Steven Romick's FPA Crescent Fund 4th-Quarter Commentary

Dear Shareholder:

Performance Overview

The FPA Crescent Fund – Institutional Class (“Fund” or “Crescent”) gained 8.42% in Q4, reducing the trailing twelve month decline to 9.20%.¹ The Fund captured just 50.4% of the average of the S&P 500 and MSCI ACWI NR’s (“MSCI ACWI”) decline in the trailing twelve months, outperforming its 74.9% average net risk exposure.2

Below you can see the Fund’s performance along with various relevant indexes.

Exhibit A: Performance versus Illustrative Indices³

The meaningful and prolonged market decline in 2022 means the market cycle that began in October 2007 has finally ended. This was the longest bull market in recent memory, surpassing even 1987-2000.⁴ Over the market cycle that ended in January 2022, the Fund performed favorably compared to the equity market on a risk-adjusted basis – generating 91.3% of the average of the S&P 500 and MSCI ACWI’s positive annualized return while taking on 64.1% net risk exposure, on average.⁵

Exhibit B: Most Recent Market Cycle Performance⁶

We believe these results mean we met the Fund’s objective of equity-like returns over the long-term despite a period that was far more favorable to a fully invested, US “growth” equity strategy than a risk aware, global multi-asset strategy. Importantly, we believe this was a conservatively earned return as we don’t believe we ever exposed the portfolio to catastrophic loss at any point along the way. In addition, the Fund was always invested in what we believed to be well-financed businesses, diversified by company and industry and never with any one or two large “bets”.

Portfolio discussion

In the last twelve months, Crescent’s top five performers contributed 3.73% to its return, while its bottom five detracted 7.70%.

American International Group (AIG, Financial) is one company that we haven’t discussed in a while, although it’s been in the portfolio since 2011. This year, AIG successfully IPO’d a portion of its life business, an important step on the way to becoming a pure property & casualty company. The company’s general insurance operations demonstrated another year of improved underwriting and profitability.

Amazon (AMZN, Financial) declined in price during the year as it became apparent that, having doubled the footprint of the company's retail infrastructure coming out of Covid, the company had expanded too aggressively. The investment community is similarly concerned that the company's cloud business, AWS, is likely to be negatively impacted by general economic malaise, which would result in a growth rate lower than that of the recent past. Taking a long-term view, we envision both AWS and retail growing over the coming years, complemented by a high margin advertising business. Looking forward, we expect the company to benefit from positive operating leverage under the keen eye of CEO Andy Jassy, who has proven himself as a results-oriented leader in his former position as head of AWS. Though the valuation looks rather rich at the moment on near-term results, if we are correct in our thesis, the valuation at present prices will look to have been a bargain in hindsight.

The remaining contributors and detractors have been discussed in the last twelve months. We ask that you refer to prior quarterly letters for additional insight.

We came into 2022 conservatively postured with net risk assets at 74.8%. We added three new positions to the Fund and exited two in the quarter. Despite that, the Fund ended 2022 with net risk exposure of 74.6%.

Markets & Economy

In an effort to tame 2022’s high inflation (6.5% in the US and 8.9% globally), Central Banks forcefully reacted by increasing interest rates, with the US Fed Funds rate increasing during the year from 0.25% to 4.33%. 1-year US Treasury Bills followed suit, increasing from 0.38% to 4.49%. An increase of more than 4 percentage points was the largest increase since 1980.⁹ While interest rates were bound to eventually increase, we just as well could have argued that might have occurred years earlier. Interest rates are the price of money – effectively the price paid for its use for a prescribed period of time. The higher the rate/price, the lower the asset value – all else being equal. This largely explains 2022’s declines in both stocks and bonds. While stocks had their worst year since 2008, bonds failed to offer the protection to which investors have become accustomed to for these past four decades with the Bloomberg US Aggregate Bond Index declining -13.0% last year.¹⁰ This has led to the return of some market rationality. Even negative yielding bonds disappeared for the first time since 2010.¹¹

While interest rates will always be a driver of returns, along with the inextricably linked economic growth and pace of inflation, your portfolio managers have greater clarity of how the companies in which we invest on behalf of the Fund might perform over time than we do of macroeconomic considerations. Very few have exhibited consistent and long-term success in trading the market predicated on such global variables.

US stock valuations are trading about in line with their 25-year average as can be seen in the table below.

