2013 Q3 FPA Crescent Conference Call

Mark H:

We appreciate you joining us today for our FPA Crescent Funds 2013 3rd quarter webcast. With the appropriate consents both the audio, transcript and visual aspects of todays call will be available on our website, fpafunds.com over the next week. Momentarily well hear from Steven Romick, Brian Selmo, 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 1993, with Brian and Mark joining Steven as portfolio managers in June of this year. Its our goal during these calls to give you, our stakeholders, a clear understanding of our current views as the team discusses the portfolio, the market, and the economy. Joining Steven, Mark, and Brian today from the Contrarian Team are Andrew August, Greg Crouch, Sean Korduner, Chris Lozano, Greg Nathan, and Ravi Mehra. Its my pleasure now to hand it over to Steven, as he begins todays webcast.

Steven:

Thank you, and we do apologize for the technical difficulties that were having. I told Mark Landecker we shouldnt use a Microsoft product to facilitate this call, but you might want to get into that with him in the question-and-answer.

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The philosophy remains the same. As always our goal is to provide equity rates of return with less risk in the stock market while avoiding permanent impairment to capital. And as most of you know, we do this by investing across the capital structure in different asset classes and around the world. The Fund has continued to do well per its charter. And performance as of September 30 looking back all the way back to our inception and all of the periods between, Crescent has performed to expectation in both bull and bear markets. The Investment Team has remained unchanged since the prior quarter. And its been nice, as I mentioned the last quarter, to have Brian and Mark really elevated to a role that they were already fulfilling anyway. And if you look at the winners and losers for the quarter, this is something that we put out there for your own edification. But quarter-toquarter, year-to-year kind of this is just a bunch of noise. Nothings out of the ordinary that really drove the portfolio either up or down for the period. The positions that one position in the list of winners has been eliminated, Omnicare. Other than theres been no substantive changes. The Crescent Portfolio characteristics as one would expect given our shareholders letters, as weve mentioned, theres been more

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opportunity in larger caps larger cap companies, which are somewhat less expensive than small caps. And that explains the higher market capitalization. And our continued focus on high-quality larger companies also shows up in the debt-to-capital that actually shows up as negative because many of our companies have a tremendous amount of cash on their books. Albeit some of these U.S. companies have it overseas and, in order to bring it back to the U.S., would have to repatriate it and pay taxes. And if you also will look at the valuations in our portfolio, this portfolio on a P/E basis is slightly more expensive than its historic average. And on a price-to-book basis, its about at its average. Our Crescent allocations at the end of the quarter you can see that our total market exposure net market exposure is about 54%, which is actually down from 66% at the end of last year, at the end of 2012. And its gone down by quarter. With the stock market up around 25% since the end of last year, this shouldnt be any great surprise to anyone. The return of the market has largely been driven bynot just in the U.S., but overseas as wellby market P/E expansion so by P/E multiple expansion. So the light blue portion of this bar chart that you see is the amount of the return that comes from multiple expansions. As you can see, in most cases it is by far and away the largest percentage of the

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return. And that of course leads to the fact that the historic P/Es that you see here on a trailing basis are slightly higher than the market averages have been since various points in time. And we show those various points in time here. And theres no mistaking the fact that this large P/E is to a very a large degree a function of the very low U.S. Treasury that we see today. And with that, were just going to go dive right into the questions, and Im going to start with And please feel free to email your questions in as we begin to answer these. But at this point in time we have some questions in front of us, and were going to talk well speak to those. Theres a question that asks how we view the valuation of the equity market in light of CAPE, the cyclically adjusted P/E that is known as the Shiller Methodology. And thats the P/E that we just showed you, which is that current price divided by trailing 10-year earnings. So in light of CAPE, what other considerations do you believe are reflected for future equity markets valuation? We showed this CAPE methodology merely to show one popular view of the world. We do not use it, or any broad metric for that matter, to buy or sell stocks. An individual asset thats fully valued, an euphism for

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overvalued. By fully valued, we mean lacking a margin of safety. If we feel something is overvalued, were going to tell you so. Theres some questions about what would alter our about the Fed and our views of the Fed, and what would alter our negative opinions of the Fed and what would make us admit that we were wrong. Or if we were correct, what things need to change that would offer up more opportunities? And so the ramification of Fed action may not be realized for many yearsor not. I realize that our negative view of the Fed comes off as an indictment, but I also dont offer up our services recognizing that we may not be much better. Its really easy to throw stones not living in a glass house. But we do point out that the Federal Reserve has not exactly terribly accurate in its projections. In 2006 they posted house prices would probably continue to rise. In 2007 they told us they wouldnt expect spillovers from the subprime market to the rest of the economy or into the financial system. In 2008 they told us that Fannie and Freddie were adequately capitalized and in no danger of failing, and that the Federal Reserve is not currently forecasting a recession. In 2009 they told us the Fed would not monetize the debt, and in 2012, giving us great comfort,

