Value Investing

Steven Romick: FPA Contrarian Policy Statement

Steven Romick’s FPA Contrarian Value Strategy (including FPA Crescent Fund) investment policy statement.

Get The Full Seth Klarman Series in PDF

Get the entire 10-part series on Seth Klarman in PDF. Save it to your desktop, read it on your tablet, or email to your colleagues.

Introduction

We devote a lot of time to the consideration and writing of our quarterly commentaries. This allocation of precious time away from our day-to-day research and portfolio management responsibilities allows us to look beyond the immediate tasks of today so that we may ponder tomorrow, giving us perspective and, at the same time, educating and informing our shareholders. We feel time dedicated to these commentaries is well spent, because a well-informed client is a better partner, one more likely to stick through the thin while awaiting the thick.

Periodic volatility (market or portfolio) and lagging returns typically lend itself to poor client buy/sell decisions; however, the market's ups and downs incubate opportunity that may not be reflected in returns for some period of time. The majority of decisions to redeem from a manager occur when their portfolio lags its benchmark. However, a good manager will frequently lag. We believe the only way to outperform longer-term is to be willing to underperform shorter-term.

Investing is an evolutionary process. We now analyze businesses, products, asset classes, and industries that did not exist twenty years ago. We therefore regularly take it upon ourselves to explain our action or, at times, inaction. Though we evolve as investors, our goal, philosophy and strategy remain constant. Up to this point, the only way to have gained a deep understanding of our thought process was to have read our past commentaries. We aim to correct that now by publishing the goal, core beliefs, and philosophies that guide our management of the Contrarian portfolios. This policy statement will summarize our investment approach, principles, and core beliefs, and we encourage all of our clients to read it.

Steven Romick: Investment Objective and Strategy

The FPA Contrarian Value Strategy (including the FPA Crescent Fund) seeks to generate equity-like returns over the long-term, take less risk than the market and avoid permanent impairment of capital.

Philosophy

  • Absolute value investors. We seek genuine bargains rather than relatively attractive securities.
  • Alignment of interests. We invest our money alongside yours, and we act as stewards of our shared capital.
  • Broad mandate. We invest across the capital structure, asset classes, market caps, industries, and geographies. We are willing to hold cash.
  • Long-term focus. We believe the best way to accomplish our goals is to accept short-term underperformance in exchange for long-term success.
  • Macroeconomic view. We incorporate an understanding (sometimes limited) of the economic environment.
  • Volatility. If we have performed our research correctly, volatility creates opportunity, not risk.
  • Downside protection / Risk minimization. We aim to protect capital first and create long-term equity-like returns second. We cannot eliminate risk, but we conduct ourselves by hoping for the best, while preparing for the worst.

Process

  • We seek the out-of-favor, unloved, or misunderstood. We are, in a word, “contrarian.”
  • We recognize that returns will not just be driven by what we own, but also by what we do not own.
  • We invest in securities that we believe offer advantageous upside/downside characteristics, and we focus on five categories:
    - Long Equity – 3:1s, Compounders, Shorter-Term Opportunities, Sum-of-the-Parts, Intra-Company Arbitrages.
    - Short Equity – Deteriorating Businesses, Balance Sheet Issues, Paired Trades, Intra-Company Arbitrages.
    - Credit – Performing Credit, High Yield, Distressed.
    - Other – Illiquid Investments and other Special Situations.
    - Cash – A residual of our investment process, rather than a macro-driven rationale.
  • We invest after conducting thorough research.

We believe our flexible approach greatly enhances the likelihood that we will deliver an equity-like return with less risk over the long-term.

Steven Romick: Investment Objective and Strategy

The FPA Contrarian Value Strategy (including the FPA Crescent Fund) seeks to generate equity-like returns over the long-term, take less risk than the market and avoid permanent impairment of capital. We think of long term as five to seven years. We define equity rates of return as the returns provided by a broad equity benchmark, such as the S&P 500, Wilshire 5000, or Russell 3000. We view risk primarily as the likelihood of suffering a permanent impairment of capital, on a portfolio basis.

The terms "long term" and "equity-like return" have an exactness and measurability. The term "risk," on the other hand, is inherently imprecise, commands imprecision and its meaning is different from one individual to another. Risk stems from the uncertainty that exists in the world. We (along with the rest of humanity) simply do not know what will happen, so we are left with trying to guard against all manner of eventualities, while recognizing that more things can happen than will happen.

Philosophy

We are absolute value investors.

We invest our money alongside yours – an alignment of interests we maintain across FPA. We view ourselves as the guardians of the capital entrusted to us. We manage the various investment products in the Contrarian Value strategy, including its public fund FPA Crescent, in a way that makes us comfortable having our family and friends commit their savings to it. Should our portfolios lag, we will most likely feel more pain than our shareholder partners.

We view ourselves as pragmatists with a healthy respect for what we do not know. We are neither optimists nor pessimists, as we invariably find ourselves hoping for the best, while preparing for the worst.

Value investing is a familiar discipline, but Contrarian Value pursues a relatively unique and advantaged strategy. Contrarian Value is unique because we have an unfettered mandate, we invest on an absolute basis, we consider the macroeconomic environment, and we have a long-term orientation.

  • Absolute Value Investing

We seek genuine bargains, not relatively attractive securities.

We invest only in positions that we believe offer a compelling economic risk/reward proposition on an absolute basis. If prospective investments do not meet that requirement, then we wait until they do. We have no interest in merely buying the inexpensive. We want to purchase a stock at a substantial discount to that company’s worth, or intrinsic value.i Our broad mandate gives us more tools to pursue an “absolute” path to value investing, where success is measured by positive returns. We reject the “relative value” path, where some may declare victory when the stock market has declined 40% and they lost just 35% of their client’s principal.

  • Unfettered Mandate

Contrarian Value operates with one of the industry’s most expansive charters. Unlike most traditional money managers, we can invest almost anywhere, using practically any instrument. We have proven our ability to successfully invest across a company’s capital structure, as well as in a variety of market capitalizations, industries, geographies, and other asset classes, while frequently holding cash. Our partners’ support and understanding of our process allows us to invest in those assets that appear most attractive on an absolute basis without regard for style box or conventional wisdom. Our investor base allows us to make the asset allocation decisions and to take advantage of compelling opportunities, no matter where we might find them. Sometimes those opportunities are in places other managers cannot or will not go.

We believe our freedom to go most places (without the requirement to do so) along with our willingness to hold cash, gives us a significant long-term advantage. For example, if large-cap stocks appear expensive, we can buy small-caps (1998-99). If high yield bonds appear less expensive than equities, we can increase our exposure to the former at the expense of the latter (2008-09). If the shares of foreign-domiciled companies appear less expensive than their U.S. counterparts, then we may invest more money overseas (2010). If common stocks and corporate bonds appear priced to perfection with little regard for exogenous risks, then our cash residual may build (2004-2008) as we wait for opportunities to invest with less downside and more upside. This approach to cash holdings is discussed further in our 2004 Special Commentary, The Case for Cash.ii We believe our investment flexibility greatly enhances the likelihood that we will deliver an equity-like return with less risk over the long-term.

Steven Romick FPA Crescent Fund

See full PDF below.