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7/27/2019 Fpa Crescent Fund Q2 2013 Webcast Transcript
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Mark Hancock: Good afternoon everybody. Thank you for waiting. My name is Mark
Hancock . Im Director of Client Service & Business Development here
at FPA. We appreciate you joining us today for the FPA Crescent
Funds 2013 second quarter webcast. It is our expectation that with
the appropriate consent, both the audio, transcript and visual aspects
on todays call will be posted on our website fpafunds.com over the
coming week or so. Momentarily you will hear from Steven Romick,
our Managing Partner here at FPA, Portfolio Manager of our
Contrarian Value Strategy, which includes the FPA Crescent Fund.
Brian Selmo and Mark Landecker who s Co-Portfolio Managers on the
strategy, as well as other members of the team. Steven has managed
the FPA Crescent Fund since its inception in 1993. And Id like to
congratulate Steve and the team as they recently celebrated the
funds 20 th anniversary on June 3 rd of this year. Its our goal during
this course and review of stakeholders a clear understanding of our
current views as the team discusses the portfolio, the market, the
economy and fields a bunch of questions that have come in prior to
and during the call. Joining Steve today, as I said, are Steves co -
managers on the strategy, Brian Selmo and Mark Landecker. As well
as key members of the team, Andrew August, Greg Crouch, Sean
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Korduner, Chris Lozano, Greg Nathan and Ravi Mehra. Now over to
you, Steve.
Steven Romick: Thank you very much, Mark. And thank you all for joining us today.
We start with always at the first with our philosophy just to make sure
this is truly engrained in your mind as much as it is engrained in ours.
Our goal is either to provide equity rates of return and avoid
permanent impairment of capital along the way, so invariably it usually
ends up meaning less risk in the stock market. We do this by
investing across the capital structure buying common stocks,
preferred stocks, convertible bonds, junior debt, senior debt, bank
debt and various sundry other types of special purpose vehicles we
may have invested in the past or may invest in in the future. The
Fund Overview, this shows the hypothetical growth of $10,000. We
never really spend much time on this, and notice Im going to spend
more time on this today. Its just that in the secon d quarter we
actually had a relatively seminal event. Theres a question that just
came through that says that people cant hear. So we marked our 20 -
year anniversary in the second quarter. And were very proud to
deliver on our specific goals these past two decades. And the very
least we can do is promise that we will work just as hard in the future.
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And Im very confident that we will do quite well overtime because we
have a process that we feel that we can replicate over many years
with the wonderf ul people involved on our team, and Ill talk about
team in a moment. Performance, most recently, has given our
continuous cost of spend. The point is to perform quite well. And the
investment committee and investment team hasnt changed much
over time I mean, in the recent year recent six months, actually. I
apologize. But the theme remains unchanged in composition, except
for one factor. But as Mark Landecker and Brian Selmo now the
added title of Portfolio Managers. Mark and Brian have been
affectively serving in this capacity for the last few years, and now they
have the title to go with the role. And I wanted to thank them publicly
and let everybody know that were quite honored to have them
alongside of me. Now theres also been one small addi tion to the
family, Mark Landecker and his wife Kim had a baby boy, Nate, during
the second quarter. Congratulations to the Landeckers. Mark is
smiling a little bit, not a lot. I want that on the record. The FPA
Crescent winners and losers for the second quarter are actually quite
interesting. Because theyre notable for the reason that it really just
shows you how much noise there is in quarter to quarter performance.
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The biggest impact in Q1, which is Covidien, declined so much in Q2
that it topped the losers chart. And as of today, Covidien has made
back all of its losses in the second quarter, which mark to market only
didnt transact. And in the second quarter decline has made back as
it approaches its all time high as we speak. Microsoft led the charge
in the second quarter and now seems to be pulling Covidien as its
leading the early third quarter charge for poor performance. Again,
this is really all just noise and nothing reflects that more than
Omnicare that you see on this page, which at numerous periods of
time of inter-quarter declines over the last few years, along the way to
doubling from our cost. The FPA Crescent allocations, when you look
at risk asset exposure, has declined somewhat from the prior quarter.
And we continue to maintain a very conservative posture in the fund.
The stock price has continued to offer little in the way of margin of
safety, a nd given the continued risk in the market, one shouldnt be
Im sorry the continuing rise in the market, one shouldnt be too
surprised to see the fund s exposure to risk assets to continue to
decline. So its declined by a few percent since the first quarter. The
portfolio characteristics slide you have in front of you now, this reflects
that things arent particularly cheap as th e P/E can certainly reflect
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which is slightly higher than where its been over our 20 years.
Price/Book is in line, Return on Equity is relatively in line. And we
continue to see better value, at least relatively speaking, and were
trying to think of ourselves as absolute, value investors. So I do
recognize that Im making a relative statement, that the larger
companies are relatively more attractive and that is reflected in our
higher market cap at $76 million. We also own a number of
companies that have important off balance sheets with more cash
than debt, and this pushes the debt to capital numbers solidly into the
negative, which means far more cash than debt, and thats the
weighted average across the portfolio. Now the reason for our
continued conservative posture can be seen in this slide of
unemployment. Y oull see three lines here . One is the red line at the
bottom, which is the lowest number. I ts the government number for
unemployment. And the other two lines reflect Th e gray line
reflects a broader level of unemployment in U-6, and then the blue
line is actually one firms opinion , John Williams opinion and
ShadowStats, that this is really where we see true unemployment
number, and basically arguing that the government number is all wet.
Now were not showing this slide to advocate that the ShadowStats
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number is the correct number. But directionally we certainly agree
with the idea that government statistics dont really show the whole
story which would be for inflation, or in this case unemployment.
Unemployment showing at 7.6% is misleading for lots of reasons and
Ill give you just one simple reason. If the same number of people
wants to be employed in the United States, the same percentage of
the population as five years ago, unemployment would be 3.5. So
unemployment wouldnt be 7.6%, it would be 10.6%. And if the same
number of people in the U.S. as a percentage of the population
wanted to work today, were seeking work five years ago. So people
give up and dont want to work, and they come out of the civilian
institutional population, they come out of the denominator, and the
unemployment number goes down. Earnings arent what is driving
the stock market, certainly not in the recent 12-month period. And
you can see that in this slide where multiple expansion is still the
predominant driver of returns. And at some point were going to need
earnings growth. And this chart is reflective of both the U.S. and
Europe, is also true of emerging markets. It doesnt happen to be true
of Japan at this point in time. And things are somewhat challenging if
you just look and one of the reasons why see the economy not
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having such terrific growth today is always to just look at the real
median household incomes. This is income adjusted for inflation.
