FPACX (FPACX) 2021-10-28 Earnings Call Transcript

This transcript is designed to be used alongside the freely available audio recording on this page. Timestamps within the transcript are designed to help you navigate the audio should the corresponding text be unclear. The machine-assisted output provided is partly edited and is designed as a guide.:

00:49 Thanks so much. Good afternoon and thank you for joining us today. We would like to welcome you to FPA Crescent’s Third Quarter Twenty Twenty-One Webcast. My name is Ryan Leggio and I’m a partner here at FPA. The slides, audio and visual replay and transcript of today ‘s webcast will be made available on our website FPA.com in the coming days. Momentarily you will hear from Steven Romick, Brian Selmo and Mark Landecker, the portfolio managers of our Contrarian Value Strategy, which includes the FPA Crescent Fund. Steven has managed the FPA Crescent Fund since its inception in nineteen ninety-three, with Brian and Mark joining Steven as portfolio managers in June of twenty thirteen. 1:31 The team will address performance in more detail during the call, but we include long-term performance here for disclosure purposes. At this time, it is my pleasure to turn the call over to Steven Romick. Steven, over to you.

01:43 Thank you, Ryan. Hope everybody on the call is doing well, and we thought we'd be having this call a year ago, post-COVID, but we're clearly not, but we do hope the best for you and your family. Chris has performed well in twenty twenty-one. Although we appreciate a partial year is not a track record make. Many neither companies hold aren't as expensive as they were earlier this year as one might expect that has caused our net exposure to decline somewhat. We believe that the fund is relatively well positioned only what we believe to be a collection of good to great businesses that trade it not unreasonable prices. 02:21 Underlying businesses that Crescent are on average that any previous point in time that we can recall, which gives us some comfort to run more invested than this historically than the case. Current positioning notwithstanding Crescent operates with a season team, conditions take advantage and diverse asset classes across various regions. 02:43 Crescent maintains unique ability to invest broadly across asset classes in different parts of the capital structure and around the world. Opportunity though comes in a lumpy fashion. There will inevitably be the extended periods when the prospects come less frequently as well as more narrowly. Close to asset classes is high yields by once again, offer high yields and good covenants versus the low yield’s weak covenants today. We look forward to prepared and are preparing for future breadth and we don't know when that might be. Regardless, we will continue to see deploying to discrete opportunities that offer equity to rate of return, that Florida margin is safety, so we might avoid permanent payments of capital. 03:25 Crescent declined twenty-five basis points in Q3 gained about thirty three point five percent for the trailing twelve months. Generating one hundred and seventeen percent of the average of the S&P 500 and MSCI ACWI’s return in the last year, significantly outperforming to fund seventy seven percent average net risk exposure. 03:47 A rotation of value has led to wait for the trailing twelve months, something we haven't seen in quite some time, growth in international live, particularly in our national growth, but still delivered what most people will generally consider respectable performance. Questions delivered better than market rates have return with as I mentioned just a bit more than three quarters of the risk exposure of the market in the portfolio. 04:11 This is a function of the funds, long equity book, strong performance returning forty seven percent in the trailing twelve months. The previous slide reflected Crescent’s long equity performance in the last year, while this slide shows to funds long equity performance over a longer timeframe. Since we've started isolating and tracking the funds’ performance, the performance of the funds long equity book in two thousand and seven It has best the S&P by one and quarter points per year despite sector headwinds over the last decade, to more value centric and foreign- domiciled companies. As the portfolio became more global, tracking performance versus the MSCI ACWI’s became more relevant beginning in twenty eleven. Since then, Crescent’s long equity book as best of the equity by four point six percentage points per annum. 05:05 Despite the S&P 500, can add gain this past quarter, most equity markets worldwide finishing the red. With China being a notable pocket of weakness. As noted in the table of the trailing twelve-month tractors, the fund did not emerge in escape with a performance of its Chinese holdings, mirroring the recent negatively in the press regarding China and large. The top five contributors added twelve percent to the trailing twelve month return around six times the negative two percent for the bottom five to track it. I may turn it over to Mark for a little more color. Mark, do we lose you? We see...

5:55 Yeah.