Exhibit E: S&P 500 Valuations¹²

Stock valuations outside the US continue to trade less expensively as noted in the table below. Exhibit F: Global Forward P/E Ratios¹³

While we cannot predict the future, we would not be surprised if additional economic weakness and (finally) a credit event might occur prior to a sustained market rebound. Higher borrowing costs due to a higher cost of capital (elevated interest rates and a larger risk premium) combined with a potentially weaker economy has historically translated into more borrowers defaulting on their debt obligations.

Credit spreads (the “risk premium” mentioned above) are still tighter than historical levels. High-yield spreads ended 2021 at 2.8%, peaked at 5.8% in early July, but ended 2022 tighter at 5.1%. Past credit cycles have seen much wider spreads; e.g., 10% in 2002, 16% in 2008, 8% in 2011, 9% in 2020. Should defaults increase from the current 1.6% to anywhere close to its long-run average of 3.6%, then we would expect that credit spreads would widen, resulting in higher yields.¹⁴

In the past, a credit event would have allowed us to take advantage of higher yielding bonds and distressed debt. While we hope to increase the Fund’s historically low credit exposure, we will do so cautiously given that borrowers have taken advantage of the terms from lenders that allow a greater flexibility to avoid bankruptcy than we have seen heretofore. Historically weak debt covenants have been the result.

Covenant-light agreements have already led to companies stripping collateral out of the company that would normally have been collateral to protect the lender (i.e., a “carve-out”). For example, J. Crew carved out the valuable Madewell brand to the benefit of the company’s private equity investors. It has also fomented lender-on-lender violence, which allows a borrower to give preference to one subset of creditors at the expense of another. Serta Simmons, for example, advantaged one cohort of lenders in the same class by having them lend the company additional money that was senior to the existing debt and allowing these lenders to exchange their prior debt into this new senior paper. In both the J. Crew and Serta Simmons cases, there were some very unhappy lenders.¹⁷

Closing

We think lower valuations and higher bond yields help position us to take advantage of any continued market weakness. We hope to “lean in” to price declines in the same way that we have in prior cycles with the goal of driving equity-like rates of return while avoiding permanent impairment of capital.

Thank you for your support. We don’t take it cavalierly that you have entrusted a portion of your capital to us to steward. It is up to us – from one market cycle to the next – to repeatedly earn that trust. Uncovering, researching, and selecting the asset classes and securities across geographies that might best serve the Fund forms the foundation of our quotidian existence. While this should help drive returns, we are conscious that many of our investors invest alongside us in taxable accounts and we therefore regularly seek to maximize after-tax efficiency, which has led to Crescent declaring only a small capital gain distribution in June and none at year-end.¹⁸

Respectfully submitted,

FPA Crescent Portfolio Managers

January 25, 2022

1 Effective September 4, 2020, the previous single class of shares of the Fund was renamed the Institutional Class shares. Unless otherwise noted, all data herein is representative of the Institutional Share Class.

2 Risk assets are any assets that are not risk free and generally refers to any financial security or instrument, such as equities, commodities, high-yield bonds, and other financial products that are likely to fluctuate in price. Risk exposure refers to the Fund’s exposure to risk assets as a percent of total assets. The Fund’s net risk exposure as of December 31, 2022 was 74.6%.

3 Comparison to the indices is for illustrative purposes only. The Fund does not include outperformance of any index or benchmark in its investment objectives. An investor cannot invest directly in an index. The long equity segment of the Fund is presented gross of investment management fees, transactions costs, and Fund operating expenses, which if included, would reduce the returns presented. Long equity holdings only includes equity securities excluding paired trades, short-sales, and preferred securities. The long equity performance information shown herein is for illustrative purposes only and may not reflect the impact of material economic or market factors. No representation is being made that any account, product, or strategy will or is likely to achieve profits, losses, or results similar to those shown. Long equity performance does not represent the return an investor in the Fund can or should expect to receive. Fund shareholders may only invest or redeem their shares at net asset value.

4 As of December 31, 2022. Source: Yardeni Research. https://www.yardeni.com/pub/sp500corrbeartables.pdf Note: We do not include 2020 as a “bear” market because the decline lasted less than 2 months. https://fpa.com/docs/default-source/default-document-library/2015-04-29-market-cycle-performance-final.pdf?sfvrsn=2

5 We are reporting on this now because one didn’t know the market cycle that began in 2007 was over in January 2022 until mid-year. The current market cycle began on January 4, 2022 and continued through December 31, 2022. Market cycles (peak to peak) are generally defined as a period that contains a decline of at least 20% from the previous market peak over at least a two-month period and a rebound to establish a new peak above the prior market peak. The current cycle is ongoing and thus presented through the most recent quarter-end. Once the cycle closes, the results presented may differ materially and may reflect a different time period than shown here.