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they told us that central bankers around the world have been in the process of learning by doing. Now all that said, what theyre doing today may end up working out quite fine. However we just dont know. We dont know if were right or wrong. And we have not positioned our portfolio one way or the other. We just know that somethings being tried that has never been tried before. Trillions of dollars have been committed in a hope, in a phrase Ive used before, to alchemize an academic argument into reality. And we think we are appropriately positioned to benefit under a range of outcomes. But under some of those outcomes we will certainly lag; in other of those outcomes well likely outperform. Theres another question that when might you limit the size of your Fund? And weve talked about this ad nauseum, and we actually wrote about this in 2012s fourth quarter letter. And we will limit the size of the Fund when we feel we cant execute on our stated goal, as mentioned at the outset of this call. And we would urge you to go back and read that fourth quarter letter to get more details on the subject. Theres a question that was posed as to whether or not we believe theres a risk of high inflation doesnt justify some of our cash and long Treasuries. How can we have higher inflation in such a leveraged world

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trying to de-leverage? So the benefit of high inflation, such as it is, will show up in stock returns. Our portfolio is bar-belled at this point. Our cash flow, you know the cash from one side of the stocks and the other. Our cash will suffer at high inflation, but stocks may not do too well either. That will really depend on how much cost can we share with customers in the form of price increases. On the other hand, deflation will clearly be a poor outcome for stock valuations. And deleveraging certainly keeps inflation in check. But we can get inflation other ways as well. We certainly have inflation out there in the world today. Now headline food prices increased in India 26%. If you look over the last decade, youve had incomes up 26% in the U.S. You have healthcare and education and gas up about double over that timeframe and still growing at rates faster than the posted rate of inflation. So we can get inflation, as I said, in other ways, and decline of fee occurrences would be one example. Theres some questions Ill start passing around to Brian and Mark. Where are the managers finding value in terms of market cap sectors and according to any other factors and metrics? Additionally for assets not invested in equities, is this simply being left and cash value being found among types of bonds? So, Brian?

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Brian:

So thanks, Steve. So let me try to take this question broadly. Sorry. Let me try to take this question broadly and address what were doing on a day-to-day and week-by-week basis on the Research Team. So theres really two parallel processes that are going on at any point in time in the research effort. One is were seeking to identify a nd maintain good and great businessesbusinesses that we aspire to own just at a different price or maybe at a given price. And so you can think about this as ongoing maintenance work where were trying to stay close to these companies, were trying to understand the industries, and were trying to have asked and answered the important questions about their competitive situation prior to the businesses necessarily being available at the price at which wed want to pay. In this regard were a little bit like Wayne Gretzky. Were trying to skate to where the puck might be rather than where it is right now. And this is going on continuously. Everyone on the team has different companies and industries they follow that would be considered good, great, or, our word, compounders. In addition were looking at what we call live commercial opportunities. These are situations that are just cheap for what they are or cheap for some type of reason, and currently an interesting investment.

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So this could be an industry thats out of favor. This could be a company thats missed earnings. This could be a restructuring. This could be something that shows up on a screen at a low price-to-earnings or other traditional value metric. And these are situations where we seek to understand the opportunity, understand the investment merit, and make a decision on the asset in the relatively near-term period. So what I would say in terms of where were finding value Sorry. Those two parallel processes is what were doing in terms of the work were doing on a dayto-day week-to-week basis. In terms of where were finding value, were really not finding much that makes a lot of sense to us on an absolute basis right now. We have been spending time on emerging markets, and weve been spending time on some base metal companies. Those have both fallen into the category of live commercial opportunities. They wouldnt be the good to great businesses that maybe we aspire to own. In terms of the second part of the question, in terms of having money not invested in equities, yes, it is largely in cash, and no were not finding anything to do in bonds. Mark, you want to

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Steven:

Another question. Sorry. Are you looking overseas for investment opportunities? And I will hand it over to Mark Landecker.

Mark L:

Sure. So weve been looking overseas for a number of years. If you were to look at the current portfolio, I think that reflects some of the fruits of our labor. So for example, youve got Unilever and Henkel, both of which are Dutch-based companies. They both operate in the fast-moving consumer goods space, and then Henkel also has a side of the business that competes in adhesives. We own Groupe Bruxelle Lambert, which is a French holding company weve talked about at our Investor Day. In Britain we hold WPP, the worlds largest ad agency, and again profiled it at the Investor Day; Tesco, a name we have talked about in the past, the leading U.K. retailer; Vodafone, leading mobile operator in Europe; and the recently re-domiciled Aon, which is British as well. We own Genting Malaysia, a casino operator we talked about several years ago, which is obviously Malaysian. Orkla, a Norwegian holding company with a base in the fast-moving consumer goods, weve talked about on prior calls. Furthermore if you were to look at our other category where the names arent disclosed, we own a Swiss industrial company, an Israeli tech company, and then another Norwegian company.