05:55 Thanks, Steven. So, starting with the top contributors, Elliot, if you want to go back one slide. If you were to characterize back in our commentary from twenty twenty, you would have found that four of the five featured as largest detractors at various points in time, meaning that well they've delivered fantastic performances here, it was a different case over the last twelve months during twenty twenty. 06:24 As suggested by the performance contribution from the group in comparison to the average position size, our patients and willingness to stay the course and suffer through short term volatility was rewarded. 06:36 As for those names and the detractors this time around, As Steven mentioned, China features prominently. As you can see by Alibaba, as well as Nexon, a Korean based Japanese listed video game company with China exposure. That said, if you put it gun to our head, we bet that given compressed valuations and recent headwinds related to our current detractors, each of our single name securities on the list is unlikely to end up as a repeat offender when we speak to you one year for now. 7:09 Elliot? Moving to our equity exposure, if you exclude the roughly three hundred basis points that we hold in SPACs, we remain having exposure well above recent lows, but we've have clearly taken some chips off the table as of late. This reflects a complete exit of several positions, as well as a combination of trims that were only partially offset by new purchases or additions to existing names. We're not making a market call here. But simply responding to the opportunities available to us on a security-by-security basis. 07:44 Elliot, what I think is important to mention is that our compass remains focused on pointing us towards investments that we believe can deliver equity type rates of return over a multiyear holding period. As Steven highlighted earlier on the call, the performance of our equities and the fund overall has been reasonable over the past twelve months and both in absolute and relative basis. 08:08 This performance was accomplished largely from seeds we planted several years back. And if you recall the slide on performance contribution I discussed just two slides ago, the names at the top of the list for contributors were Alphabet and AIG. Coincidently, both names that were originally purchased roughly a decade ago back in twenty eleven. 08:32 Now, we haven't tried to predict what challenges the next decade is going to throw at us. But each day we look at the portfolio and try and ensure we're giving ourselves the fighting chance to deliver equity type rates and return over the coming three to five years, we will also avoiding permanent losses of capital. As it relates to future proof the portfolio, many of the recent additions to the fund rely outside the top twenty are exposed to markets we believe have favorable growth prospects. And we did not surprise us over time, if some of these names make it into the top twenty through appreciation or incremental purchases. That said, we're certainly not looking to turn the core of the portfolio to simply so we can have shiny new names to talk to about. Steven?

09:17 Thanks, Mark. Crescent net risk exposure declined about five points a year ago to seventy-three-point one percent but you'd exploring a three point two percent allocation to add or below trust value spec basket, net risk exposure is down by about eight points to around seventy percent a few points movement and exposure up or down is just noise, but with the continued market strength, it shouldn't be surprise for our long time shareholders that exposure has declined somewhat. Crescent exposure in national stocks remains near its historical high as a percentage of the fund’s equity exposure. About thirty nine percent of the fund’s equities are based outside the United States, which is really closer to forty one percent and forward exclude the more bond life stacked exposure that's in the portfolio. 10:09 Judging a company based on its country of Domicile alone is a bit of a ready and our view the funds global exposure should be considered not only a function of what country in which corporate headquarters might be located, but also from which countries their revenues are sourced. Some revenues, I'm sorry some companies have far more revenues and profits coming from outside their own borders. On a lookthrough basis, almost sixty four percent of Crescent’s portfolio company’s revenues are derived from outside of the United States. 10:44 This chart, it shows that international stocks trade on average at a lower priced of earnings ratio PD than its U.S. spirits. Using the MSCI ACWI’s, Ex-U. S. And S&P 500 for the respective of international and domestic proxies. Since two thousand and one, foreign stocks have traded an average discount of fourteen percent when compared to U. S. Stocks. Today, foreign stocks traded a twenty nine percent discount a twenty-year low. We do not believe that the businesses we own outside of the United States are so substantively different in quality and growth prospects to justify such a wide discount, and that's our significant exposure to foreign Domicile companies. 11:26 Versus the MSCI ACWI’s and S&P 500, the company is holding the fund continued to exhibit better are trailing three year or earnings growth rates and executing analysts suggesting that these companies will have more growth respectively, and yet they still trade you for them benchmarks. The average PD valuation of Crescent’s portfolio companies based on consensus estimates looking forward one year is sixteen point seven times, lower than both MSCI ACWI’s and the S&P 500. The portfolio company treated an average one point eight dollars book value, forty percent and sixty percent cheaper than the ACWI and S&P. Less expensive in our international companies as pointed out the partner slide contributed the fund's lower valuations were compared to the S&P 500. 12:14 Crescent portfolio companies has delivered three-year trailing earning script per share of twenty percent that isn't either the ACWI’s four percent or the S&P seven percent. Now three years forward earnings projected to be higher as well. As we know actual results can vary widely from expectations. Nevertheless, we hope that this is directionally true.