6 Source: Morningstar, FPA. Comparison to any index is for illustrative purposes only. The Fund does not include outperformance of any index or benchmark in its investment objectives. Market Cycle Performance reflects the most recent S&P 500 Index market cycle (peak to peak) where market cycle is defined in footnote 5 above.

7 Reflects the top five contributors and detractors to the Fund’s performance based on contribution to return for the trailing twelve months (“TTM”). Contribution is presented gross of investment management fees, transactions costs, and Fund operating expenses, which if included, would reduce the returns presented. Percent of portfolio reflects the average position size over the period. The information provided does not reflect all positions purchased, sold or recommended by FPA during the quarter. A copy of the methodology used and a list of every holding’s contribution to the overall Fund’s performance during the TTM is available by contacting FPA Client Service at [email protected]. It should not be assumed that recommendations made in the future will be profitable o r will equal the performance of the securities listed.

8 Risk Assets include all investments excluding cash and cash equivalents. Net Risk Exposure is the percentage of portfolio exposed to Risk Assets. The “Common stock, long” equity exposure and the Fund’s “Exposure, Net” include a 2.9% allocation to a SPAC basket consisting of 69 SPAC investments as of December 31, 2022. Portfolio composition will change due to ongoing management of the Fund. Please see Important Disclosures for a description of the potential risks of investing in SPACs.

9 Source: FRED. As of December 31, 2022.

10 Source: Bloomberg. As of December 31, 2022.

11 Source: Financial Times, Bloomberg. As of December 31, 2022. There were no negative yielding bonds (> 1 year maturity) per Bloomberg at year-end 2022. https://www.ft.com/content/35779b15-ca04-441a-bc3f-507b030ed45f

12 As of December 31, 2022. Source: Factset, Federal Reserve Bank, Robert Shiller, Standard & Poor's, J.P. Morgan Asset Management Guide to the Markets. Forward Price to Earnings is a version of the ratio of price-to-earnings (P/E) that uses forecasted earnings for the P/E calculation. * Note: Price to cash flow is a 20-year average due to cash flow data availability.

13 As of December 31, 2022. Source: Factset, MSCI, Standard & Poor's, J.P. Morgan Asset Management Guide to the Markets. Forward Price to Earnings is a version of the ratio of price-to-earnings (P/E) that uses forecasted earnings for the P/E calculation. The Fund does not include outperformance of any index or benchmark in its investment objectives. Please refer to the Important Disclosures for definitions of key terms and representative indices used for each geographic market shown in the table.

14 Source: FRED and J.P. Morgan Asset Management Guide to the Markets. Long-run average is based on monthly historical data beginning in January 1990.

15 As of December 31, 2022. Source: J.P. Morgan Asset Management Guide to the Markets. Long-run average is based on monthly historical data beginning in January 1990. Default rates are defined as the par value percentage of the total market trading at or below 50% of par value and includes any chapter 11 filings, prepackaged filing or missed interest payments. The default rate is the last twelve-month figure and tracks the percent of defaults over that period. Spread-to-worst is the difference between the yield-to-worst of a bond and the yield-to-worst of a US Treasury security with a similar duration. Recovery Rate is the extent to which principal and accrued interest on defaulted debt can be recovered, expressed as a percentage of face value. High-yield is represented by the J.P. Morgan Domestic High-yield Index.

16 Chart as of August 31, 2022. Source: The 2023-2024 Credit Cycle Public & Private Credit Markets Outlook & Opportunities Q4 White Paper page 6. Marathon Asset Management.

17 Sources: Serta, June 11, 2020: https://nypost.com/2020/06/11/leon-black-suing-mattress-giant-serta-simmons-over-unlawful-scheme/; J. Crew, May 4, 2020; https://www.prnewswire.com/news-releases/jcrew-group-inc-announces-comprehensive-agreement-to-deleverage-balance-sheet-and-position-jcrew-and-madewell-for-long-term-profitable-growth-301051688.html

18 The information provided herein is neither tax nor legal advice. Investors should consult with a tax or legal advisor before making any investment decision.

Past performance is no guarantee of future results and current performance may be higher or lower than the performance shown. This data represents past performance and investors should understand that investment returns and principal values fluctuate, so that when you redeem your investment it may be worth more or less than its original cost. Current month-end performance data, which may be lower or higher than the performance data quoted, may be obtained at www.fpa.com or by calling toll-free, 1-800-982-4372. The FPA Crescent Fund – Institutional Class (“Fund” or “FPACX”) total expense ratio as of its most recent prospectus is 1.17%, and net expense ratio is 1.14% (both including dividend and interest expense on short sales).