And this number has been on its longest slide since the depression.
Now this chart only goes back to the late 1960s , but its not going to
have an inconsequential impact on spending if you have your real
income declining for years on end. N ow the economys had some
bumps some improvement along the way. It doesnt look so terrible
for lots of different reasons, not the least of which is government
involvement. But the US savings rate has been declining, and this
chart here shows you that. Now as savings rates come down, you
end up with more conservative spending. People pull it down to go
and make ends meet or buy something special, whatever the case
may be. But clearly its not something that can continue to go down in
velocity as it has been. There are some positive points in the world
today, and obviously we ve mentioned these before. Natural gas
prices remain relatively low, which is great for our manufacturing
capabilities in the country that are located close to natural gas
facilities. And we have auto sales that are still well below their peaks.
So as these things, as natural gas prices Im sorry the auto sales
move back towards a norm, revert to a mean, thats some benefits to
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the economy. Housing starts same thing. Housing starts still remain
well below where theyve been historically. Now were not arguing to
go back to peak, but it should go back to some normal level that will
still be higher than where we are today. But stocks and price, most, if
not all of this in. So, if you look at the historic P/E on this Shiller chart
that you see here, you can see that the current P/E is smoothed out
over ten years is 23.6x earnings. And that is much higher than its
been at any point in time in the past on an average basis. I mean, not
the highest point, but its well above average, I should say. And one
of the reasons you get there is because the treasury yield is so low
and Im going to argue, artificially low at just 2%. And the reason
that we like this Shiller methodology is it looks at earnings as a
denominator averaged over ten years, so it really smoothes out those
big peaks and valleys that you have in earnings. And another reason
we like it, looking at it on a trailing basis, is that we dont place a lot of
stock in projected earnings. If you look at this chart here that is titled
Wall Street Blind Optimism , you see 18 data points. These are 18
years worth of projections, and in each year you see, in these
squiggly lines, you have, at the beginning of the year, the expected
earnings over the course of the year. They are coming down to what
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the actual earnings end up being. So they start high, to the left, end
up low, to the right. Now, thats true in 15 of the 18 cases. So in 15 of
the 18 data points, in 15 of the 18 years Wall Street was overly
optimistic, and we dont expect that to be any different in the future.
Its nice to be optimistic and its a wonderful way to live your life, but
its not necessarily the way to make money. Were more on the
pragmatic side and take this realistic approach. And the reality is
theres less fuel out there for equity valuations. And you look at this
chart that showed the G7 average 10-year government bond yield,
you can see that 13 years ago that the yield was 5.5% and now were
down here at under 2%. Now that is thats federally declining level
of interest rates, and around these developed economies has been
fuel for risk assets around the globe. So, at some point interest rates
are going to change and when that does and when interest rates end
up going back up, its not going to be good for the same risk assets
that have benefitted from this downward sloping chart. Turning to
high yield bonds, high yields are equity and these arent cheap either.
And this chart shows you the S&P 500 versus junk spreads on an
inverted scale. So as junk spreads are going our yields are going
down and spreads are getting tighter, you see the line actually going
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up. And you can see how the stock market and high yield bonds are
so closely correlated. Covenant-lite levered loans are a pretty darn
good indicator as to what the risk is. And in an environment where
people are perceiving risk, lenders are more willing to just capture the
yield and get what they can for the loan that theyre m aking and not
worry about any kind of covenants or worry less about them. As a
result, theres actually more risk in a lot of loans out there, whether it
be in high yield bonds, or in this slide that you see in front of you,
covenant-lite levered loans. Because covenant-lite levered loans
show you that this chart shows 25% of these levered loans are
covenant- lite. That is to say, that they dont offer a great deal of
protection, or as much protection as it had in the past for the lender,
which is obvious ly good for borrowers. Now were going to, over time,
take advantage of opportunity when it shows up, and thats going to
be where theres market volatility. And volatility shows up for a host of
different reasons at times that we cant predict. So we j ust sit there
and wait for there to be that kind of negative volatility which creates
fear in the individual company, and therefore stock price; creates fear
in the market as a whole or industry group or an asset class, or
something of that nature. So you can see in this chart that you have
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in front of you that the VIX in this is the measureable utilities, the red
line. And as that line tends to go up over time, our cash which is on
an inverted scale, on liquidity, tends to be pulled down. So as the
index comes down, then as volatility comes down, you end up with
periods of time where theres complacency, and you see longer, flatter
periods like the period of 2004 to 2007. And in that timeframe there
was just a lot more complacency, as we all know now with hindsight,
and that kind of thing shows up in the VIX index. I want to make it
very clear, we dont manage to a volatility index. We dont think about
it at all. This just happens to be the case where it shouldnt be any
great surprise that where there is bad news, where there ends up
being fear, where theres fear there ends up being volatility , and thats
where theres the opportunity. And just to give you some idea of how
our liquidity kind of ebbs and flows over time. Im going to turn it over
for a large cap view a large cap technology view that Mark
Landeckers going to walk you through to give you a perspective on
process and how we think about and work through things at FPA. So,
Mark, Im going to turn it over to you.
Mark Landecker: Sure. So weve never branded ourselves as tech investors at FPA .
