- Third Avenue continues disciplined investing across their five funds.
- Martin Whitman's Quarterly Letter discusses public and private credit-worthiness with candor and humor.
- "Active Share" succinctly defined and applied to Third Avenue Value Fund and family of funds by extension.
- This quarter I focus on the Small-Cap Value Fund and some fund holdings.
This is my second article discussing Third Avenue Value funds, a habit I began with this article. I have been a long-time owner of the Third Avenue Value Fund, and have always found Martin Whitman's letter and the quarterly reports of all the funds educational and informative. This quarter's mailing also included the annual prospectus dated February 28, 2014, while the quarterly reports are dated January 31, 2014. I will endeavor to download electronic copies next quarter to facilitate an earlier and more timely review instead of waiting for my mailed "hard" copies.
Third Avenue has always maintained a tightly focused value investing mindset. The phrase "well-financed company trading at a (deep) discount to our conservatively estimated net asset value" or similar probably appear in every quarterly report ever filed. Mr. Whitman and the portfolio managers focus on individual companies and also often mention they cannot predict macro-economic factors. They also do not "chase" momentum stocks and have held large holdings of cash when prices have become too "dear". Much like Berkshire-Hathaway (NYSE:BRK.A) (NYSE:BRK.B) and other value-oriented investors, this has hurt performance when market multiples are expanding, which is discussed in this quarter's letters. While the funds enjoyed a good year in 2013 and the 1st quarter of 2014, the over-all market gains were not matched due to this value orientation. While some upside was lost, protection from quick shifts in market sentiment exist in TAV funds not available to the index investor.
One reason for this is the "active share" component of the Third Avenue Funds. "Active share" is the percentage of investments in a fund that differ from the tracking index (adapted from Investopedia). A higher active share means the managers are actively managing the fund and not merely copying their tracking index. This does not mean there is high turnover nor is it directly related to performance. As active, bottom-up managers, the portfolio managers at Third Avenue have fairly high "active share" measures. This is exacerbated by a general aversion to "window dressing" and following the herd mentality exhibited by the portfolio managers. This also hurts performance during momentum driven markets but also serves to diversify a portfolio that also contains index funds or ETFs. Personally, this is one way I use TAV funds-balancing the index funds in my 401(k) by purchasing TAV funds in other accounts.
Another distinctive feature of the Third Avenue Funds are turnover rates nearly 50% or less than the averages among actively managed funds. With the exception of the Distressed Credit Fund, all the Third Avenue funds display exceptionally low turnover from year to year-normally about 1/3 of positions. This is driven both by a disciplined buying process, and that many of the investments need some time to "work out" and realize intrinsic value-often in a resource conversion of some type. Rapid trades are rarely made, and the aforementioned lack of "window dressing" trades also depress turnover. This benefits the TAV investor whether in a taxable or tax-sheltered account by reducing hidden transaction costs but especially would be of benefit to the investor holding TAV funds in a taxable account. Limiting turnover should shelter this investor from short-term capital gains-especially important if annual distributions are reinvested, incurring a tax liability that must be paid from other sources.
Another similarity between Mr. Whitman and team and Mr. Buffet and Mr. Munger and their portfolio managers is the large ownership stake/skin in the game they hold in the Third Avenue portfolios. Mr. Whitman has always mentioned that much of his personal wealth is in the funds, and this is also the standard for the portfolio managers. They manage their specific fund as an owner as well as the hired manager. This is also carried over into the investments each fund makes-one evaluation of a target company's management is whether they also have "skin in the game" and manage the company as owners instead of as short-term oriented managers. Mr. Whitman and the portfolio managers "walk the walk" as owners of portions of companies, not traders of pieces of paper and put their personal fortunes behind this. While the mutual fund industry has a proclivity to hire away managers and seek higher fees, the fact that many Third Avenue managers retire from the company after years managing a fund and building their wealth as owner-managers aligns their interests with the investors in the funds.
Fund in focus: Small-Cap Value Fund
The Third Avenue Small-Cap Value Fund is an actively managed value fund investing in well-capitalized small companies as reflected in the Wilshire small-cap index or the Russell 2000. One distinction that definitely impacted 2013 results is that the portfolio managers follow a disciplined, bottom-up approach, so unlike those indexes and funds that track them tightly, the managers hold cash, sometimes as high as 10% of the fund. The fund managers compare favorably to the index since inception, but have recently underperformed. This must be taken with a grain of salt, as the fund's most recent one year performance was 31.47%. The fund is invested in 23 distinct sectors, 1 limited partnership and the aforementioned cash and short-term cash-like investments.
This quarter's report highlights two new positions and details why 3 of the eliminated positions were removed from the fund. While exactly mimicking the fund is not my intent, both these stocks and the rationale behind the decisions are instructive, whether one holds the Small-Cap Value Fund or not. The new position I'd like to discuss is World Fuel Services (NYSE:INT). World Fuel Systems is a fuel logistics company that provides fuel across three segments-land, aviation and maritime. The company had major contracts providing fuel to the U.S. military in Afghanistan and while this is a short-term negative, Third Avenue Value sees this as a temporary issue that doesn't significantly impact INT long-term. This is one example of the opportunistic, bottom-up analysis TAV funds show in their portfolio management and is both beneficial for owners and instructional for investors alike. World Fuel Systems is a solid company with many other contracts, and buying a good company at a reduced price due to temporary setbacks could prove successful in the long run. This quarter's report also highlights why the fund eliminate three of the stocks out of those positions eliminated, which also is illustrative. They list two reasons, first, that each company, while cash-rich, didn't have strong reinvestment or expansion opportunities. Second, and making the "dead money" even more troubling, managements at these companies didn't display capital allocation skills deemed to be worthy of continued investment. While a cash-rich company could be a good investment, management must have a reasonable plan to turn the cash into earnings, return it to stockholders, or otherwise successfully employ it, or it's "dead money" and other investments will have better long-term results.
Summary and application
It should be obvious I am a fan of the Third Avenue approach and have been influenced by Martin Whitman and teams' letters over the years. The Third Avenue family of funds provides a value investing based approach and a diversified group of funds. While an active investor or speculator (in the "Graham-Doddsville" meaning of those terms) will likely find both specific opportunities in both individual investments, ETFs and other funds, TAV funds could be used to provide foundational investments alongside index funds or ETFs as the core of a portfolio. Best wishes for success in your investments!
Additional disclosure: I am a long-term holder of the Third Avenue Value Fund.