12:36 Brian and Mark and I are going now address questions that have been submitted. Some questions have been answered in our prepared remarks. We won't answer questions if the involve the security, which we are currently transacting or it's on our topic for which we cannot offer an educated or useful view. So, I'm going to turn first two questions where have been pre submitted. And first question was what is the biggest master risk that you see has the country financially across the [Indiscernible]? We are currently in electronic territory. What we put to you what is that not the case? This extended period of low rates, easy money at large fiscal deficits has felt contribute to the inflation we're seeing today. There are other factors as well like a tight labor market, structure supply chain, etcetera. New inflation settles out is really beyond our capabilities. We one takes a longer deal, we continue to feel that there is a larger risk to not being invested, particularly, if one owns as we think we do good quality growing businesses that are not unreasonable priced. 13:42 That is not to say that the market once again correction and test investors conviction. We continue to hold a fair amount of cash to can be put to work at such a time. There a few questions, following a similar way of thinking, so I'm going to address them collectively. Questions are historically obviously, the present market, are there any historical parallels to today's investing environment that you might find particularly useful to consider. Do you see parallels to [Indiscernible] dotcom bubbles and comments on market valuations based on various indicators? 14:15 U. S. Stocks on average are achieved by most historic metrics, but those metrics don't generally factor in the unusually low interest rates that improve valuations today. We have read some real quick today’s environments dotcom bubbles. We don't see it that way. There are more better companies today with many winners take all or winter take most businesses as compared to the plethora businesses with poor business models that existing that debt. However, we believe that some valuations today on the higher side and might difficult to justify over time. 14:48 For more on that topic please refer to the last quarter's webcast where Mark discussions the most expensive ten percent of the market. For our objective, we seek to avoid permanent premise of capital, which leaves an incumbent on us to determine the appropriate price to pay. One can always stay too much even for the best of businesses. 15:07 The NIFTY 50 of the year of seventy serves as a good example. Some of constituents no longer exist or our shadows of their former cells, the name appear, Ray-Ban products, JCPenney, [Indiscernible] which became Kmart, which then became serious simplicity pattern, polar and digital equipment to name a few. Nothing is forever. 15:29 There is a question about our re-hedging positions. We have some very small company specific hedges like VMware versus Dell. Soft-bank workers and Softbank group. We also have an S&P index in the aggregate to three represent just around three percent of NAV. 15:46 There is a question regarding Bank of America our rationale per for having sold it and what seems to be a general widening of the U. S. Bank exposure in the portfolio. Turn that over to Brian.

23:20 With this Mark second birthday present [Indiscernible].

23:23 No I I think this, I think taking a matter.

23:25 Steven I didn’t take any stronger questions, it’s my birthday, please.

23:28 Yeah, you do a number three, So this number two, is, could you please explain your stockholdings and how they figure into your total returns? So very briefly, we own a portfolio of SPACs and for those not familiar prior to a deal announcement a SPAC often trade as a unit, which is a combination of a share and a warrant when you can purchase those units at less than the trust value over the shares you're set up with what we think is a very low downside, really no downside if you don't sell the position and some optionality on the upside. And so, downside production comes from your ability to put the shares back at trust value, which you've paid less than and the option on the upside comes from the potential for the shares to trade to above trust value in the event the deal is consummated or announced and also for the warrants to become active and pick up by five year life typically at a fifteen percent premium to the trust value. And so that means that if you do a basket of these, we would suspect that a diversified group would have a fair number probably the vast majority in our estimation successfully complete a deal. And so kind of think of that then we would at least get the warrants and that probably leads to a positive return that's helpfully above cash and probably has a reasonable chance of outperforming high yield. So we think of these as a better than high yield risk reward, They do show up in the portfolio as equities and so the question and how does it figure in your total returns our total returns will be benefited to the extent there are gains when the companies undergo [Indiscernible]. There was actually, I think in article or a mention of this in the Wall Street journal, two, three weeks ago, although I think a bond manager who sort of mentioned this as a similar thesis sort of saying that they think that this is a more attractive credit risk than say the credit market. That's certainly our view also.