But if you were to look at sectors fully here at the moment, youd
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actually see that tech makes up the largest portion of the portfolio. So
before we get into Tech, the three names were going t o talk about
here, and there are others in the portfolio, some of which you can see
in our holdings. Others, which actually we continue to hide because
theyve purchased them in the last 12 months and dont want to
disclose the names as of yet. But if we think about Microsoft, Cisco
and Oracle, and you just look at this slide here, we like to say, if it
wasnt for bad thered be no news at all , as it relates to these three
companies. But surprisingly while we want to invest in Tech, it is
probably dangerous to look in the rear windshield. Nonetheless, if
you look at the performance of these three companies, on average,
over the past ten years, or even from 2007 to 2012, you can see that
in terms of revenue growth and EPS growth, each has actually
exceeded the S&P 500 Median. And you can see the numbers for
yourself from this slide. If we go past revenue and EPS and we
actually look at Return on Equity, you can see the same trend. Each
of Microsoft, Oracle, Cisco generate higher ROEs than the S&P 500
on average. And as a group, they were actually almost doubled from
2002 to 2012. And over the last year 2012 on a loan, 22% versus
15%. And we should not e that that ROE is negatively impaired by
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the fact that each of Microsoft, Oracle and Cisco maintain large cash
balances that effectively act as a lead weight when one calculates
through channel and equity ratio. But, nonetheless, still exceeding the
S&P. Now if we go forward to Enterprise Value/EBIT, many of us
were probably back when we had the dot com days. And even after
the dot com fizzled out, if you looked at Microsoft, Cisco, Oracle in
2002, the valuations traded at an enterprise value of high teens in
terms of pre-tax earnings of EV to EBIT as you can see on what I
believe is the red line on this chart. Now as we go forward over the
next decade, you can see that at present just by the fact these
companies have grown revenue, EPS and generate return capital that
all exceed the S&P, the companies now actually trade at a discount to
the S&P as it relates to EV to EBIT with the group on average now
coming in less than ten times versus the S&P which would be above
ten. If you go to another earnings metric, which would be the P/E
ratio, you can once again see the same trend from 2002 to 2012.
These three companies were once very expensive as it relates to
valuation and theyre now firmly entrenched in value category trading
at a discount to the S&P. Lastly, another popular metric to look at
would be the dividend yield. Back in 2002 these companies actually
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didnt even pay a dividend full stop, yet alone trail the S&P. Now we
roll forward to today, each of the companies has more disciplined
capital allocation program, and even excluding buy-backs that all
were doing on a regular basis simply as it r elates to dividend yield, all
were yielding above the S&P average. So while there are no
guarantees that these tech companies as a group will provide
excellent returns, we do think from our purchase price we have a
tremendous margin of safety, and Ill ca ll it cautiously optimistic that
well be able to achieve equity -type returns from our cost during the
three to five year holding period.
Steven Romick: Thank you, Mark. Im going to we have a number of questions that
has come in over the transom in the last few weeks, and we have
some additional questions that are coming over the transom as we
speak. And well do our best to get to them in the allotted time . And if
questions arent answered, please call Mark Hancock or Brand e
Winget in our client servi cing team here at FPA and well make sure
that every question does get answered even if it isnt getting
answered live on this call today. So the first questions that I have is a
number of questions from one person regarding Google, is it frothy, is
there a catalyst for Apple, should we swap out Hewlett Packard, plus
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in the biotech space, and issues or thoughts regarding committing
natural resources. We own a few of these companies. I just
mentioned Google, we do own in the portfolio today. Look, I think if
they could go back to that slide that I showed earlier about what our
valuations are in the market, where valuations are for our portfolio.
Ca ndidly, we dont think our portfolio is real cheap. We cant sit here
and tout our book today and tell you, well, were really excited about
the companies we own and their valuations. We like the companies
we own, dont get us wrong, but the valuations are not particularly
cheap across the portfolio, and one can speak to that on a host of
different companies. And with respect to Google specifically , theres
other questions about that, Mark, as well. Do you want to speak to
Google specifically?
Mark Landecker: Maybe if we just step back from a broader basis. So we like to think,
we would never ask anyone to give us all their money to manage, but
we act like they have. And with that in mind, we have to construct a
portfolio thats essentially robust to any environment. What that
means is, we want to do okay if theres a deflationary outcome in the
world. We want to do okay if theres an inflationary outcome. These
are both scenarios that we worry about. So if you look at the portfolio,
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theres a number of names which we will say are just not outright
cheap. And we can put Google in there as an example. But what we
think they are, are fantastic hedges against inflation. If you think
about the business model of Google and some of the other
companies Im thinking of such as AB Inbev, for example, the
headline P/E is not classic value guide territory. But what they offer
an excellent opportunity to do is protect ones purchasing power over
time by basically allowing us to clip coupons on the earnings yield
thats reasonable given the high quality of the business and the fact
that each of the companies in question are very well protected against
inflationary environment. But of course that protection doesnt come
cheap, and at present, it reveals itself in a P/E ratio that we have to
pay. As for Google, it falls into the fact that we think its a great
manag ement team thats allocated capital , incredibly well. Brian could
probably talk about the Toothbrush Test for Google and why we think
theres embedded optionality that doesnt reveal itself at first glance.
Brian Selmo: I guess what Marks referring to is Google projects that they would
pose to themselves that have to be in common use the way someone
would use a toothbrush every day. And so Google has a few blue sky
opportunities in front of it that probably arent in the stock currently. I
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think Mark and I would say were very impressed clearly from the
outside, but with the organization and the types of opportunities that
they tackle. And its not inconceivable that there could be additional
large businesses within Google. If you rewind five, six, seven years,
there wasnt an Android operatin g system. I think now theres 900
million people on it this is just from the Google s second quarter call
and I think a million-five are signing up every day. And so if you think
about the kind of opportunities that theyre seeking to address, thats
an example of success. Well have some failures along the way, but
we think its still an interesting business. And probably the valuation
isnt quite as stretched if you were to try to peel back and tease out
what you were paying for just the core search function.
Mark Landecker: A lot of cash on the balance sheet as well. So if you were to tax the
foreign cash, bring it back in, the valuation gets a bit more reasonable.
And of course with a company like Google, we expect it to be larger,
rather than small over the years. It falls into our compounded
category. And because of that, we probably look at what the
company will be worth a few years out, not necessarily on trailing
earnings.
Brian Selmo: And maybe just to think in terms of our strategy, in an environment
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where there are lets say less absolute bargains to go around, I thi nk
were more comfortable to hold the higher quality businesses at
stretched valuations and are probably going to be quicker to exit
positions that fall under sort of the 3:1 or trade-oriented categories of
the portfolio. And if you watch over time, youll notice that in the
turnover of the names.