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And I will also add: if you were to look at the portfolio this time last year, you wouldve seen a couple Japanese names that have since been sold in the rally there. And lastly we also own Canadian Natural. But as someone who grew up in Canada, Ill say that the name doesnt really count, as many Canadians think of Canada as the 53rd state, as embodied by the fact that Brian used a Wayne Gretzky hockey reference earlier in the call. Brian: Steven?: Mark L: Steven: But Wayne Gretzky played for the L.A. Kings. And most Americans are aware that we have 50 states, thank you. Im a resident, not a citizen, for the record. Okay, we are we think were good investors, as some of us have failed geography. Mark L: Steven: Im the international guy. In our judgment, how difficult will it be to unwind the QE balances? What needs to go right, and what could reasonably go wrong? Well, we are so far from being experts, Im afraid our opinion is of little value. Besides the Fed has to taper first before they can unwind. And that means $85 billion a month in purchases of bonds has to go down eventually to zero, and then the unwind can be discussed.

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In what ways might your bond debt and/or equity strategies change in a rising rate environment in order to avoid rate drag on performance? Brian? Brian: So I would say were not specifically editing a portfolio to avoid rate drag or any other particular issue like that. And in terms of the way the portfolio would change, its always going to change in response to opportunities. And so if spread became very wide and that was driven by interest rates going up, we would be participating. We would expect to participate in the high yield and distress market. If certain types of investment on the equity side that were that were sensitive to rates were penalized and were available at cheap absolute prices in response to rates rising, wed expect to buy into those types of assets and businesses. Theres nothing were doing specifically to set ourselves up to benefit from increasing rates right now, but clearly we would expect our equity portfolio to do well if rates were driven by inflation. And to the extent the overall world is penalized by increased rates, we would expect to be able to redeploy cash in a number of different types of assets at lower or more attractive prices. Steven: Why dont you do the next question, Brian?

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Brian:

Next question is: what are your annualized goals for the Fund as return over the inflation rate? We dont have a specific goal in terms of the Fund versus inflation. And I think much like other things in investment, it just depends. And so it depends on what the rate of inflation is. If the rate of inflation Sorry, we should go back to the first principles. The goal of the Fund is equity-like returns with less risk than the equity market. So on the long-term basisthink about this as rolling five-year periodswere looking to keep up with the S&P 500. Now in some environments thats going to be 1,000, 1,500 basis points better than inflation, and in other environments thats going to be maybe a couple hundred basis points better than inflation. So its really going to depend on whats going on in the world and what the rate of inflation is in terms of how we would hope to perform relative to

Steven:

Do you have plans for a more activist role in your common stock investment? When opportunities present themselves, we expect to be constructive in our conversations with management. Weve had some success. In the first quarter we were instrumental in the removal of the chairman of a Fortune 500 company in an oil business based in Los Angeles names Occidental Petroleum. Given our larger size today,

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managements have generally been more willing to entertain a conversation with us. Although we are a 13G filer, we now have the ability to convert to a 13D filing, which allows us more latitude in our discussions with management and/or other shareholders. What to add to that? Brian: So I would say that this is something in terms of an active role, the word wed like to use is constructivist. And I think that its one of the big advantages of size is that we would hope to be large or anchor-type shareholders in a number of good businesses over time where we have an ongoing constructive dialog with those companies, and were maybe assisting or encouraging them on capital allocation and maybe M&A activities. And so this is something that we do expect to be involved in over time. Our goal is probably not to be on the front page of the paper and known as rabble-rousers. Steven: So how does foreign policy matters and the war drums beating across the Middle East affect the Fund? Would the Fund be significantly affected if Americas pulled into another war in the near future? Now war is bad, theres no question. But our views as to what may or ma y not happen do not impact the Fund. Our views with respect to what might occur in the Middle East any way.

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However if war comes and brings fear with it and that in turn causes asset prices to decline to levels that create the potential for us all to risk-adjusted return, then you can expect us to be buyers. But were not in the business to try to prognosticate whats going to happen. Theres been lots of wars in the past, and I would unfortunately hazard a guess theres going to be some strife in our future. Theres a question that related to George Michaelis, our former chairman of the firm. Starting with George Michaelis in 1986, FPA Fund managers have a history of being courageous enough to refrain from buying into bubbles even if they look bad for awhile. If the stock market gets into bubble territory, would you be willing to decrease Crescents allocation to common stocks? Well, first, were bottoms-up investors. Our exposures to stocks decline when we dont find value and when cash increases as a byproduct. The stock market can be in bubble territory, but individual stocks can be inexpensive. Take the internet bubble of the late 1990s for example. Indices appeared pricey. P/Es looked quite high when we were looking the Russell Indices or the S&P 500. But the stock market itself had numerous inexpensive small or medium size companies. So we want to

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not confuse the idea of a stock market index with a market of stocks. And so you can have a disconnect between the two. So going back to the I think the ethos of your question is the idea that are we going to be willing to take a stand and not be fully invested? If we dont see a Fund opportunity, then the answer to that question is yes. And weve exhibited that before in this Fund, and I think to some degree were exhibiting it now, with cash reaching 40%. Lets turn to some questions that have come in here since the call started. I think Ill turn this over to Mark. Whats so great about Microsoft other than the fact that they cant buy Nokia twice? Tell us about the opportunities that youre finding and where. Mark L: Ill take the Microsoft part. And if youve been a participant on prior calls, weve probably always said: its not that theres anything particularly great about Microsoft. Its just that good things happen in cheap stocks, and it was a cheap stock. Weve gone on in length on prior calls about sort of what we think would go right for Microsoft with respect to their corporate opportunity, the R&D spend perhaps harvesting some new developments. But at the end its a cheap stock. We always viewed Steve Ballmer rather negatively. Its a potential positive depending who gets added as a CEO . But were not sure who that is yet, so lets not speculate.