25:45 And it's important just to think of it in frame it just to put it in one set and instead there's in our view, but not a lot of downside, and we have some optionality in the upside.

25:55 I mean the extreme example of this would be unfortunately don't own it, but the trump’s back, had we had that in the basket, it would have resulted in a very big return across the entire basket. So you don't need a ton of winners if you have one or two that are successful out of the SPACs.

26:13 Mark, your questions here, [Indiscernible].

26:23 Sure, sorry, the question is how do you quantify the risk of owning Chinese stocks in an unstable regulatory environment with certain industries like education being entirely wiped out. So, we don't own any companies in the education sector. If you think about the names that we do own with direct exposure, you would be Baidu, it would be Naspers and Prosus a bit of underlying exposure to Tencent and lastly, Alibaba. And then of course, we have other names that have exposure to China, but aren't “Chinese Company”. 27:03 We think it's a pretty low order line remote risk that other industries get wiped out. You could choose not to invest in Russia because once appropriated. If you use that logic think Russia is the best performing market over the past year. We don't have any exposure, but I just think because something happened once it's not a great parallel to draw. The government hasn't shown any signs to date and I think it's unlikely going forward because if you want to inspire a company excuse me a country to have citizens that raise their cost of living or standard of living excuse me, hardworking, build a semiconductor industry, for example, I don't think you get there by showing all the semiconductor engineers that if you pull your life's working into something in an effort to develop interesting technologies for example, and enrich yourself in the process, they could wake up and seize it on a moment’s notice, we'll inspire greatness. 28:05 I think this requires a longer answer, but the short answer is if we think it's pretty unlikely that doesn't seem to be the path. That the country is going down. The satisfaction with the education sector had been well flagged was completely against the common prosperity and had spoken about for some time and it was - I think also a pretty popular move with the public at large. 28:34 I think you might hear people. I mean, I want saw a survey about whether people would switch phones from Apple if to keep WeChat if it wasn't available on your Apple phone anymore and something like ninety percent plus that they would get their Apple phone to be able to keep WeChat. I think the government would be unlikely to completely wipe out various platforms, but we hard to have a real coaching answer on this one.

29:07 The only thing I would add is from a portfolio or risk management perspective, we've talked about whether it's China or Russia or leverage financials or other sort of categories of investments that we've made over the years that certainly have discrete out of left field risks that might result in material impairments to individual positions or groups of positions and we've always sought to manage that exposure on a thoughtful basis from a portfolio perspective such that if the unlikely were to happen, it wouldn't be devastating to the portfolio. Now, we suffer losses certainly, but you kind of can't have any returns unless have some level of risk that you run. And so specifically with regard to China, the conversation we would have had as a group it's we would have settled on sort of an aggregate exposure we're willing to have and we can live with it and we think that it would be unfortunate is the unlikely were to happen, but it's also something that we sort of live to fight another day. So, we sometimes get a question from people. 30:15 Price of company X is down, therefore you must love it that much more. And so I don't you just buy it blindly. And I think idea we have is that there is some things that have idiosyncratic risk that could be catastrophic that sometimes a change in price just reflects an increasing the probability of that risk occurring and all things equal maybe isn't just automatically better at a lower price there are other companies with different balance sheets or with different legal ramifications or structures where you would just be more comfortable averaging down averaging down. And so I think those are attributes that we try to keep in the front of our mind when we're managing the portfolio separate from China specifically.

31:02 I think if you also go back to the transcript from the last conference call, you'll see we talked about China for about forty five minutes or so. So that might give you a more detail looking to our thinking?

31:17 Well, there's one question, there is one last question. That is not portfolio specific, it's broader. And since Ryan versions here, I thought I turn it over to him just to add a quick thought and then maybe to make himself available. If there's a quite additional thoughts as well. Right.