Mark Landecker: And, in fact, even if you look at our holdings next quarter once they
come out, so not for Q2, but for Q3 , youll see theres some names
that are going to be out of the book. We wont talk about which ones
yet because some are still being sold.
Steven Romick: Theres a number of questions about asset classes we find fully
valued and a number of questions about high yield bonds and some
of those just merge a number of these questions together. Theres a
number of areas we do find specifically unattractive, and specifically
that would be any area that is most directly impacted by the artificially
low level of interest rates that exist today as a result of quantitative
easing. And so when we look at some of those specific areas, that
would be any of those kinds of businesses, industries or asset classes
that are tied closely to interest rates. So thatd be master limited
partnerships, real estate investment trusts, and then of course high
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yield bonds. So this is not to say that any of these asset classes go
down. All we mean to say is that the yields at which these companies
trade, some of which traded in the case of a number of reasons,
above their NAV, net asset value. Or high yield bonds are going to
trade at very, very tight yields tight spreads rather with a low starting
yield. These are investments that were n ot willing to make. We want
to buy from those people who are foresellers of something, and we
dont want to be in the mi dst of a stampede where people feel the
need to buy because their yield that theyre getting on their fixed
income investments or what they may have had in cash is so low. So
those are the kinds of things that we do truly try and stay away from,
and that just gives you a little bit of a flavor for some of the fully
valuated asset classes. Any other areas or sectors that we find
unattractive that we care to talk about?
Brian Selmo: Unattractive? No, I think that
Steven Romick: And so the question actually came up specifically about high yield
bonds is, what would make it sort of larger allocation high yield
bonds? I mean, when the yields S imply when the yield is higher.
Weve always tended to look at the last couple of decades. Lets get
yields north of 10%. Again, go back to our goal. Equity rates of return
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with less risk in the market. And if we can accomplish that goal with a
bond, we will do it. That doesnt mean we want to buy a bond with a
slightly lower yield, but the lower the yield, the less risk were willing to
assume the further away we get from an equity rate of return. And
so as that point in time, we get aggressively invested in high yield
bonds as we did in late 2008 and early 2009 when yield spreads were
blown out to 20%+. And we were having yields in a number of
investments that were north of 20%, north of 30% for a number of
different bonds that we own. Tha ts not where we are today. We
admittedly sold some of our bonds a little bit early, and a lot of the
bonds we did own were short of maturity and they termed out and we
had the cash delivered to us at that maturity. So what next? We dont
know when next, because right now its not attractive and we cant tell
you exactly when its going to be attractive. We can tell you theres a
trillion dollars in the last three and a half years of new debt issue. We
can tell you that theres a larger amount of tripl e C and non-rated debt
thats eve r been issued in any point in time in history. And that will be
fodder for future opportunity, but its not where we are today. There is
a question I think from one individual who doesnt understand the way
we think about our fixed income set of our portfolio. And the question
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is, is given the long bear market for bonds, please talk about how the
fixed income side of your Fund will be managed where you minimize
the drag that bond losses could incur, and then target profits on both
sides of the portfolio. I dont really know what the latter part means,
so I ll address the first part. Our fixed income portion of our portfolio is
largely a credit-based portfolio. That is to say we assume more credit
risk. That does not mean there is an interest rate risk on the portfolio
at points in time. It does not mean that were not going to go and buy
bonds that mature in 10 or 15 years. We will at points in time. We
just want to make sure were getting paid with the yield to just ify any
credit risk or interest rate risk for that matter. But by and large, what
were doing in our portfolio of fixed income securities is invest in
companies buy bonds of companies that have higher yields. At a
point in time when those high yields are not so high, we end up on the
sidelines. And thats really where the largest portion of our cash
comes from today. Theres a question about...
Brian Selmo: Maybe highlight that, Steve, because we dont really have a bond
portfolio right now. Were 2% i n bonds. And so if you think about the
Fund, the Fund moves dynamically in response to opportunity or lack
of opportunity. So, Mark mentioned there wasnt Tech in the fund 13
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years ago when it was expensive. Right now, we think bonds are
expensive and we find it difficult to see absolute opportunity, so we
dont have them. So rates go up, were not going to have a direct loss
on a bond portfolio because we dont have a bond portfolio.
Steven Romick: That doesnt mean we cant find yield investments, but theyre harder
to come by. We find them in different ways. As the high yield market
was at troughed and we found other op You know, we were
reducing the portfolio, we found other opportunities in subprime home
loans, but that was more of a risk-based asset than a yield-based
asset. But we also made an investment theres a question on this
today about I cant find the specific question at the moment, Ill find it
in a minute but about an investment we made in an Atlanta office
building. It was actually a Florida office building , it wasnt Atlanta. We
actually lent money to complete an office building in South Florida,
and we had hoped to get an 11.8% IRR in the money that we lent to
this building, which was it was a much higher yield than we would
have gotten in high yield bonds at that point or most other any other
that we found at the point in time, fixed interest investment to offer
that kind of asset coverage that this investment did. Well, Im
unhappy to report that that the IRR on that investment was actually
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closer to the mid-teens rather than just sub-12 as we had hoped. And
the reason why we express negatively is that the reason why you end
up with a higher IRR is that we got paid back sooner, so the
commitment fee that we got upfront ends up becoming a larger
portion of our higher IRR. We also didnt get everything drawn down
that we wanted, so we ended up making a higher return on less
capital committed for a shorter period of time. Now theres other
opportunities that come up and were actually in the process of
working with the same partners we worked with on that prior Miami
office building investment to underwrite another building thats being
currently constructed in Florida and that yield will also be a
reasonable yield for us in the low teens really 11%. As our target,
whether it ends up being there or not or higher or lower, we dont
know. So we do find some of these one-offs, but these are not whole
portfolios of fixed income securities to Brians point. And a point in the
future that we will reinvest in there, in bonds when spreads are wide.