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And Ill turn it over to Brian about the opportunities youre finding because thats a much more difficult question to answer. Brian: I thought I had previously dodged that question in the prepared remarks. In terms of opportunities were findingthis is number 6 The question is: overall is there a small pockets where you are finding value? In general is more value available in the U.S. or abroad, and are any sectors more or less attractive than others? Theres a specific question about large cap tech versus financials in there. So its a long question. In terms of finding value, I think both in terms of my comments earlier and the portfolio having a large cash component, the answer to this is were just really not finding a lot to do. We look at things that show up on 52-week lows in terms wide commercial opportunities. We look at industries that are depressed. We just really havent been finding a lot of things that make sense or that offer a material margin of safety. So I wouldnt call out any sectors as being particularly attractive. We do have a have done a number of large cap well capitalized tech companies, and we continue to hold those. But I wouldnt necessarily say that theres screaming opportunities. So next. Steven: How do you explain the multiple expansion in U.S. markets this year where the focus is liquidity-driven market? Look, I mean, rates are really

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low, and we all know that. We all know people are struggling to live off a fixed income, who are being pushed into stocks they feel because they need to get a return. And I think that the lack of other places to go has just brought money into the market. It has brought money to all risk assets. You can speak to obviously things go to go beyond the stock market, and look what its done to multifamily housing and other types of investments in real estate that you see in this country. So I think that thats the largest explanation for it: the money has to find a home. Theres a question about I agree the academic arguments are not reality, so is it even worth listening to the Federal Reserve anymore? I mean, Ill leave that to you to judge. Is our thesis for CNQ, Canadian Natural Resources, reliant on the Keystone XL approval? For those of you not aware, that is the pipeline that is seeking approval to bring heavy crude down from Canada and into refineries in the U.S. in locations other than the area just below the border, which are those refineries are operating at tremendously high capacity utilizations. Theyre extracting their pound of flesh from the heavy crude companies. W ell, see, our thesis does not rely on getting that Sorry, the questions are moving around on me. Our thesis does not rely on

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Keystone XL approval. And in fact for any of our investments our investments rarely hinge on just one thing happening right. That generally places too great a risk on a company on any given investment. In fact when we look at oil companies in general, wed like to be right predicated on potentials other than having an increase in price. So we tend to look at our oil companies, when we do own them, and say, look, if oil is $60, $70 a barrel, can we still make money over the next few years although maybe not over a three-month, six-month, or even oneor two-year timeframe. Brian: We also dont plan to look at oil companies as often as we have in the past, which we talked about on a prior call. Steven: Thats fair. Thats fair. So we actually have no idea if the pipeline will get approved, and our thesis does not hinge on that. Question number two was answered already, wasnt it? Brian: Steven: Yes. Okay. Would the Fund consider arbitrage positions and it actually mentions a company name. Were not in that business. Brian: But, yes, would we do an arbitrage position? Sure. I mean, I think Id call out things where were long one stock and short another as arbitrage-like positions.

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Steven: Brian: Steven: Brian:

Right. Were talking about merger or Yeah, we wouldnt Anythings possible. We havent done The truth is spreads and merger arb have become a: how good is your relationship with a prime and whats your borrowing rate. Its not a business for an equity buyer the way it was 20, 30, 40 years ago. So its

Steven:

It also depends on some other variables as well. Just a company and maybe a company we wouldnt mind owning if the deal broke down and we could sure buy more.

Brian: Steven:

Yeah, sure. So I spoke a little too flippantly in that regard. There are different kinds of arbitrages. I was referring to merger arb in the context of the company mentioned. Do we want to mention another company, #3? Does somebody want to talk about it? So just be aware theres some companies that get mentioned that we dont always choose to discuss publicly because we may be either increasing or decreasing a position. So were not going to mention that.

Mark L:

Is any of the questionIll just jump inabout names that have been sold? Steve, you can probably list off some of the names that have been

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sold. I can Brian and I will try first. We dont have a ready list, but someones asked for whats been sold this year Steven: Brian: We mentioned Omnicare. We sold Health Net, we sold Lowes, we sold Xerox, and we sold ITT. We sold Travelers. We sold Ensco. Oh sorry, I may not be close enough to the mic. I may be missing one. I dont know. Mark L: Brian: Steven: Brian: Xerox you said? I think I said Xerox. Those are largely so question 1 All told, 11 positions I think in the year-to-date period. I always enjoy hearing books youre reading. Whats on the current list? P.S. Im enjoying the Shipping Man so far. Im glad to hear it. Im living parts of that book, so Im glad you enjoy it. But it doesnt require me to go to Europe, so Im fine. Theres a new book out called The Floating City, which is about the underground economy in Manhattan, which is probably interesting, that I havent read yet, but I got it yesterday, and Im looking forward to it. So thats all Ive got. Mark or Steve? Steven: Unfortunately the one book I was reading will give little interest to anybody other than if youre looking at the one company that weve recently been accumulating because it is long and dry. And were not going to talk about that company right now.

