FPA Crescent Fund commentary for the first quarter ended March 31, 2017.
The FPA Crescent Fund (“the Fund”) returned 3.37% in the first quarter of 2017. This compares to the 6.07% return of the S&P 500 in the period and the 6.91% return of the MSCI ACWI index.
The first quarter was a strong one for global markets and the equity portion of our portfolio participated. The Fund’s top five performing positions added 2.08% to our return while the bottom five detracted -0.49%.
Unlike the financial sector that dominated Crescent’s 2016 returns, there wasn’t any one sector that was an unusual driver of performance year to date. However, Arconic was one company that did stand out, increasing 42.41% in the quarter, which added 0.73% to the Fund’s first-quarter return.
Arconic’s recent stock price performance was neither a function of great industry fundamentals nor of the company successfully executing on plan. It was more a function of Elliott Management Corp., an activist investor, seeking a change in leadership.1 We would view such a change favorably as well.
My partner and co-portfolio manager, Brian Selmo, recently authored a letter to Arconic’s Board of Directors, expressing our disappointment with both the company’s board and management given their collective failure to manage the business and deliver shareholder value. Their destructive action (and inaction) left us little alternative but to publicly voice our opinion. That letter is available on our website: www.fpafunds.com.2
AIG’s fourth quarter results were disappointing, which caused its stock price to decline -3.44% in the first quarter, detracting -0.12% from performance in the period. However, AIG’s share price has increased slightly more than 20% in the trailing twelve month period. The company took an additional reserve to account for poorly underwritten Property & Casualty policies. Nevertheless, we were heartened to see that the board held management accountable and removed the CEO responsible. We continue to hold our AIG stake that trades at just 0.83x tangible equity.
A more encompassing shareholder letter about Crescent and the markets in general will be published midyear.
April 10, 2017
See the full PDF below.
FPA Crescent Fund 1Q17 Webcast Audio
FPA Crescent Fund 1Q17 Webcast Transcript
Steven Romick: Thanks for joining us today. We’re going to spend the next hour discussing the FPA Crescent Fund’s recent performance, current portfolio, share some broader views and take your questions.
Crescent has maintained the same investment philosophy and approach for more than two decades. We invest across the company’s capital structure in different asset classes and around the world. We are absolute value, not relative value investors, only committing capital when we have both a solid understanding of the business and the risk reward of it as an investment. In what seems to be increasingly at odds in a world that seeks immediate gratification, we exercise patience in all aspects of our business.
Crescent aspires to deliver equity rates of return but assume less risk in the process. We’ve been able to accomplish this over multiple market cycles as noted in the highlighted blue section in the upper right. For the quarter, the Fund returned 3.37%, marginally below its exposure when compared to its equity benchmarks. On a trailing 12 month basis the Fund returned 14.2%, capturing 82% of the S&P 500’s return and 94% of the MSCI ACWI’s return despite averaging less than 2/3 of its exposure.
In Q1 the Fund’s top five performing positions added 2.1% to our return, while the bottom five detracted 0.5%. Arconic was one company that stood out in the quarter, increasing 42% and adding 0.7% to the Fund’s Q1 return.
Unlike the financial sector that dominated Crescent’s 2016 returns, there wasn’t any one sector that was an unusual driver of performance year-to-date. Our investments continue to outperform the indices. In the 10¼ years shown here our long equity book has returned far more than our benchmark indices. When compared to the MSCI ACWI we have just one year of underperformance. It was 3 years versus the S&P 500. The worst of these data points was -2.4% and the average of the four just -1%. On the other hand, the average alpha delivered in the majority of the years when we bettered our benchmarks was +7.5% and +5.9% for the MSCI ACWI and S&P 500 respectively.
Crescent has performed as should be expected over time, doing relatively better in softer markets and lagging in bull markets. When looking at rolling 5-year performance since inception Crescent outperformed in 100% of the bear markets and 97.5% of what we’re calling normal markets, but has underperformed in 87% of the bull markets. In the aggregate, we’ve outperformed in over 60% of the rolling 5-year periods. Also, unlike the S&P 500, Crescent has had positive performance in every rolling 5-year period.
As stock markets continue to rally in excess of the rate of earnings growth, valuations continue to expand. Therefore it shouldn’t be a surprise that the Fund’s net exposure was 61.6% at the end of the first quarter, 2.6% less than year-end 2016 and 1.7% less than our average over the last couple decades. However, I should point out that such small differences are really nothing more than noise. Crescent’s portfolio characteristics haven’t changed much. The portfolio continues to be large cap centric at this point in time. Reflecting our value orientation the Fund equities trade at an average forward P/E based on consensus estimates at 14.3x, significantly lower than the S&P and MSCI, 18.2 and 16.6x, respectively.
The Price/Book is, at 1.6x, significantly lower than the S&P and MSCI, 3.1 and 2.2x, respectively. Return on equity is lower than the benchmarks but I don’t believe the delta would be significant on a normalized basis. You may note that the balance sheets of our companies may not appear to be as cash rich as in the recent past. Debt/Capital was -33.6% at year-end 2016, which means, on a weighted average basis, the companies we owned were in a net cash position. At the end of Q1 Debt/Capital increased to -0.3%; a more neutral position and still far less than the Fund’s benchmarks. The increase in the Fund’s Debt/Cap is primarily due to Microsoft having issued $17 billion of bonds in Q1 and because of the company having moved a portion of their short term marketable securities portfolio to Treasuries that mature beyond one year.
Crescent continues to look for opportunities globally. Around 20% of the portfolio is currently outside North America. But, the companies in which we have invested have around 56% of the revenues derived from outside of the United States. If stocks weren’t inexpensive before, the market increase in Q1 only served to take valuations higher. The current cyclically adjusted P/E, the CAPE ratio, is now 29.4x and stands in the 96th percentile. When looking at P/Es based on forward earnings valuations don’t look quite as egregious. The S&P 500’s forward P/E is just a bit over 18 times, just 16% more than its average since 1990. However, that average is skewed higher by the lofty P/Es of the tech bubbly late 1990s.
On a median basis, stock valuations are higher than the prior two market peaks, both here and in Europe. If you look at this table you can see median earnings 21x, Price/Sales, 2.5x, Price/Book, 3.3x, all higher than the prior two market peaks in the US. In the global, the MSCI ACWI, P/Es 18.6, Price/Sales 1.9 and Price/Book is the only data point that is lower than one of the other market peaks and that was in September 2007. It was 2.6x for the MSCI ACWI. And we would argue that’s largely because of the financials in Europe whose balance sheets are not particularly good and whose weight as a percentage of the index is greater.
See the full PDF below.