High yield bonds are like vacation homes. You go there and visit
when the weathers nice. Well, the weathers not so nice the
weathers not so great right now for us, which means its ac tually
attractive to other people I guess. Theres a question that I love
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FPA CX, but Im worried. The strategy has been superseded by
events, at least for the foreseeable future. I would welcome
comments on any of the following on your upcoming conference calls.
How can absolute value funds flooded with so much liquidity that all
asset prices are inflated? Lets start with that one first, and then Ill
just turn it over to Brian.
Brian Selmo: I mean, I think hearing the tone of the call that we find the world
challenging. But the way we respond to it is by, one, holding cash, so
letting that build up if we dont find bargains. And two, maintaining
positions in stocks, some of which might be a little bit more expensive
than where wed find it attrac tive to buy, but respecting the fact that
there could be a dramatic inflation. And so thats been our approach
to do it. I mean, time will tell how correct that approach has been.
Mark Landecker: You can see theres a number of questions up on the scre en about
bonds, interest rates, the like. I think Steve largely probably address
them. And so if you see treasuries on the holdings, these are very
short- term treasuries, essentially cash substitutes. So were not
taking what we call interest rate or duration risk with those securities.
And even the potential real estate loans Steven mentioned that were
looking at funding, these are all short duration investments, meaning
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under three years and actually maybe possibly under two, such as our
last Miami or Florida investment, if you will. So just to nip it in the bud,
because we see all these questions popping up, we dont have
duration risk in the portfolio. Were not holding bonds of extended
maturities and we dont think were subject to a wood saw effect in the
event that rates kick up on our fixed income portfolio. And thats just
sort of it.
Steven Romick: Theres also some que stions about specific shorts and we dont
answer questions regarding our short book. We may periodically
proffer a view in a pion on a company were short, or in either a naked
basis. Usually not on a naked basis. Usually if its edge against
another long we have in our books. So, just so youre aware for the
future, shorts are a very, very small percentage of the portf olio and its
not something that we comment on.
Brian Selmo: There s a couple of questions on size and sort of flexibility and impact
on the portfolio. I think Id refer everyone to the fourth quarter letter,
first of all, and as a brief overview I thin k we discussed that theres a
very broad mandate for the Fund, so its not just an equity fund, its
not just a debt fund, its not just a U.S. fund, its not just an
international fund. Its really a go anywhere, do everything fund, so
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the very broad markets that we participate in. A nd then next its a
matter of having a broad and deep team. That in part is the three of
us but its also everyone else doing the research and working with us.
And then there are two conditions that we think the size of the fund
might impact us. One is on flows, if we were to get dramatic. In flows,
wed certainly have to consider stopping that. That hasnt been the
case. And then second, our expectation for the future or for the
existing opportunity set, I think whether its due to very low rates,
whether theres concerns about liquidity in government bond buying
programs which theres a handful of questions on. That sort of has
left us thinking that there will be significant opportunities in the future.
You know, I th ink Steves alluded to some charts on volatility. We
think volatility will be much greater, and so we think that it will be
manageable to deploy the capital in a responsible way and in some
attractive absolute opportunities. Thats sort of it on that.
Steven Romick: Just to shift gears because theres actually a question 21. Could you
recommend a recent book you like? I mean, Brian, Mark and I read
different kinds of things. But, go ahead.
Brian Selmo: I have a book. Some on the call may or may not know, weve been
trying to buy ships for a period of time. Theres a book called The
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Shipping Man which I would recommend to everyone to read.
Mark Landecker: Short read, beach read, entertaining.
Brian Selmo: Its a summer read.
Mark Landecker: And its not based on Brian. He does not wear Gucci shoes, he wears
Prada, just for the record.
Steven Romick: Theres a book called Pride of Carthage, which I read earlier this
summer to which I think was actually quite interesting. And it seems
like when you deal with governments, you look at what
governments how they can affect outcomes for economies and
societies, and you looked at what This is about Hannibal
Carthage and you look how the governments, the Carthaginians,
how they handled what would happen in their empire. How, basically,
if they had done things differently, the Mediterranean would look
completely different than it does today. And its just interesting to see
how governments act, and they acted irrationally. Theres a lot of that
in that bo ok as well. So I thought that was interesting. Its not as light
a read as The Shipping Man , but I would recommend that none the
less. Theres a question about Tesco. Lagging in the fund in the
quarter. Do you still believe in its management order to improve its
situation in the managements capability to improve the situation?
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Mark Landecker: So Ill be brief here, because the answer is probably similar to the last
two or three calls. Tescos transforming from what previously believed
themselves to be a growth company to more of a cash flow return
company, return on capital focus. So youve seen theyve exited the
U.S. or at least announced their intention to exit the U.S. They
havent actually extricated themselves from the debacle y et. Theyre
pairing back CapEx forecast which takes them time, because when
you open a new store it goes through a formal planning process with
the local regulatory bodies. Its actually a number of years in the
making. But needless to say, theyre pulling back on n ew store
openings in their home market of the U.K, as well as other markets
such as China. So if we just look at the business in the U.K. and
some of the other nice markets: Thailand, Korea, etc., it a pretty good
business. Were buying Tesco as a whole. Lets call it somewhere
between 10 and 12 times earnings depending if earnings are a little
good or a little bad. Its got about a 4% dividend yield, and
management is incented through the bonus scheme to increase return
on capital, which is why youve seen them do things like exit Japan
and the likes. So, we hope theres more good news on the way as it
related to capital allocation, and from what we can tell, looking at
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customer surveys and the like, theyre improving the shopping
experience in the U.K., which hopefully should flow through to
operating margins as well as same store sales, and a pickup in the
U.K. economy would help as well, at least as it relates to the U.K.
market. So, I think if you go back to our Investor Day, we probably
said Tesco sort of towed the line between a compounder and a 3 to 1
we thought when we bought it. Its now more firmly entrenched in the
3 to 1 camp and its probably where it will stay for the rest of its life
whether we own it or not, which means that were a pr ice sensitive
buyer of Tesco. We dont think its going to grow forever. Were more
price sensitive, but at the current valuation were a happy holder.
Steven Romick: Were a price sensitive buyer for everything. I mean, thats what we
do. Theres a lo t of questio ns that are already here. Were going to
kind of take about ten questions and merge them into one. These
questions about whats happening to margins and have they peaked.