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Mark L:

Ill just jump in. Theres a question on emerging markets. Are you finding opportunities? This was asked in the last question as well sorry, last conference call. We sort of know the higher quality companies we want to own in emerging markets. They havent entered the value range. So despite emerging markets coming off, weve not been doing anything there. But we do work on emerging markets. So as an example, Brian and I were going to take a trip to Brazil a few weeks ago, probably started planning it about a month ago. And as we requested meetings to meet with management teams whom we liked, we werent having much luck. And so I happened to ask the broker, and they said, oh, all the CEOs and CFOs are in New York for a conference that week. So Brian and I went to a conference in New York. We met about 18 companies, for the most part CEOs, CFOs. It was a productive week, but nothing came out of it because we just generally dont view the names as being cheap enough. But rest assured if theres an emerging market where think values are emerging, we will hop on a plane if need be, or obviously do the work from a distance. But what we need to get done to get comfortable, we ll do. We would hope to put money to work.

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Steven:

Theres a question that is: how do you work, if at all, with certain other more engaged investors and companies that we own? So there might very public investors in some of the companies we own. Referencing Microsoft for example, theres one firm that makes an excellent presentation and clearly more engaged with management than we are with respect to that company. With respect to this one, wither its Microsoft or any other company, there are times we speak to the other shareholders. Sometimes we seek them out; sometimes they seek us out. It depends on what we or they are trying to accomplish.

Brian:

Yeah, I think Steve hit it right. I mean, sometimes wed be actively engaged with other shareholders; sometimes we wouldnt talk to them at all. It really depends on the situation.

Steven: Mark L:

Mark, if you Yeah, I mean theres one company for example that we wanted to issue 30-year debt at an opportunistic interest rate within the past 12 months. And they were probably open to the idea, but they werent quite sure how everyone would feelthere shareholder base and constituentsissuing debt. And so we sort of got on the phone and called their friends. And they issued as much debt, they told us, as the market could handle. And

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they said we heard from all your friends, and that helped us along. So Im not going to call that activistjust supportive, if you will. Theres a question here Ill just take since Im talking about GBL. Groupe Bruxelle Lambert lost one of its cofounders, Mr. Desmarais, Sr. Does it affect your views of the future of the company? Ill say not significantly. Brian and I had a conference call with the current CEO of the company, whos the son-in-law of Albert Frere, whos the founder of the other side of GBL, and it was actually a very productive call. We talked to him GBL owns some assets that we sort of think are crummy, and he sort of echoed our opinion. He thought they were not as great assets as well, and he was extricating himself from these assets. And then we said, hey, you bought this one asset that we think is pretty incredible, sort of expensive though, but great asset. He said, I agree; I think its an iconic asset. Its fantastic; its going to look cheap in a few years. We asked him some more questions, and he said, you know what? No ones ever asked me these questions. Yeah, youre right how youre reading the situation. So we think how we read the situation is broadly accurate. Were constructive on the name. Were constructive on the current management team. And we could see it as a potential shareholding for many years. We

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get a dividend yield. Theyre owning high-quality and higher quality companies going forward. Brian, you were going to say something? Brian: We think but I was going to say, based on our conversation, were optimistic that the portfolio decisions will be much to our liking over the next five years at GBL. Were optimistic. We dont know for sure, but were optimistic. Steven: Brian: Well, we never know for sure of any of the positions we own. I mean, we just to put it they have one holding still which we dont love. And we sort of said it. He said, yeah, I dont love it either, okay? I dont want to put him in an awkward spot, but yeah so it was Steven: Brian: Mark L: Steven: I can imagine getting a lot of phone calls, so which company is that? We are not mentioning it. Yeah. How does our investment strategy differ from Berkshire Hathaway? Well, lets just start with the fact that Mr. Buffett has the benefit of permanent capital, and so hes got a tool chest that allows him to do other things that we arent able to do. Hes also investing a lot more capital. But at its Mr. Buffett is obviously the worlds best known value investor. We consider ourselves a value investor. And theres subtleties that describe the differences between the two of us certainly, but

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Mark L:

I dont think wed ever compare ourselves to Warren Buffett for a variety of reasons, meaning directly. But the one thing where I think we could say were similar is were opportunistic, and weve got a wide open canvas on which to paint. So if you look at Warren Buffetts career, at times hes done private companies. Hes done public companies. Hes done preferred shares. So even right now I dont know if Steve wants to talk about it, but were, okay

Steven: Mark L: Steven:

Im going to on the real estate? Yeah, so go ahead. Yeah, no, so the advantage of permanent capital is you can do some things that you wouldnt otherwise be able to do, which, as Mark mentioned, private companies. As an example, we do have the ability inside of our Fund to inside of Crescent to be able to accept some illiquidity. And there are a few examples weve discussed in the past, and theres a couple more examples today. One that Id be willing to discuss right now is weve partnered with a group to invest in first lien loans in real estate, some of which are construction, some of which are just buildings that have been built that are in the process of being leased out. And theyve got some kind of issue surrounding them in one form or another.

