund’s credit exposure o High-yield ex-energy is not cheap yet

• The Fund does not have meaningful exposure to travel- or energy-related stocks (as of year-end or recently)

• We do not believe any of the Fund’s long equity holdings have balance sheet issues

• We believe the Fund still has ample liquidity to take advantage of potential future opportunities2

• The bottom 10% of companies in the S&P 500 have declined more than 54% year-to-date – the Fund does not own any of these companies

Details

• Equities are not cheap – yet

• Due to elevated valuations in many of the equities we own and a lack of distress or adequate yields in the credit markets, we began 2020 with a net risk exposure of just 63.7%

• This was nearly 10 percentage points less risk exposure than the end of 2018 and one of our lowest exposures in recent years

• The S&P 500 was at a Shiller P/E (10-year cyclically adjusted) of ~31x as of the end of February, higher than the 27x level at the previous market peak in October 2007
  • The S&P 500 is now at a ~23x Shiller P/E, as of March 16, 2020

• The S&P would need to drop another ~10% (~2150 on S&P 500) to get to a 20x Shiller P/E
• Recall the market was at a 13x Shiller P/E in March 2009

• The market has dropped ~30% but is still ~1.5% higher than the December 2018 lows3

Exhibit A: Shiller P/E4

• High-yield ex-energy is not cheap yet

• The Bloomberg Barclays US High-Yield ex-Energy index has a yield-to-worst of just 8.01%

Exhibit B: US High Yield ex Energy (YTW) vs 10-Year US Treasury Yield5

Exhibit C: US Corporate BBB-Baa vs 10-Year US Treasury Yield6

• We have increased the Fund’s net equity exposure since the end of 2019
• We believe part of the portfolio is priced at attractive risk/rewards but part is still priced at just good risk/rewards
• By no means do we think prices are at crisis or “you have to do well” in a worst-case scenario level for high-quality businesses
  • This is why we have increased exposure, but have not become more fully invested
• While we hope to become fully invested, we see enough downside to continue wait for what we believe to be great prices
  • When we think great prices arrive, we will ring the bell

Exhibit D: FPA Crescent Fund Preliminary Equity Exposure7

Thank you for your continued support.

1. The S&P 500 was at 2,386.13 as of the close on March 16, 2020 and it was 2,506.85 as of the close on December 31, 2018. The S&P 500’s low in December 2018 occurred on December 24, 2018 with a close of 2351.10.
2. The Fund’s cash and cash equivalent exposure at 12/31/2019 was 36.3%.
3. See footnote 1 for S&P 500 levels in December 2018.
4. Source: Robert Shiller, http://www.econ.yale.edu/~shiller/data.htm, as of March 16, 2020. The Shiller P/E ratio is calculated by dividing the current price of the S&P 500 by ten-year average earnings and adjusting for inflation. CAPE = cyclically adjusted price-to-earnings ratio, and is also commonly known as the Shiller P/E ratio or P/E 10 ratio.

5. Source: Bloomberg, as of March 16, 2020. US High Yield ex Energy is represented by the Bloomberg Barclays US High Yield ex-Energy Index. Yield to worst reflects the lowest possible yield on a callable bond without the issuer defaulting. It does not represent the yield an investor should expect to receive.

6. Source: Bloomberg, as of March 16, 2020. US Corporate BBB-Baa is represented by the Bloomberg Barclays US Corporate (BBB-Baa) Index.

7. Source: FPA, as of March 16, 2020. Portfolio composition will change due to ongoing management of the Fund.

Important Disclosures

This update is for informational and discussion purposes only and does not constitute, and should not be construed as, an offer or solicitation for the purchase or sale with respect to any securities, products or services discussed, and neither does it provide investment advice. Any such offer or solicitation shall only be made pursuant to the Fund’s Prospectus, which supersedes the information contained herein in its entirety. This document does not constitute an investment management agreement or offering circular.

The views expressed herein and any forward-looking statements are as of the date of the publication and are those of the portfolio management team. Future events or results may vary significantly from those expressed and are subject to change at any time in response to changing circumstances and industry developments. This information and data has been prepared from sources believed reliable, but the accuracy and completeness of the information cannot be guaranteed and is not a complete summary or statement of all available data.

Portfolio composition will change due to ongoing management of the Fund. References to individual securities or exposures are for informational purposes only and should not be construed as recommendations by the Fund, the portfolio managers, the Adviser, or the distributor. It should not be assumed that future investments will be profitable or will equal the performance of the security examples discussed. The portfolio holdings as of the most recent quarter-end may be obtained at www.fpa.com.