Steven Romick’s FPA Crescent Fund commentary for the second quarter ended June 30, 2015.
The FPA Crescent Fund decreased 0.15% in the second quarter and is unchanged since year-end 2014. The S&P 500 increased 0.28% in the second quarter and increased 1.23% year-to-date. Larger companies, on average, performed better. Returns for both the quarter and the year, thus far, were driven by growth stocks. The Russell 3000 index has both growth and value components that, although not perfect, give some sense of which style is outperforming. This year, so far, has been all about the growth stocks, with the broad R3000 Growth index returning 4.84%, more than the -0.51% R3000 Value index. 1 Such is the cross borne today by value investors such as ourselves.
With rates rising, bond markets have suffered as well. The Barclays U.S. Aggregate Bond Index declined 1.68% in the second quarter and 0.10% in the first six months.
FPA Crescent Fund’s best and worst performers largely offset each other in the second quarter with the winners adding 0.94% and the losers detracting 0.93%. No distinct news drove the price change for these securities during the period.
In the most recent quarter, we published a white paper on market cycle returns that can be found on our website (www.fpafunds.com).2 We hope that it further educates our investors as to what we consider appropriate time frames by which to measure our ability to meet our stated objectives: to deliver equity rates of return over the long-term with less risk than the market while avoiding permanent impairment of capital. We believe it’s important to measure this objective over full market cycles.
We define a full market cycle as the period from one market peak to the next that includes a market correction along the way. That is, a market high, followed by at least a 20% correction over at least a two-month period, which is, in turn, followed by a new market peak. A market cycle, by our definition, begins with the ending of one bull market, followed by a bear market and ending with another bull market. Since FPA Crescent Fund began, our focus has been on long-term performance over a market cycle rather than short-term results.
The left chart depicts the prior full market cycle from the market peak and dot-com bubble in 2000 through an estimated 45% correction, followed by a housing market and subprime loan-fueled new peak in 2007. From March 2000 to October 2007, we delivered a 14.70% annualized return, better than both the S&P 500 and an S&P/Barclay’s Aggregate blend. And this occurred with much less downside. The right chart reflects the current market cycle that began in October 2007. Since then, FPA Crescent Fund has returned an annualized 6.82%, also better than these indices and also with less downside.
Less important than the market cycle return, but relevant nonetheless, is the drawdown. Put another way, how large was the decline from peak to trough? The maximum drawdown of the S&P 500 in each of the market cycles depicted was approximately 45% and 51%, respectively. It’s been some time since we’ve seen that kind of market weakness but as long as there are economic cycles, wars, government intervention and fear and greed, we’ll continue to have the ups and downs of a market cycle. If not, we’d all be better off in an index fund or ETF.
To avoid repetition and in lieu of what is generally this period’s longer market commentary, we would like to refer you to a speech entitled “Don’t Be Surprised” that I gave last month to the CFA Society of Chicago.5 It is available on our website as well.
It continues to be a seller’s market. Private equity firms have been refinancing their debt at historically low rates and/or reducing their ownership stakes for the past few years. Shares in initial public offerings (IPOs) are being sold at the quickest rate in years. 2014 was the largest IPO year since 2000 and IPOs remain robust in 2015, thus far, despite decelerating from last year.6 And, the vast majority of those newly-issued shares in 2015 are for companies that have negative earnings.
It remains challenging to find those investments that appropriately discount a reasonable worst case scenario. Until such time as that changes, we continue to add depth and breadth to our library of prospective investments so as to be ready when opportunities arise. Mark Landecker, Brian Selmo and I thank you for your continued trust in our Contrarian Value team.
July 14, 2015
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