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Its a fairly significant pipeline, one where we can actually put some capital to work in Crescent. Weve made a couple recent investments in here just last week. They dont show up in quarter-end. They are showing up they will show up at the end of the fourth quarter. But these are investments that we expect to get a yield with great collateral someplace in the low teens what we think was very low risk and not terribly correlated with the rest of our portfolio. Do you think I should include anything else in the topic, guys? Mark L: I think Brian just closed a shipping deal. Oh, its not closed? Shaking your head? No we spent time on the shipping industry. Weve mentioned it I think in prior calls. We closed a small private deal there last week. Brian: Sorry. To bring it back to the question, how are we different than Berkshire, I think (1) Berkshire is an operating company. It is really not an investment portfolio at this point. (2) Buffetts smarter than probably all of us in the room combined. But (3) hes also older, so I dont know that wed switch seats. In terms of how Well, I dont want to be 80 -something. Anyone raising their hand? Okay. Sorry. Steve: Brian: Elliott can take that out. But one thing that we do thats a little bit different than other public mutual funds, though, which I think Steve was getting at, is that we do make

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some private investments, whether these are outright in businessesso recently weve funded a container shipping venture, which can be thought of as a traditional private equity type of investmentor direct loans, which Steve was talking about. Now these are necessarily going to always be a small portion of the Crescent portfolio, but it is something thats a little bit different from other public funds. Mark L: And its something that its an opportunity that wouldnt exist if we didnt have some girth in order to facilitate these transactions. We have partners in this who are looking for a certain amount of capital. And if we didnt have the capital that we have today, we wouldnt be able to participate. Brian?: And I think, though, if you look at Berkshire, what hes done a g reat job with is hes going hes done historically hes gone where the value has been. So I remember back in 2005 at the shareholders meeting, he put up a slide of high yield bonds that he was able to purchase three or four years prior to that. And I think it was a letter from Oaktree, Howard Marks, where he highlighted the yields that were available at the time. He maybe didnt buy all those exact bonds, but he said, look, this is where the value was a few years ago. He said, right now Im not finding anything, so Im not buying any bonds there. Its not wildly dissimilar to how weve gone in and out of various sectors such as high yield, maybe small caps in the

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past, so on and so forth. And so wed say thats probably how were most similar to Berkshire. Unfortunately Mark L: Male: Steven: Operating with an unfettered mandate. Fair. Theres a question about overlap with one other fund that is managed by FPA. Im going to answer this question more broadly than with respect to one fund. The question specifically is: is there any overlap with fund, which this person also owns. I mean, we have there is some overlap in some form in various funds in the firm. But its important to know that what overlap there is there may be in some cases; its very, very minor. And its also important to know that we are very close colleagues with the individuals in our firm. However, our research that we do conduct within the Contrarian Team is our own, and we hold our own counsel as we invest in our companies. Do you guys want to add to that? Brian: I mean, just for full transparency, we dont see each other as portfolios until you see the portfolio similarly. So if we wanted to see what Dennis Bryan was owning in SMAV or any of the other funds, wed go on the website and wed pull up the holdings, and thats how we see them. So there could be times where we own the same names; there may not be

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Mark L:

The research teams are distinct groups within the firmindependent, serving

Steven:

Unlike a Fidelity, which pulls from a research pool, we actually operate with self-contained teams of analysts and portfolio managers. To that end, one of the individuals on our team, Greg Nathan, is the architect of a couple of names in the healthcare space for us our successful Omnicare investment that we have liquidated at 2X as well as our investments in pharmacy companies, both CVS and Walgreens. Theres a question here with respect to CVS, which is a la rge equity holder in our Fund. Could tell us why us why you like the name given the many unknowns in the industry? And I think that theres unknowns in every industry. With respect to the pharmacy business, CVS owns a pharmacy benefit management business. And were not as enamored with that business. Its actually a high return capital business and has done well. But we actually hedged part of that exposure out by shorting another company out in that space. So we just wanted to be long. The pharmacy business was at admittedly much, much lower prices when we first purchased these companies. But we liked the idea at the time we bought them a few years ago that America was getting older. There was a as it gets older theres an

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increasing need for pharmaceuticals. More drugs are being supported by the government in the form of, say, Medicare Part D or for that matter Obamacare. So we think that it plays well to deliver these drugs to the users. Now that said, we dont think its quite likely that these pharmacies as a point of distribution will be replaced by government entities. I dont think theres really anything else to add on the subject. We still think that theres going to good prospects for the industry. Greg, do yo u want to add anything to that? Greg N: Sure, I would just say weve discussed this at length before in terms of why we like CVS. But we think they are uniquely positioned in the industry, being vertically integrated with their pharmacy medical management, which gives them certain advantages that no one else in the industry has, as well as long-term tailwinds from aging demographics, as well as market share gains that should continue for the foreseeable future. Steven: Mark L: Thanks, Greg. Maybe Ill just add Ill just add: so we shorted out the PBM portion. Coincidentally, for those of you who subscribe to Fortune, there was an interesting article on Express Scripts in the most recent issue. And back