Whats the S&P 500 going to do for the second half of this year?
What s going to happen to the interest rates when are they going to
go up? How much are they going to go up? How is the stock market
going to react when interest rates do go up? The answer to all these
question is, is we dont know. Were in the business of buying
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business, were in the business of buying assets. Were in the
business of buying businesses and assets when they are trading out
of favor. When theres kind of the arbitrage between perception and
reality where we believe that the future is much better than what is
perceived to be today in the present. And so we dont know the
answer to all these questions. I think that realistically that we think
were pretty good at what we do at finding these assets and doing our
work and digging deep on them. And when the market throws up
good pitches and theres strikes and we hope are hopeful to hit them.
And once in a while, admittedly, we miss a strike. Were working on
something and it doesnt get into the portfolio because its gone up too
fast. I mean, its very difficult for us, the way we invest, to invest in a
market where the chart is steeply upper- sloping to the right. Thats
just not a world where we excel never have and never will. Where
we do think we do quite well is buying those assets and buying
businesses where people perceive that theyre going to be challenged
for a longer period than we think, or that they are declining and we
view that with this new management team are going to be better in the
future. Or a business like Tesco where Tesco had some of its market
share taken from them from local competition. Theyve not been the
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greatest allocators of capital in recent years, but that seems to be on
the mend. And so we dont think that the good news that can happen
at Tesco is in the stock. And as Mark likes to say, you know, Good
things can happen in cheap stocks. Theres also another question
about, again, speaking broadly, and what will Obama Care do to the
market? We dont know. I mean, I dont think Obama Care knows
what Obama Care is yet and exactly how it will be implemented.
Theres been a number of head fix along the way in terms of
implementation. Its going to certainly affect some healthcare
companies when it does finally get implemented, and could it in turn
have some impact on the economy? Sure. When exactly that will be,
we dont have any idea. Theres a question about our views on cash
as well as where weve been on cash historically. Let me find that
question.
Mark Hancock: Were down.
Steven Romick: Wer e down. Oh, were down.
Mark Hancock: We would need the 2008.
Steven Romick: What number is this? Well, while we find that question Im going to go
turn to the slide. Turn that slide, Elliott. So, I think this is going to
answer the other question that was out there on cash. And cash, we
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have a very flexible approach to cash. But the headline, actually, the
title of the slide actually makes it sound like we are actually making a
conscious decision about cash . Were not. Were making a
conscious decision about businesses and assets and the prices that
we trade in. And if they are attractive and they provide that margin of
safety, we will buy those businesses. We will buy those assets
regardless of what the backdrop looks like. When the world didn t
look great in 2007 we were nervous. When the world didnt look so
great in 2008 and 2009, we were still nervous. Maybe we were
always nervous, but we were able to take action and invest your
portfolio for you. Its our average liquidity at different p oints of time.
You can see these points of time with that peak liquidity. And the
peak liquidity are returns from those peaks were just less than 6% in
the ensuing two years. But from trough periods we actually where
we pulled liquidity out of the single digits, you actually had the
compounded growth rate for the fund, and the next two years was
mid-teens. So the average liquidity in those returns in the earlier chart
that we showed you going back to the inception of the Fund in June of
1993, the average liquidity has been about 26%. And I wouldnt be
surprised, and Ill put this to Mark and Brian as well, if they have a
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different spin on this. But our liquidity in excess of that today, but over
time I wouldnt be surprised if our average liquidity is lower in the
future than where its actually averaged to start with, but its going to
be in and around its going to go up and down. And one of the
reasons for that is we do have a long return view of what governments
are doing in central banks in developed economies around the world.
Its going to be more like an inflationary than not, and stocks will end
up being better than cash in that event one. Two, this is a product
that is to be run by me alone, and as the team has gotten bigger, as
theyve bui lt the team and then other people who are here around this
table have helped build this team and have become integral to the
process, we have a greater ability to invest more broadly. To own a
few more companies than we did before because we have the skill set
to do it. To invest in industries that werent otherwise invested in, to
invest in asset classes that werent otherwise invested in. So I
wouldnt be surprised in the future that cash isnt averaging less than
it has averaged historically. Brian, Mark?
Brian Selmo: I think I would agree with that. I would say that I would expect the
cash balance to swing around quite a bit. So I would expect there to
be perhaps lower lows and highs probably around the level were at
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now. I think thats all of ou r working assumption. I think I would point
out on the cash side, it just goes kind of for everyone to think about
what were doing, right? Looking at the question, were not predicting
where the 10- year is, were not trying to figure out if high yield i s going
to do great or not next year. Were just saying, hey, if theres nothing
to buy were going to let cash pile up. So we run the risk of under -
performing in a really strong up market. Thats kind of something part
and parcel of what we do. Were very comfortable with. Were also I
think Steves chart shows and were glad to stand on Steves
credibility that, yeah, when we do decide to buy stuff, sort of the track
record of identifying good opportunities and good times to buy things,
its worked out over time and wed expect it to work out over time also.
Steven Romick: Theres a question here, Mark, for you, since youre our on -point
person on WPP, asking here our thoughts on Omnicom and Publicis
and the recent announcement.
Mark Landecker: You know, its probably good for the industry as a whole
Steven Romick: But on the basis of WPP was the question.
Mark Landecker: Yeah, so its probably good for the industry as a whole. For those of
you who dont follow the advertising agencies as closely, theres been
some talk in the market lately about some of the larger customers like
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Proctor and Gamble, for example, pushing the advertising agencies to
basically stent payment and almost acted like a bank in funding their
working capital. So Proctor and Gamble says, hey, instead of taking
45 days to pay you, I want to pay over 90 days, for example, and
youll pay for my median and Ill pay you back. By Omnicom and
Publicis getting together, its definitely gives them more heft in
pushing back against customers like that with WPP can benefit from,
because no doubt, they will be pushing back as well. It, I think, helps
on pricing. Generally, if youve looked at markets that tend to
consolidate with a fewer number of competitors over time, they often
have higher margins than very fragmented markets. Here the number
of large real critical mass agencies is shrinking by one, but if you think
about that as a percentage of the participants the big guys are IPG,
Omnicom, WPP and Publicis, so essentially youre r educing it by 25%
because one out of four is essentially gone. So we think its a benefit
for the industry as a whole. WPP will get to piggyback on them, and
look, there might be some ancillary benefits such as good people who
become available because th ey dont like the fit of the new
Omnicom/Publicis. There could be trying conflicts, which historically
is the management in the industry, but nonetheless, I think Publicis
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and Omnicom represent both Coke and Pepsi, if Im not mistaken.
