FPA U.S. Value Fund webcast audio, transcript & slides for the third quarter ended September 30, 2015.
FPA U.S. Value Fund 3Q15 Webcast Audio
FPA U.S. Value Fund 3Q15 Webcast Transcript
Greg Nathan: First, I want to thank everyone at FPA who has helped with the launch of the FPA U.S. Value Fund. I truly appreciate your hard work over the past number of months. Second, I want to thank long-time shareholders as well as new investors for entrusting your capital with us. I want to let you know that our interests are fully aligned. Managing FPA U.S. Value Fund is not just my professional focus. It is my obsession, and I will work very hard to deliver shareholder value.
Now I’d like to walk you through my investment philosophy. The most important thing in investing is to avoid permanent capital impairment. Permanent capital impairment can result from investing in a business whose profitability is structurally declining, paying too high of a multiple for a company, investing in a company with too much financial leverage that can’t make it through a tough business cycle without having to restructure. Thus, I focus on finding quality companies at attractive valuations with low financial leverage. I want the portfolio to have an appropriate level of diversification—by number of investments and industry exposure.
So how do I find quality companies at attractive valuations? I look for quality companies that appear misunderstood, as well as industries that are out of favor. I define “quality” as companies with strong and enduring competitive positions, growing businesses within growing industries. A growing industry is key because without it there will be typically poor earnings growth and investment returns. For example, just look at the performance of Staples, the number one office supplies retailer over the past decade—huge destruction of capital. Lastly, I want my companies to have high returns on capital and robust free cash flow generation. I prefer companies with good management. However, often the reason good businesses are offered at attractive prices is because of poor management. Therefore, I will consider such companies provided there is not a structural impediment to replacing management and there’s a large enough discount to my estimate of their intrinsic value. Bottom line, the quality of the business and valuation are the most important investment criteria.
Let me walk you through the key parameters as to how the portfolio is constructed. The FPA U.S. Value Fund’s all-cap strategy affords me the ability to invest wherever the best opportunities arise. At least 80% of the portfolio will be invested in U.S. companies. At the same time I have the ability to make opportunistic foreign investments. Appropriate diversification… typically 20 to 30 companies. Individual positions will not exceed 5% of total assets at the time of purchase; approximate average position size is 3–4%. Normally fully invested… the reason for this is the portfolio is made up of what I believe are undervalued high quality companies that should compound in value over time. Cash will unusually not exceed 10% of the portfolio.
Constructing a portfolio begins with idea generation. There are many ways I find potential investments. Having researched and analyzed various companies and industries for over 15 years, I have a very good knowledge base to pull from. For example, having done extensive research on the pharmaceutical supply chain, when one of the highest quality companies in the sector, McKesson, sold off this summer, I was able to quickly brush up on the company, understand why it was out of favor, confirm it provided a good risk-adjusted return, and add it to the portfolio.
I constantly read various publications, news articles, and buy-side as well as sell-side research. When I’m on vacation, this is also what I do for pleasure. You can just ask my wife. I think it’s important for existing and potential shareholders to understand just how much of a passion I have for investing. I love what I do. Even though this is my occupation, I do not feel as if it’s a job. This is what I will do for the rest of my life. I get a huge rush from finding a great company the market is giving away. So please don’t ask me for any good book recommendations because essentially all I read about is information on various companies that are potential investments.
Once I have identified a potential investment, I conduct thorough research and analysis of the company and its respective industry. How does the company’s business make money? How competitive is the industry? What is the company’s competitive position within the industry? Does the company have a strong and lasting competitive advantage? Is the company operating at an efficient level compared to its key competitors, or is there room for improvement? Does management have a good track record? How is management compensated and by what metrics are they incentivized? How does management allocate capital? Lastly, after building realistic low-base and high-case scenarios, does an investment at current prices provide a good risk-adjusted return?
See full transcript below.