32:21 Sure. You can just reach out to [email protected], our general mailbox, and we'll make sure it gets to the appropriate person. I believe that's the last question correct Elliot. Great.

32:33 And with that, thank you everyone for listening to FPA Crescent’s third quarter twenty twenty one webcast. Of course, if we missed your question, if you have any additional questions, as I mentioned, please do not hesitate to call your relationship representative or email us at [email protected]. We now turn it back over to the system moderator for closing comments and disclosures.

32:56 Thank you for your participation in today's webcast. We invite you your colleagues and shareholders to listen to the playback for this recording and view the presentation slides that will be available on our website within a few days at fpa.com. We are due to visit the website for additional information about the funds such as complete portfolio, holdings, historical returns and after-tax returns. Following today's webcast, you will have the opportunity to provide your feedback and submit any comments or suggestions. We encourage you to complete this portion of the webcast. We know your time is valuable and we do appreciate and review all of your comments. Please visit fpa.com for future webcast information, including replay. We post date and time of upcoming webcast towards the end of each current quarter and webcast are typically held three to four weeks following each quarter end. If you did not receive an invitation by email today's webcast and would like to receive them, please email us at [email protected]. 33:57 We hope that our quarterly commentary webcast and special commentary will continue to continue to keep you appropriately informed on strategies discussed today. We do want to make sure you understand that the views expressed on this call are as of today and are subject to change without notice based on market and other conditions. These views may differ from other portfolio managers and analysts at the firm as a whole and are not intended to be a forecast of future events. A guarantee of future results or investment advice. Past performance is no guarantee nor is it indicative of future results? Any mention of individual securities or sectors should not be constituents as a recommendation to purchase or sell such securities or invest in such sectors. And any information provided is not a sufficient basis upon which to make an investment decision. 34:49 It should not be assumed that future investments will be profitable or will equal the performance of the security or sector examples discussed. Any strategic or market data mentioned during this webcast have been obtained from sources believed to be reliable, but the accuracy and the completeness cannot be guarantees. You should consider each funds investment objectives, risks and charges and expenses carefully before you invest. The prospective details each funds investment objective and policies, risks, charges and other matters of interest to prospective investor. Please read the perspective carefully before investing. The prospectus may be obtained by visiting the website at fpa.com by email at [email protected]. Toll free by calling one eight hundred nine eighty two four three seventy two or by contacting the fund and writings. 35:46 FPA Funds are distributed by UMB Distribution Services LLC. This concludes today's call. Thank you and enjoy the rest of your day.

00:07 Hello, and welcome today’s webcast. My name is Sarah, and I will be your event specialist today. All lines have been placed on mute to prevent any background noise. Please note that today’s webcast is being recorded. During the presentation, we will have a question-and-answer session. [Operator Instructions] It is now my pleasure to turn today’s program over to Ryan Leggio. Ryan, the floor is yours.

5:52 Can you hear me now.

15:58 Sure. So, I think that one year right to observe that we do reduce the bank and financial exposure in the portfolio specifically exited bank comparing from last year this time. We've exited Bank of America. We've exited CIT and we've significantly reduced our position in Signature Bank. 16:18 I think the Each investment in company has a specific story, but the easy way to think about it is that the valuations are very different today than they were when we bought those positions or largely as we held them off and on in various sizes over the last number of years and so depending on which of those companies we're talking about, they would have traded at anywhere around tangible book to fifty or more percent discounts tangible book at the time we bought them. And at the time we've sold them, they will have traded anywhere from a small premium to over two point five times tangible book. And so given that we think tangible book acts is a sort of anchored to wind word or anchor to success depending on where you are in a cycle for a balance sheet intensive financial business, we think it's a pretty relevant metric around which to focus our attention and when the price is less discounted. We're opt to have a smaller position in any given situation.

17:26 Thanks, Brian. Mark, there's a Mark is not in the room with Brian and myself. And so, it's a little bit awkward in the interactions. So, apologies for that. But there's a couple of questions, I think you have in front of you that are there for you to address assuming that you have those written from the pre-submitted side, do you want to address those?

17:48 First. Why don't you go ahead and read them if you've got some hands...?