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when we were looking at CVS, probably the biggest discussion we had the whole time was about the PBM business and do they deserve to exist? Whats the right margin? What value do they add for the customers? And if you pop open your Fortune magazine if you get it or you find the article online, youll probably see that the reasons we had for shorting the PBM might not have been right or wrong, but they raised questions. Greg N: Mark L: Steven: They were real reasons. They were real reasons, yeah. Yeah, because we knew that we liked one part of the business, and we just didnt want to have to make the decisions we liked the other side of the business. We just didnt have a conviction one way or the other. Mark L: Steven: There I think #1s been answered. Yeah. Can you comment on little areas that you think may be getting hot and prone to future opportunity leverage loans? I think what youre asking is: if come on areas that maybe are a little too hot, then I think thats not just levered loans. I think its almost any loan thats out there. I mean, starting yields are low and interest rates are low. The spreads to those starting yields are not exceptionally wide, and theres be en a massive amount of loans that have been issued over the last four years. In the last

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four years, these companies arent dumb. I mean, theres been $1 trillion of loans refinanced. And of those $1 trillion of loans refinanced, about $300 billion of it have been triple-C and nonrated in the last 3.75 years. So thats probably the fodder for future opportunity for us. But its certainly not an opportunity there today, and we had to reduce our positions here clearly too early, and things have only gotten more expensive therei.e., the yields have continued to decline. And so if we felt they were a little too hot before, theyre certainly way too hot now. Mark S?: I think you can take what Steve said broadly for anything thats dependent on ultra-low yields and access to ready financing based on those yields is something that were pretty concerned about. Steven: We have some a number of other investments in the Fund that we we addressed a couple of them today. We talked about mentioned real estate and mentioned shipping briefly. Theres some other smaller little things in there that we have, and were just aging to table conversations on those other investments at this point in time. You own a lot of established tech or cheap tech names. Do you have a view on IBM? Mark L.: I can take it. So I mean, look we own a bunch of names. You can assume that we run the ruler over IBM. Generally we dont make a habit of

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commenting on companies that we havent disclosed we own. Im not saying we own IBM or we dont. Im just saying weve looked at it. We have a soft view. Its actually a bit of a difficult beast to have a really strong view on. So weve actually tried to peel away the layers on the onion, and we have worked on it. But we dont have anything to say one way or the other right now. Brian: Mark L.: Mark L.: But were aware of it. We saw they missed earnings. We saw the stock traded down. Which we dont think are actually the real earnings, so we do the cash flow analysis weve talked about in the past. Brian: (And then you can bring us back to process, right? So if you think about what were doing on the research side, were trying to stay aware of any and all things that would pique the interest of someone looking for cheap stocks or things that are out of favor. So when a company like IBM misses earnings, is down 10%15%, underperforms the market by 2030% in a year, its safe to say that its been read, its been worked up, there have been calls made on it, whether its IBM or any other name that fits those Mark L: And Ill say Brian used the Gretzky analogy before about skating where the puck is going to be, not where it is. Sean Korduner actually worked up IBM for us a couple months back.

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Steven: Mark L:

Before they missed. Yeah, before they missed. And we made the decision at the time there wasnt needless to say, you dont see it in the holdings.

Mark L.:

But with a name that we thought could get cheap was probably maybe not a million miles away from being in the zone. So wed actually already done our work prior to them missing earnings. So it just caused us to refresh, if you will, which speaks to the research library we build up over time. And thats a game plan that were already maybe a few days or a week out on various companies we have in our library such that, if they do trade down even if only for short periods of time, were ready to act in a quick fashion.

Steven: Brian: Steven:

Do we want to speak to the first two companies? I dont. So just be aware that theres every company in our portfolio, were not necessarily, as I mentioned before, willing to discuss. So something to add?

Brian?:

No, I mean, theres certain companies we talked about this on the last call. Theres companies where the multiples have gotten a little richer. And Ill just use that. And we said before they dont strike us as being screamingly cheap. .But what we have to do here is balance the need to

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both protect your capital, as well as protect against possible inflation over time. And so theres various companies we own that dont necessarily jump out as cheap at the moment. But if you think about lets say were managing our parents retirement fund, if you will. We cant afford to have our parents just sitting on cash. They dont protect against inflation. But we also dont think its an appropriate time to be fully invested where multiples in general are. And so some of the holdings that you see in the portfolio we think offer an opportunity to provide equity-like returns and protect capital over a multiyear view. But it doesnt necessarily mean that we think were going to compound it 1520% a year despite the fact we still own them. Brian: And weve decided to stay longer in names that are better and maybe great businesses and be quicker to exit things that are more 3:1 turnaround trade-oriented situations, and thats If you go back to the list of things we sold this year, youll notice that, with the exception of one or two names there, we probably wouldnt categorize those as great longterm compounders. Steven: And as I mentioned in my introductory remarks, our portfolio has become much higher much more global, much higher quality than it has been at points in time in the past for these reasons.

