FPA 2013 Q4 Capital Fund Conference Call (see comments from Steve Romick’s call to FPA Crescent shareholders here), and FPA International Value Fund).
Since its inception in 1984, the primary objective of our Small/Mid Cap Absolute Value Strategy, including the FPA Capital Fund, is to invest in a limited number of small- and medium-size companies and produce superior long-term investment returns. We have been proud to have been able to achieve such goals, and that we’ve generated index-beating returns of remarkable investment cycles thus far. We hope and expect to continue to implement the same disciplined process and meet these objectives in the years to come.
Berkshire Hathaway’s Buffett On Diversification
In his 2014 letter preview, Buffett states that, far from being a weak choice, indexing can often achieve investor's goals far more easily than complicated picking strategies. This is a special guest post by Robert R. Johnson, Ph.D., CFA, CAIA. He is a full professor of finance at the Heider College of Business at Creighton Read More
It is now my pleasure to introduce the team members, Dennis Bryan, Arik Ahitov, and Nile Garretson to the audience. And I will hand it over to Dennis Bryan to commence the presentation.
Dennis: Thank you, Mark. On this call, we’ll cover a few different segments: the performance segment, portfolio segment, a market overview, and some questions and answers after we go over the first three segments. Arik will
cover the first two performance and portfolio sections, and then I’ll cover the market overview, and then we’ll go into the Q&A.
Before I turn it over to Arik, I’d like to inform our investors and shareholders that we’ve extended an offer to an analyst who is currently working in New York City. We’ve reviewed over 100 resumes and talked with over 25 potential candidates over the past seven months to add to our team. But the individual we’ve extended the offer to is the best fit for our team today. Assuming that the obligatory background checks go smoothly and the logistics of moving from New York to Los Angeles don’t present any problems or complications, we expect our new analyst to officially join our team on April 1st. And we look forward to giving you more information once that individual is actually here in a couple months.
With that, I’ll turn it over to Arik.
Arik: Thanks, Dennis. Good afternoon, everybody. Thank you very much for joining us today. Let’s go to Slide 3. I will go over this slide quickly because I will use the next two slides to go deeper in explaining the components of our performance. On this slide, you can see our performance for the portfolio for different time periods, including inception, compared to Russell 2500. Our return in 2013 was approximately 23%.
Let’s go to Slide 4. The blue box shows the benchmark performance on the left and the portfolio’s performance on the right. The red bar depicts the shortfall due to not being 100% invested, and the green bar shows the impact of our stock selection has made for the portfolio. We can see that the performance of the stocks matched that of Russell 2500. This is an especially nice feat because this was the third best showing of Russell 2500 index since the inception of the Fund 30 years ago. And the Russell 2500 ended the year with P/E ratio of almost 28 versus our portfolio of 15. The underperformance was fully due to our large cash balance. Clearly we are very happy with our 2013 performance of 23%, but it has been lower than the indices. But we have achieved this result while having a much more defensive portfolio.
This is what I mean by a more defensive portfolio. Our portfolio has a great valuation advantage over our benchmark. Our P/E ratio, about 15, is significantly lower than Russell 2500’s 28. Here is an interesting fact. The P/E multiple on Russell 2500 increased by 30% in 2013 at a time when earnings growth has been anemic. Price is going up, but earnings are stagnant. What we see is a great expansion of valuation multiples that is not backed by earnings improvement.
Looking at some other numbers here, your portfolio is not only cheap on the P/E front, but also the price-to-book is 30% lower than that of Russell 2500. If you look at the last two lines, you will see that your portfolio is not only significantly cheaper, but also has a higher return on average equity and deploys significantly less leverage.
This chart shows the strategy’s cash balance and exposure to different industries since 2000. I know that there are a lot of colors on this page, but the gist is we simply go where the opportunities are. We increase and decrease our weighting to industries based on opportunities, not based on benchmark weights.
For example, let’s look at technology. This is the dark blue line at the bottom of this chart. It represented over 20% of portfolio in 2000 and continues to decline to sub-10% by 2006, and then started climbing again and now sits at 25%. We can also look at financials: 17% in 2001 to 1% in 2006. Maybe most interesting, the consumer retail made up 40% of our portfolio ten years ago, and they stood at only 4% in 2013. We had 0% exposure to energy in 2001, and now we are about 25%.
The top part cash… cash levels increased greatly in 2006 and 2007, as a number of our companies were bought out, and we continued to trim our positions as the market went from one record to the next.
Today we are in a similar situation. Cash is simply what is left after we allocate capital to our best ideas. Today the market is expensive, so we have more cash than usual. That said, I do not want you to think that we need the market to go down by 20% for us to make an investment. You will see that we have added 13 new names over the last three years or so, including four in 2013, as the market continued to appreciate.
We decided to include this slide because having a large cash balance is a function of two factors. Cash either increases because the portfolio managers are having a hard time identifying companies to put into their portfolio, or cash increases because the portfolio managers believe that the proverbial Mr. Market is offering them such bid that they feel obligated to sell all or part of their positions because the reward-to-risk ratio warrants them to do so. Long-term clients know that our average holding period has been over five years for a long time, and it stands at over seven years right now. So this chart shows that team has been able to identify an adequate number of capital funds where the ideas over the past three years despite Russell 2500’s ever increasing price-to-earnings ratio. So the main cause of the high cash balance is the team’s decision to take advantage of these high valuations to harvest part of our gains.
This chart shows our performance since the inception of the account. I usually do not spend much time on this, but I think it’s important to highlight the long-term performance. Our goal has never been about performance over any one-year period, but over a long cycle. Our long-term clients will remember that we have lagged the market in a number periods over the past 30 years. For example, we underperformed for four years in a row in 1997, 1998, 1999, and 2000. We also underperformed two years in a row twice, both in 2003/2004 and in 2006/2007. Yet the cumulative effect of the performance has been very robust, as can be seen on this slide.
We tend to underperform when the market valuations are high because we take advantage of those periods by selling into strength. We do not find it prudent to buy great companies at 28 times P/E and will continue to identify FPA Capital Fund worthy companies and only purchase them when the risk/reward ratios are in our favor.
This slide shows the upside/downside captures since the inception of the Fund. As you can see on the left, it is not high performance during up markets that separates us from the pack but rather, as you can see on the right, our performance during down markets that really account for the outperformance.
Full FPA Capital audio call here
FPA call slides here 2013-q4-capital-webcast (1)
FPA Capital full transcript PDF 2013-q4-capital-fund-conference-call (1)
2013 q4 Capital Fund Conference Call (1)