And thats just an example. Were not saying one of those will go, but
you can take that through the auto industry and any other consumer
facing or business industry.
Brian Selmo: There will be bids.
Mark Landecker: Yeah, therell be opportunities. If nothing else it will probably force
some customers to put some things up for tender, which just gives
WPP a chance to win.
Steven Romick: But also, interestingly, its not just a question of what it means to
WPP, and the question was asked in the context of WPP, and it can
posed in the context of IPG. Brian?
Brian Selmo: I mean, noting that, it probably means its more likely that IPG gets
bought.
Mark Landecker: Exactly.
Brian Selmo: I think that IPGs been thought to be an acquisition candidate for a
while, but this probably increases the odds.
Mark Landecker: And theyll benefit from the same things we just discussed. So,
favorable for the industry as a whole, and we actually think, you know,
well be watching Omnicom and Publicis that much closer as well. It
makes that a potentially interesting name if theres an opportunity,
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perhaps, to get involved there in the future. We already watch them
closely.
Steven Romick: There is a couple questions asked regarding our investment in the
farming partnerships that weve invested in, and why the second Fund
was so much smaller compared to the first investment that we made.
And it was just because our mutual fund was larger and we just re-
upped in the investment to gain more exposure. We have an illiquid
bucket in these funds. We have a number of different illiquid
investments that we make. And when we make a illiquid investment
we have to be conscious about how much of that bucket is filled at a
point in time as were very careful of that with the idea that, if the Fund
were to decline 75%, that these investments could still be a
manageable position to fund. And in the case of the farming, the
farming investment is a longer term investment. And the farming, too,
investment that you questioned about is still in the---the capital
commitment is larger than the position size, as you actually mentioned
in your question, because its still in drawdown mode.
Mark Landecker: So theres 20 questions left10 minutes. Im going to tackle two at
once. Theres a question how Brian and Mark work with the team,
and theres a question about Potash. So, just as an example, Brian
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leads a Tuesday meeting where all the analysts get together. We talk
about what were working on, anybody have ideas, anybody seen
anything interesting, specific company names schematic. At
yesterdays meeting two analysts were both chomping at the bit to
look at Potash after its decline, and theres a question here, Would
you look at Potash? So we will announce formally here, for the
analysts listening to the ca ll, were staging a final death battle
between Sean the Snake Korduner, Chris the Lionheart Lozano to
see who gets to look at Potash. People like to look at it. So yes, well
look at Potash and
Steven Romick: Just to be clear, these are monikers Ive ne ver heard.
Brian Selmo: Mark came up with those on the fly.
Steven Romick: And theyre going to stay here.
Brian Selmo: Lets expand those answers. Theres a handful of questions on
natural resources in emerging markets. Would we invest in them?
Are we interested? Do we have thoughts? Yes, we would invest in
them. On a couple we have thoughts. No, were not going to discuss
them right now. And that kind of addresses
Steven Romick: But we also do invest in emerging markets. We already have. We
have investments in a casino in Malaysia called Genting. And so we
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do, in the portfolio today, do not have a large exposure. I mean,
emerging markets clearly have underperformed more recently, but the
higher quality businesses have not declined to those kinds of prices
that we find attractive. A lot of the companies that are really down
and out are those kinds of companies that are more leveraged and/or
more cyclical.
Mark Landecker: These are 3 to 1s that are out of favor right now, but we dont think as
of yet they offer sufficient return for the risk we take. And as it relates
to the international compounders, theyre not at the right valuation.
But if you look at the portfolio, Elliott, you can go to the slide that has
the geographic revenue breakdown, if you know which one.
Steven Romick: Yeah, its not on this slide. Its not on this one.
Mark Landecker: Yeah, you just go past that.
Steven Romick: Yeah, go back, sorry.
Mark Landecker: So you can see, just as an example, so the portfolio, if you were to
look at the invested portion, roughly half of the revenues will be
derived from outside North America. And you have companies in
there like AB Inbev whose got a big Brazilian portfolio, theyre big in
China, youve got the WPPs of the world, youve got the J&Js of the
world. So we have exposure. We have some direct exposure
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through Genting Malaysia, for example. But were watching this
space closely. We would opportunistically like to increase our
exposure to what the world generally calls faster developing markets
but we want to do it on a price sensitive basis. So we need that
margin of safety. And historically, if you follow the emerging markets
over time, you basically dont have to pay up for growth. Youre going
to get chances every five, seven years to get these companies at the
same type of valuation, the same sort of margin of safety as you get
with classic sort of developed market companies. So were not going
to pay high multiples just because theyre in a country with a fancy
sounding name.
Steven Romick: Theres a question and I think its a really good question, and it
speaks to profits. How much time, roughly, do you spend in face to
face meetings with management groups representing companies you
buy? And I think what wed lik e everybody to take away from our
research process is, we really try and understand the businesses we
invest in, and really try and gaining a realistic sense of that business.
And speaking to the management teams face to face is certainly a key
part of wh at we do, but its not the majority of what we do. To
understand a business is to spend time reading about where that
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industry has been over time, or that business operates within. Where
in the case of farming, reading the book Cadillac Desert: An
Emergence of Grain or with the auto industry reading the book by
David Halberstam called The Reckoning. And so that actually takes
up a lot of time is to get that grounding. And then we, obviously, are
reading all the financials of the companies and reading the financials
and reports of their competitors as well. Im not referring just to Wall
Street reports, by the way, Im talking about industry studies and
looking at a consulting firm study of the Paris-based business, etc.
And so, thats a lot of what we do. And then we also do a lot of work
trying to interview the current employees and/or ex-employees and
talk to the vendors and talk to customers and trying to understand the
business from kind of from the inside out, bottoms-up and top down.