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Theres a question about our target turnover rate or range for the portfolio. Is it entirely a product of your opportunity set? Could a lower return equity environment result in shorter term holding periods for a greater number of holdings? We dont manage to a turnover rate. When we find companies that are good growing businesses that are inefficiently priced and we feel that we have good risk adjusted returns available to us prospectively, we make investments in those companies. And generally they end up sticking around for about five years or so. Its a byproduct of a research process that it allows us to be relatively tax-efficient. So our turnover in the past has been 20% a year or so. And might it be 25 or 30? Yeah, possibly, but its not going to change so dramatically. Youre not going to I think itd be highly unlikely you would ever find a year that would have we would have 70% of this portfolio turn over. Mark L: I mean, I wouldnt, excuse me, underplay the tax efficiency. So were all Im speaking for the group in generalthe analysts as well as Steven, Brian, and I were all shareholders in Crescent. We all pay taxes. None of us have some magic coat that allows us to escape the taxman. So were very cognizant.

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Mark L:

So we manage the fund in a tax-efficient manner. So for example right now theres a name were dribbling out of each day. We basically dribble out of our long term laws, because

Brian:

Meaning its gone 12 months for us. And so bringing to point, so we dont manage for a turnover number. And we happen to own businesses at reasonable prices that are good compounding values of the underlying franchise for five, ten years. Also though remember: everything we do is opportunistic. So if we buy a name, it runs up very quickly, we sell it. So were selling names weve held 12 months right now. Its something that goes on. At the same time were holding things excuse me. Weve had Walmart for seven, eight years. I dont want to

Steven:

I have to go back and look at the exact year that we purchased it, but if we decided

Brian: Steven: Brian: Steven:

I mean, were closing in on a decade at this point. No, but More than five years? Brians only been a PM since June. I just want to reemphasize that. We didnt own it a decade ago when it was trading at 25 times earnings. Weve owned them for quite some time because Walmart, although not a cheap company, it gives us a compound. What we get is an incredibly

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high quality business. We have almost 30% in sales coming from overseas, and their markets are growing relatively well. And we think that its important to be mindful of the fact that I mentioned this before in past letters: we looked at Walmart like an infinite duration bond with a rising coupon. And that really hasnt changed today from where it was, although its admittedly 50% higher than where it was. So its clearly not inexpensive, and this speaks to the idea of wanting to make sure that we own stocks in our portfolio that can protect usagain going back to the earlier comment today about bar-belling the portfolio between equities and cash. And Walmart fits solidly in there. But theres a number of companies in our portfolio that, in a world of better opportunities, you might see us transition back, or you will hopefully see us transition back from a high-quality to something that has a little bit more 3:1s in it. Mark L: Ill just take Theres a quick question. Does a 40% cash flow demonstrate that youre pessimistic about the American economy? No, it just means that, as Steve mentioned earlier, from a bottoms-up perspective were having trouble finding value. Theres economies we could be optimistic about, but the stocks arent cheap. So theres a

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famous line that goes, look, you can have good news or cheap stocks; you cant have both. And that works on a global Steven: Mark L: Joe Rosenberg. Yeah, Joe Rosenberg at Loews. So that works both ways. So no, were not making a stand about the American economy. We might have used, but [Several talk at once] Steven: Brian: Steven: 2006. Ill define that as closing in on 10 years. My favorite question of the day: what are the 51st and 52nd states? Were very optimistic about Puerto Ricos chances of it. And would it be 52? Mark L: Steven: Mark H: If you include Canada, would it? You called Canada 53. All right, Im going to turn it back to Mark Hancock. The last question that just came is actually addressed on the website on our fact sheet because those metrics are displayed. So thanks, team. And again back to those of you who have been with us from the beginning, sorry for the technical difficulties. This concludes our Third Quarter 2013 Crescent Fund Webcast. We invite you, your colleagues, and shareholders to listen to the playback,

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view the slides, and read the transcript that will be on our website, fpafunds.com over the next few days, with the appropriate consent. We urge you to visit the website for additional Fund information, such as complete portfolio holdings, historical returns, and after-tax returns. Following todays recording, you will have the opportunity to provide your feedback. We read it, we take cognizance of it, and any constructive feedback that you have would be well received, so thank you. Please visit our website, fpafunds.com in the future for webcast information including replays. We will post the date and time of the prospective webcasts during the latter part of each quarter and expect the calls to take place generally, as is in the case today, three to four weeks following each quarter end. We hope that our shareholder letters, commentaries, and these conference calls will help keep you, our investors, appropriately updated about the Strategy. We do want to make sure that you understand that the views expressed on this call are as of today, October the 29th, 2013, and are subject to change 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.

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Any mention of the 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 investment decision. The information provided does not constitute or should not be construed as an offer or solicitation with respect to any securities products or services discussed. Past performance is not a guarantee of future results. It should not be assumed that the recommendations made in the future will be profitable or equal the performance of the security examples discussed. Any statistics have been obtained from sources believe to be reliable, but the accuracy and completeness cannot be guaranteed. You may request a prospectus directly from the funds distributor, UMB Distributors LLC, or from our website, fpafunds.com. Please read the prospectus carefully and the Contrarian Value Policy Statement before investing in our Strategy at FPA Crescent Fund. Thank you again for todays your participation in todays webcast, and this concludes it. Thank you. [END FILE]

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