FPA Crescent fund Q1 letter to investors – also see Steve Romick: The Importance Of Full Market Cycles

Past performance is no guarantee of future results and current performance may be higher or lower than the performance shown. This data represents past performance and investors should understand that investment returns and principal values fluctuate, so that when you redeem your investment it may be worth more or less than its original cost. Current month-end performance data may be obtained by calling toll-free, 1-800-982-4372.

The Fund commenced investment operations on June 2, 1993. The performance shown for periods prior to March 1, 1996 reflects the historical performance of a predecessor fund. FPA assumed control of the predecessor fund on March 1, 1996. The FPA Crescent Fund’s objectives, policies, guidelines and restrictions are, in all material respects, equivalent to those of the predecessor fund.

S&P 500 Index includes a representative sample of 500 leading companies in leading industries of the U.S. economy. The index focuses on the large-cap segment of the market, with over 80% coverage of U.S. equities, but is also considered a proxy for the total market. Barclays Aggregate Index provides a measure of the performance of the U.S. investment grade bonds market, which includes investment grade U.S. Government bonds, investment grade corporate bonds, mortgage pass-through securities and asset-backed securities that are publicly offered for sale in the United States. The securities in the Index must have at least 1 year remaining in maturity. In addition, the securities must be denominated in U.S. dollars and must be fixed rate, nonconvertible, and taxable. The Consumer Price Index is an unmanaged index representing the rate of the inflation of the U.S. consumer prices as determined by the U.S. Department of Labor Statistics. There can be no guarantee that the CPI of other indexes will reflect the exact level of inflation at any given time. The CPI shown here is used to illustrate the Fund’s purchasing power against changes in the prices of goods as opposed to a benchmark which is used to compare Fund’s performance.

60% S&P500/ 40% Barclays Aggregate Index is a hypothetical combination of unmanaged indices comprised of 60% S&P 500 Index and 40% Barclays Aggregate Index, the Fund’s neutral mix of 60% stocks and 40% bonds. These indices do not reflect any commissions or fees which would be incurred by an investor purchasing the stocks they represent. The performance of the Fund and of the Indices is computed on a total return basis which includes reinvestment of all distributions. It is not possible to invest in an index.

in the first quarter while the S&P 500 returned 0.95%.

Our winners in the quarter added 1.10% while our losers cost us 1.44%. Nothing newsworthy happened to any of these companies so the limited share price movement was just a result of the typical prattle that occurs every day the market is open.

Winners Losers
Naspers Tencent
TE Connectivity Microsoft
CVS Alcoa
Thermo Fisher Oracle
Alibaba Bank of America

Globally, low interest rates continue to be the principal driver behind investment decisions for individuals, corporations, foundations, endowments and other capital allocators. Bloomberg lists nineteen countries’ 10-year bonds on their World Bond Markets home page with an average yield of just 2.2%.1 If you consider Greece an outlier, then the yield on the remaining eighteen sovereigns drops to 1.6%. Investors continue to opt for a riskier path since they want or need a return that’s anything better than that.

The definition of what makes an attractive investment these days is now broader than it has perhaps ever been thanks to a 1.6% hurdle rate2. Long-term decisions are being made based on what we at FPA believe are impermanent conditions. Of course, everything in an altered state looks better. We’ll spare you the inevitable comparison to the bad choices people make when they are a bit sloshed but suffice to say many wake up later with regrets and well, we’ll pass.

We have talked about the impact of this low-yielding environment on the stock market ad nauseam but the repercussions can be felt and seen in all risk assets around the world. For the first time in history, a country was even able to sell 10-year government bonds with a negativeyield.3 Switzerland issued a 10-year note at -0.055%. Mexico, meanwhile, was able to issue a 4.2%, 100-year bond denominated in Euros. There has never been 10-year sovereign debt that a buyer had to pay for the privilege of owning and the Euro has never been validated with a 100-year bond. Put another way, investors are paying a fee for the security of the Swiss Franc or making a century-long bet on the Euro, a currency that’s only existed for 13% of the bond’s duration (and we haven’t even mentioned the additional credit and interest rate risk that comes along with it).4,5 We haven’t spoken to anyone who has admitted to buying either but we never met anyone who fessed up to buying Michael Jackson’s Thriller album and it sold more than 50 million copies.

We understand lenders are taking advantage of an unprecedented seller’s market. Who can blame them? It’s the buyers who stymie us. Call us old-fashioned but we continue to want to receive more in return than what we offer. That’s something we’re finding rather challenging in the market today with P/Es marking time in the 95th percentile.

P/E 10 Ratios by Percentile6

So the stock market continues to make monkeys out of us as we await the next occasion to commit more of our collective capital. This hasn’t been the first time nor will it be the last, but we do wish for a shorter duration between opportunities. This is already the longest bull market of the last 70 years.

Length of S&P 500 Bull Market in Months7

  1. In addition, there’s the risk that Mexico is assuming in that its income is not Euro-centric. If the Peso weakens vs the Euro, their costs increase.
  2. Euros were introduced into circulation on January 1, 2002. http://en.wikipedia.org/wiki/Euro
  1. P/E 10: The ratio of current index price to the average inflation-adjusted earnings of the prior ten years. Source:

http://1.bp.blogspot.com/-He-FUT80LBk/VRW9-GphrrI/AAAAAAAAdJA/IoWdjLLJYuU/s1600/PE-10%2BShort.png 7 Source: Albert Edwards, Societe Generale. http://1.bp.blogspot.com/-xBLEfg8gZBo/VQKJkLfy_rI/AAAAAAAAc8E/Ozyzgbn3LqI/s1600/SG%2B2015-03-13B.png

Conclusion

We appreciate that ours is not an annuity business. We must therefore continually earn our stakeholders trust – investors, partners and employees – but for us, that takes time as it always has.

Our longer market commentary will be written per usual at the end of the first half. Respectfully submitted,

Steven Romick

President

April 20, 2015

  1. As of April 20, 2015. Bloomberg function: WB
  2. Hurdle rate is the minimum rate of return on a project or investment required by a manager or investor.
  3. We are referring to nominal bonds, not TIPS. Nominal bond is a bond which makes payments of a fixed amount, rather than a fixed real (inflation-adjusted) value. TIPS stand for Treasury Inflation-Protected Security. It is a security which is identical to a treasury bond except that principal and coupon payments are adjusted to eliminate the effects of inflation.