FPA International Value Fund q3 transcript – see Steve Romick Q3 conference call here
In the past three months, however, the market presented us with opportunities to invest in a number of companies. Some were companies we had followed for a long time that were either on our focus list and experienced some element of positive change, or on our best-of-breedlist and experienced price correction. Some were companies we had newly researched as well.
As a result, our cash balance came down significantly throughout the period. At the end of the quarter, it had reached about 30%, again down from about 40% only three months ago. As we’ve mentioned several times in the past, our cash exposure is not a function of ourtop-down view of the state of the world economy or that of capital markets. (5:01) Rather it is a residual output of our bottom-up investment approach. Because of the relatively concentrated nature of the Strategy, as well as its smaller size, it is possible for our cash exposure to come down materially in a short period of time, all else being equal. A few good investment ideas suffice to bring it down.
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Now with these declines against what we consider to be relatively stable business values, we believe that market prices no longer adequately reflected the underlying fundamentals of the individual businesses, and thus we’ve become active buyers of these companies.
Now our investment discipline dictates that we purchase stocks that trade at at least more than a 30% discount to intrinsic value and that we weight them in the portfolio based on the discount to intrinsic value they each offer relative to the existing holdings. Unfortunately, or fortunately maybe depending on how you look at it, stocks which come to offer such
discounts are often—and in particular when we find ourselves many years into a run-up in market prices—on downward trends. This is the reason why in the past we’ve characterized our approach as often contrarian. The mere fact that we are purchasing these stocks doesn’t mean that they can’t or won’t continue to fall and thus offer even greater discounts to intrinsic value after we started purchasing them.
In many instances we observed that negative sentiment is a self- feeding spiral that takes time to reverse, which is also why we take a long- term view of investing. So the stocks we buy, they tend to go down further in price—not always, but it’s very often the case.
(9:02) As we take a high conviction approach where we invest primarily in our best ideas, new portfolio additions can be large position at the onset. Because individual portfolio weightings are also based on relative discounts to intrinsic value, this is particularly true again when market prices have run up and we’re presented with multiple opportunities within a short window of time. And this explains the large exposure to the newly added name. This also means that new holdings, which continue to experience declines in share prices can have a meaningful negative impact on the Fund’s short-term performance. In short, it’s not surprising or short-term performance to suffer at times of more aggressive capital deployment irrespective of our cash exposure.
The fourth thing to understand is that we’re not market timers. What this means is that we have no ability to predict when a stock is going to hit bottom. So we do not try and guess. Once a name trades at a discount to intrinsic value in excess of 30%, we invest. If it gets cheaper, which it often does, thereby negatively impacting performance, we buy more. Similarly we do not put our toes in the water and start slow, so to speak. The weighting is set based on relative discount to intrinsic value at the onset and achieved as soon as liquidity permits. We do not play a game and try simply because we can’t to maximize our discount. And the same thing is true on the sell side. We do not try and maximize return by holding on to a rising stock. We consider it a fool’s game either way that could only lead us to miss out on opportunity or worse to permanent losses.
(15:06) Last but not least, we typically invest over several years, and we do not consider a quarter as particularly meaningful. We say it now like we’ve said it repeatedly when short-term performance was much stronger than it is now. We recommend shareholders to evaluate the
Fund’s returns over the medium to long term. As mentioned in past commentaries, we expect the Fund to experience short-term volatility at
times. But volatility does not equate to permanent capital destruction. Rather it often translates into opportunities for us to deploy capital at prospectively high rates of return. And typically we lean into market volatility to invest in high-quality businesses with a high margin of safety. As a result of that, we make experience periods of poorshort-term performance. Longer term however, we should be able to reap the rewards of this investment discipline.
Taking advantage of market volatility is precisely what we’ve been doing this past quarter. It is consistent with our philosophy and in fact much different from what we experienced in the first quarter of 2012 when European equities were already punished in the market. The Fund then was down by more than 5%. And by June 30, 2012, the weighted average discount of our holdings was 36%. Today it stands at a similar level of 34% that means that we’ve been able to redeploy capital towards ideas with greater prospective returns while retaining a large portion of the performance the Fund has generated since inception both on an absolute basis and against the Index.