17:51 how would managers quantify the opportunity available in the stock sale? Is there a large potential number of purchase candidates are more of the opportunities are broad versus domestically? I'm going to add the next question into because there's some overlap. I know the team is not macro driven and you're buying stocks and not markets, but what will it take for the rest of the world to outperform in the U. S, the mantra was rotation of value much less tech us by the U. S. And with check lagging hasn't done the trick.

18:22 Sure. I'll try and answer both those and excuse the rambling in advance. But with respect to quantifying the opportunity available in the stocks we own, I'll draw your attention to the Q2 commentary, which I think Steven also mentioned earlier where we did note it's a rather unique time or were more invested than we have been historically, but we're also quite comfortable with what we owned and our net exposure. 18:44 Now, if you think about the world, what we're really trying to do is just be directionally right, rather than calculating a specific price to value like some of our peers mind. That said, we continue to the favorable view of securities within the portfolio, as I noted earlier, and that covers both a qualitative perspective, meaning we think we own attractive businesses with strong competitive positions as well as with respect to valuation. 19:09 Now, I won't go so far as to say there are a lot of potential purchase candidates. But as noted in the letter, we have continued to be active on the buy side with approximately seven percent of Nav coming from securities we purchased in the past twelve months. And this excludes several names, which we uncharacteristically both purchased and sold within that same period. 19:31 As for names in the Harbor, the teams currently hanging around the [Indiscernible] quite a few companies that have the looks of being actionable addition. While, we need some time yet to determine if we'll be able to rack up a few rebound. Teams are currently researching, include a cross section of ideas both domestically and abroad, but if anything is probably tilted a little bit more domestically at this particular moment. 19:53 As for what it will take for the rest of the world to outperform the U. S. Probably not something we really feel or in a position to opine on. But I will personally note that the same meaning Facebook, Amazon, Apple, Netflix, Google, Microsoft account for about twenty five percent of the S&P 500 and as such play a large role in driving S&P performance. But as we've seen this quarter from the constituents that have already reported in Q3 several which we own, the underlying businesses continue to go from strength to strength. Stepping back, as it relates to our particular portfolio, our aspiration is over the next three to five years, we can search the globe and assemble a portfolio securities that gives us a fighting chance of delivering equity type rates of return regardless of whether it is growth, value, domestic or international that's leading the pack. Steven or Brian?

20:54 Thanks, Mark, and happy birthday. And so as a present for birthday, I'll take the first question on the board, which is what are your thoughts on broad man saturation at Comcast and Charter. I see you smiling, okay. 21:13 I think a couple of things. One we don't have the definitive view of what will happen with broadband penetration. It's clearly nearing the end of sort of the easy gains from either taking from DSL or people signing up for the service. So new subscribers, I think will certainly be less over the next five years than they were over the last five years. That's just probably mathematical certainty. The companies in question, have I think in our view, a reasonable prospect of continuing to grow at a rate that would make them attractive investments at their current valuations and I think those sources of growth in varying degrees will come from some level of population growth. So, they'll expand their physical plant on the back of that. There'll be some growth I would think on their commercial or small business and certainly wireless is area where they've seen pretty successful efforts to date. I think on top of that there would be a whole for expectation that slowing footprint or news customer base would allow the businesses to improve margins over time as it's somewhat less expensive to serve an existing customer base that appears to be exhibiting lower term than it is to sign up in service new customers and so with a combination of those things, we think that they have reasonable chance of successful business operations and results in a period when certainly new subscribers will be slower. And the other thing, I would add, which is always important to us is that the price you pay and where they're valued, I think doesn't demand that they can grow top line, it's say ten percent a year or anything like that prospectively. That would be my take on that question. 23:18 The second question, I think I will also take...

31:33 Sure. Thanks, David. The question is, what's your view on some mutual funds turning in ETFs? We've noticed that as well, I think on a weekly basis, we see news. I think you'll notice that most of the funds that are doing that are primarily equity funds and all I can say is we've evaluated that option for Crescent, but in short, given the capabilities of the portfolio in terms of asset classes and what the fund owns now, we don't believe it's currently a viable option. Any shareholder who would like to learn more about our thoughts and research into the ETFs space is welcome to reach out to our relationship management team or me personally.

32:19 And you want to give me mail for that?