This Time It’s Not That Different
Dear Fellow Shareholders,
In our third quarter 2017 letter, we wrote extensively about changes to FPA Capital Fund (Trades, Portfolio)’s portfolio’s management structure following weak results in two out of the last three years. In that letter, we listed the steps we were taking to ensure we were doing more of the right things and fewer of the wrong things. In summary, we pledged to:
- Avoid position inertia
- Be more nimble
- Differentiate between long-term and opportunistic investments
We have already started to increase the quality of the portfolio, and we have implemented many changes. To put these changes into perspective, over the past seven years, we initiated four positions a year on average. In the four months since the announcement we did the following:
- Initiated five new positions
- Eliminated six positions
- For the 17 remaining positions:
- Increased our weighting by more than 100bps for seven positions
- Decreased our weighting by more than 100bps for three positions
You should expect further changes as time goes on. 2017 was one of the worst years in the FPA Capital Fund (Trades, Portfolio)’s history, as the Fund was down 5.11%. Let us briefly recap why we should still have the privilege of managing your capital.
Why Invest With The FPA Capital Fund (Trades, Portfolio)?
The FPA Capital Fund (Trades, Portfolio) is, and has always been, a highly differentiated product. Our historical outperformance is a direct result of our ability to position ourselves differently than the competition. As a reminder, here are a few of the key elements that we believe separate us from the pack:
- Highly Concentrated – We hold between 20 and 40 positions, which allows our returns to differ materially from our competitors (average of 158 positions for U.S. small- and mid-cap mutual funds and 197 across all Morningstar U.S. equity categories).1
- Benchmark Independent – Sometimes an entire sector is cheap or expensive, and since our process allows us to position the Fund accordingly, our sector concentrations will differ materially from illustrative benchmarks such as the Russell 2500.2
- Cash for a Rainy Day – Cash is a residual of our investment process. When our opportunity set is poor (like today) we hold more cash (our cash level, at the end of the fourth quarter of 2017 was 29.6%). However, we are ready to deploy this cash at a moment’s notice for compelling opportunities (the average cash and bond positions of U.S. small- and mid-cap mutual funds was 4.8%; this figure was 3.4% across all Morningstar U.S. equity categories).3
- Client-centric - We insist on giving clients a fair deal. Our fees are ranked “Below Average” by Morningstar, and they have been for years.4
- We Eat Our Own Cooking – We are shareholders alongside you. I am a shareholder, with a significant portion of my net-worth invested in the Fund. I also recently added to my position.
Our portfolio remains highly differentiated today, but we believe there is safety in solitude. Currently, almost 60% of the portfolio is invested in energy-related companies and cash. This compares to less than 5% in energy and 0% in cash for the Russell 2500.5 The rest of this letter will answer the following two questions:
- Why do we have such a large exposure to energy?
- Why is our cash level so high today?
Source: Cornerstone Analytics, 11/30/2017
Our energy investment is not just tied to our belief that oil prices will go higher, however. We also see that extreme investor bearishness, and perhaps apathy, have caused oil-related equity performance to disconnect from crude oil commodity performance.
The Road to Lower Inventories and Higher Prices
Bear argument #1: Global demand growth will fizzle out.
Continue reading with charts here.