And thats what we try and do. So yes, management teams are very
important to what we do, but its certainly not the most important thing
we do.
Mark Landecker: We spend a lot of time, though, on that respect, interacting with
management teams. Theres a question about would bewere
activists. And well say referring to that, well, theres a portfolio
holding. Its one of our larger nameswe wont say which. We talk to
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the company on a quarterly basis, and its a larger Fortune 500
company. And we said, hey, rates are really low. It would be nothing
but the best thing in the world if you issued 30-year debt. And we sort
of get on that with them every quarter. We might call our friends and
say, Hey, do you mind calling management and say, hey, issue 30 -
year debt. Its the best thing youll ever do. Maybe the next quarter
when we talk to management they say, Hey, we got a lot of calls from
your friends that we should issue 30- year debt. Yeah, its not that bad
of an idea. Were basically going to sell a s much 30-year debt into the
market as itll stomach. So theres subtle
Brian Selmo: And now their 30-year debt is already trading down 15 points. So
were happy to report that they successfully tattooed the bond market.
Mark Landecker: And in other instances weve talked about this on calls last year we
are willing to take a more activist bench when needed. We dont
necessarily seek out these opportunities, but if we stumble upon them
we will
Brian Selmo: Yeah, theres a question, if we dont like whats going on will we be
active? And the answer is yes.
Steven Romick: And we have been most recently. In the first quarter, beginning of the
first quarter, we really became quite active on one of our portfolio
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positions that we were fairly public on. And as a result of, in part, our
efforts and the efforts on the part of our team, you know, Greg
Crouch, was a terrific help in that regard we were able to gain a very
clear view of what an appropriate thing was to recommend to the
company and recommend to the board and then talk to other
shareholders about. And we were very happy in the end that we
accomplished what we set out to do. I think just to highlight what
Mark was saying about speaking to companies, we want to, especially
for these core businesses, the businesses we love, we really want to
understand the businesses and we also really want to help if we can.
And we dont pretend we can manage the business, but we want to
help if we can be of some service. And theres an example of a
company that we used to own that was an automotive dealer that we
owned a number of years ago, that we help to avoid bankruptcy
because we urged them to do certain things with the balance sheet
close to the 11 th hour at the fourth quarter of 2008. And so when we
can offer that counsel and do that, youre not going to get there. Its
just a place where the companies will actually listen to you, and
unless youve actually gained their trust first and shown that youve
done the work to understand their company.
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Steven Romick: We have time for just a couple more questions, and again, theres a
number of questions that are left and were not going to be able to get
to but all the questions stay in the call. But if theres something that
you feel wasnt answered an d you want to make sure that it is
answered, please resend that email to Mark Hancock. Mark, to your
email, or to Elliott. Who does it go to?
Elliott: [email protected].
Mark Hancock: Again, [email protected].
Steven Romick: So send your question repeated, if you wouldnt mind. Send another
follow-up question if you have that, and well make sure that you do
get the answer because our goal is to educate our shareholders. We
think the best educated shareholders are the best kind of
shareholders to have and we view it as our obligation to you to
provide that. Any questions that jump out at you guys?
Mark Landecker: I mean, someone asks you, look, we realize what weve said on this
call, that were not talking up our book, and theres a question,
Whats the better long term investment decision continuing adding
to Crescent now, in the future, or hold more cash? Wait for the
decline and better entry points for additional purchases? So what
weve essentially tried to do is take that decision out of your han ds.
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Were not telling anyone to put more money into the Fund now, but for
those who have, weve got to make that same choice each day when
we wake up. And it just speaks to the fact, again, what we said earlier
in the call, we want the portfolio to try and be robust to any
environment. Not optimized to a particular outcome, but just robust
because the future is an uncertain place. And so were all waking up
and weve got the same problems with our own savings. We actually
are all invested in the Fund o urselves, and so you can imagine its
something were thinking about on a daily basis.
Steven Romick: And I think thats a really great way to wrap it up. We are committed
to this Fund as shareholders as you are, and we thank you for your
time and continued commitment. And we will continue to do what we
have done for the last 20 years, well into the future. Thank you very
much. Mark, Ill turn it over to you.
Mark Hancock: Thanks gentlemen, and thank you our listeners for listening and
participating in our second quarter 2013 Crescent webcast. We invite
you, your colleagues and clients to listen to the playback and view the
slides and read the transcripts from todays webcast that will be
available on our website: fpafunds.com, over the coming week or so.
We urge you to visit the website for additional information on the Fund
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such as complete portfolio holdings, historical returns and after-tax
returns. Following todays webcast you will have the opportunity to
provide feedback. We take it seriously and appreciate any
constructive either positive or negative feedback that you happen to
provide. Please visit our website: fpafunds in the future for future
webcast information. We will post the date and time of the
prospective webcast during the latter part of each quarter, and expect
the calls, as is in the case today, to take place three to four weeks
following each quarter end. We hope that our shareholder letters,
commentaries, these conference calls and special commentaries help
to keep you, our investors and stakeholders, appropriately updated
about the Fund. We want to make sure that you understand that the
views expressed on this call are as of today, July 31, 2013, and are
subject to change based on market and other conditions. These
views may differ from other portfolio managers and analysts of the
firm as a whole and are not intended to be a forecast of future events,
a guarantee of future results, or investment advice. Any mention of
individual securities or sectors should not be construed as a
recommendation to purchase or sell such securities, and any
information provided is not a sufficient basis upon which to make an
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investment decision. The information provided does not constitute or
should not be construed as an offer of solicitation with respect to any
such securities, products, or services discussed. Past performance is
not a guarantee of future results. It should not be assumed that
recommendations made in the future will be profitable or will equal the
performance of the security examples discussed. Any statistics have
been obtained from sources believed to be reliable, but the accuracy
and completeness cannot be guaranteed. You may request a
prospectus directly from our Funds distributor, UMB Distributor
Services, or from our website: fpafunds.com. Please, read it carefully,
and our Contrarian Value Policy statement before investing. FPA
Crescent Fund is offered by UMB Distribution Services, LLC. Again,
thank you for your participation today, and this concludes todays
webcast.
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