Value Investing

FPA New Income Fund 1Q15 Webcast [Audio, Transcript, Slides]

FPA New Income Fund webcast slides, transcript, audio for the first quarter ended March 31, 2015.

FPA New Income Fund webcast webcast audio

FPA New Income Fund webcast webcast transcript

Ryan Leggio: Turning to our investment philosophy, we think it’s relatively straightforward, but we believe it’s relatively unique in the asset management industry. First, the investment team focuses on not just producing consistent absolute returns but, as I will talk about more in detail in just a minute, consistent real returns—that is, returns above and beyond the rate of inflation. Essentially our goal is to preserve and grow one’s purchasing power over the long run. Second, and this is really important, the team will only make an investment when they believe they’re adequately compensated for taking on the risk of that investment. By risk, we mean the risk of both default and increased interest rates or inflation. This requires the team to apply discipline when there are prolonged periods of meager investment opportunities. More detail regarding the team’s investment philosophy can be found in the Absolute Fixed policy statement on our website, fpafunds.com.

The Fund highlight page is up on the screen now. And for those of you listening on the first time, there is a lot on here, so I’ll focus on just a few items. The Fund’s primary investment objective is current income and long-term total return. The Strategy seeks positive absolute returns over rolling 12-month periods and positive real returns over the long run, which we define as rolling five-year periods. The Strategy is benchmark-indifferent, and will invest at least 75% of its assets in securities rated double-A or higher. And finally at the bottom of the page, options, futures, shorting, and leverage have not and will not be used in the Strategy.

Turning to performance, while we like to focus on long-term performance, we know many of our investors are interested in how we have performed more recently. As we have mentioned on previous webcasts and letters, the last few years have been challenging, given low starting yields and modest-to-low credit spreads. The chart on this page really proves this point. For the sake of simplicity, we use the last three calendar year returns—that is, 2012, 2013, and 2014. The chart shows how various indices—the Barclays Aggregate 1–3 Year Index, the Barclays Aggregate 3–5 Year Index, and the Barclays U.S. Aggregate Bond Index—would’ve done under our stress test, which is simply the approximate projected return if interest rates rise one percentage point over the course of a calendar year.

If you focus your attention on the far left of the chart where it says 2012, the negative 41 basis points in blue at the top means, if rates had risen 1% during calendar year 2012, the 1–3 Year Index would’ve returned about a negative 41 basis points. The formula for the return is on the top, and let’s walk though this as a particular example.

At the beginning of 2012, the yield-to-worst for that 1–3 Year Index was 87 basis points. And if rates had risen over the course of the year, by the end of the year, the Index would’ve been yielding 1.87%, with an average yield during the year of about 1.37%. Now the duration of that Index was 1.78 years during the year, which is how you get to the total return of minus 0.41%. The 3–5 Year Index would’ve returned a negative 64 basis points during 2012. And at the bottom, the Aggregate Index would’ve returned minus 2.21%. Now the reason all of these numbers are negative is simply because the average income one would’ve received during each calendar year was less than the duration or the interest rate risk of each index. In 2012, 2013, and 2014, even short-dated indices like the 1–3 or 3-5 Year Index would’ve produced negative total returns had rates risen 1% over the course of those calendar years. The Barclays Aggregate Index was even more exposed to rising rates, given it had a duration of approximately five years.

We show this data because we think one appropriate way to think about the Fund’s performance more recently is to consider it alongside a passive index-based alternative that performs the best under our stress test. As long-time shareholders know, we are continually stress testing the portfolio to position it to achieve a positive return should interest rates rise by 100 basis points, or one percentage point, over a 12-month period. Over the last three years, the broad-based index that would’ve performed the best, though still producing a slightly negative return, under that same stress test at the beginning each calendar year, would’ve been the Barclays U.S. Aggregate 1–3 Year Index. Basically if an investor hadwanted to invest in an index-based alternative that would’ve performed well under our stress test, during the last three years, that investor would’ve invested in a vehicle that tracked the 1–3 Year Index.

Over the past three years, looking at the bottom table on the page, through the end of the year 2014, FPA New Income returned 1.39% net of fees versus 0.93% gross of fees for the Barclays U.S. Aggregate 1–3 Year Index. Our risk-adjusted results were even more compelling. Over the past three years, the Fund took on about 20% less interest rate risk as measured by duration. To earn our fees, we believe we must outpace a cheap, passive index-based alternative on a risk-adjusted basis. Importantly this won’t always be the Barclays U.S. Aggregate 1–3 Year Index as interest rates rise and fall in the future. An advantage to investing alongside us is that, as interest rates and credit spreads move up and down, (8:01) we will reposition the portfolio accordingly to take advantage of what we believe are the best risk-adjusted opportunities in the fixed income marketplace.

See full FPA New Income Fund webcast transcript below.

FPA New Income Fund webcast slides

Investment objective

  • The Fund’s primary investment objective is current income and long-term total return. Capital preservation is also a consideration.

Characteristics

  • Seek positive absolute return within rolling 12-month periods
  • Seek positive real returns as defined by CPI + 100 bps over rolling five-year periods
  • Benchmark indifferent

Investment profile

  • Rigorous security and portfolio analysis seeks to mitigate risk:
    • Value-driven investing
    • Duration actively managed
    • Security and portfolio stress test
  • Investment restrictions as stated in the prospectus:
    • Minimum 75% must be rated “AA” or higher
    • Maximum 15% in aggregate in Interest Only, Principal Only, Z bonds, and Inverse Floaters
    • Maximum 25% in foreign U.S. dollar or non-dollar securities
  • Other restrictions:
    • Maximum 15% in restricted or illiquid securities
    • Options, futures, shorting, and leverage prohibited

FPA New Income Fund

See full FPA New Income Fund webcast slides below.