Dear Shareholder:
Performance Overview
The FPA Crescent Fund – Institutional Class (“Fund” or “Crescent”) gained 2.67% in Q2 2024 and 16.37% in the trailing twelve months.1 The Fund captured 84.5% of the MSCI ACWI's return in the trailing twelve months, outperforming its 71.0% average net risk exposure.2
Performance versus Illustrative Indices3
| Q2 2024 | Trailing 12-month | ||
| FPA Crescent | 2.67% | 16.37% | |
| FPA Crescent – Long Equity | 3.85% | 23.71% | |
| MSCI ACWI | 2.87% | 19.38% | |
| S&P 500 | 4.28% | 24.56% | |
| 60% MSCI ACWI / 40% Bloomberg US Agg | 1.75% | 12.49% | |
| 60% S&P 500 / 40% Bloomberg US Agg | 2.60% | 15.42% | |
Portfolio & Market Discussion
The stock market has been a tale of the haves and have-nots with returns lifted by just four contributors (Nvidia (NVDA, Financial), Microsoft (MSFT, Financial), Alphabet (GOOG, Financial), and Amazon.com (AMZN, Financial)) that represented 43% and 53% of the MSCI ACWI and S&P 500 YTD returns, respectively.4
Though Value outperformed Growth in 2022's market rout, Growth is again leading the charge. In the last year, the S&P 500 Growth battered Value by more than seventeen percentage points while the MSCI ACWI Growth beat the Value component by almost eleven percentage points.
Value managers have not had an easy time of it. In the past decade, Value has underperformed Growth by such a significant margin that it threatens its existence as an investment philosophy.6 Many investors have capitulated and fired their Value managers, pushing some Value managers into early retirement. Others have converted to the Temple of Growth.
Active Large Growth mutual fund assets are ~90% larger than their Large Value brethren, up from 24% larger a decade ago, reflecting that investors have capitulated on Value. 7 The last time these numbers approached similar levels before 2020 was around the growth bubble peak in 2000. We offer neither complaint nor excuse as we look to a future that hopefully has more opportunity with less direct competition.
With respect to the recent performance of the Fund, in the previous twelve months, Crescent's top five performers contributed 7.18% to its return while its bottom five detracted 1.38%.
The following investments were meaningful to the Fund's trailing twelve-month return and have not been recently discussed.9
Building materials (largely concrete, cement, and aggregates) company Holcim (XSWX:HOLN, Financial) has performed well over the past year. In addition to strong operating performance, management has taken several steps to return value to shareholders and improve awareness of the company's underlying business strength, including repurchasing shares, increasing the dividend, and announcing plans to separate the company's North American business.
Citigroup's (C, Financial) shares have appreciated (along with other bank stocks) from a profoundly depressed level of less than 50% of tangible book value to a modestly depressed level of 70%. We expect the company to deliver significantly improved results and sizable capital returns over the next few years.
Charter (CHTR, Financial) has faced challenging operating conditions that have led to its share price weakness. Competitors have been overbuilding with fiber assets and fixed wireless has proven to be meaningful. There has been concern regarding the sustainability of business derived from subsidized customers. And, the company's near-term capital spending budget has exceeded expectations. Compounding matters, its relatively high leverage ratio adds volatility to its stock price. We look forward to the company demonstrating the competitive strength of its converged (fixed and wireless) connectivity offering, ramping down capital spending, and reaccelerating share repurchases.
CarMax (KMX, Financial) is the largest independent used vehicle dealer in the US. With 245 locations and 30 years of operating experience, CarMax has built a strong brand focused on providing the best user experience for buying a used car. Consumers can shop online and in -store (quickly transitioning from one to the other at any point in the process) and don't have to haggle with salespeople. Purchasers can pre-qualify for vehicle financing on its website and then shop/compare vehicles by monthly payment with complete confidence that the price displayed will ultimately be what they pay. Vehicles all meet a 125-point inspection to the CarMax Quality Certified standard, and if something goes wrong, vehicle buyers have an industry- leading 10-day money-back guarantee. CarMax uses the data from its millions of vehicles purchased and sold to understand the right price to buy, recondition, and sell used vehicles, and as a result, has consistently generated an industry-leading gross profit per unit (GPU) for decades. We believe each part of CarMax's sales proposition would be difficult for smaller independent peers to replicate, let alone the entire customer value proposition. Even Carvana, CarMax's best-known peer, lacks:
1. The option to shop in-store or test-drive the vehicle for 24 hours before purchase.
2. CarMax's range of finance providers.
3. CarMax's 10-day money back guarantee (Carvana has a shorter 7-day money-back guarantee).
While a recent downturn in used vehicle sales due to the impact of higher inflation and interest rates on monthly vehicle payments has hurt CarMax's recent volumes and market share, we believe it continues to improve the customer experience, which we think will result in increased vehicle sales volumes and market share gains within its existing store base that should drive higher profits per vehicle and improve the company's returns on invested capital. As of year-end 2023, CarMax has ~4% of the fragmented used vehicle market, and while we don't know exactly how big the company can ultimately grow, a good long-term yardstick is CarMax's oldest stores, which have 10%+ market share (which is still growing).
With market valuations higher, Crescent's net risk exposure has understandably declined but your portfolio managers have not sat idle. In the second quarter, we exited one position and added two others.
We remain mindful of seeking to deliver a good return while assuming reasonable risk in the hopes of avoiding permanent capital impairments. While there are many ways to mitigate portfolio risk, Crescent offers various types that consider company valuations, risk exposure, business quality, and diversification.
It would be difficult to argue that the market has stocks on sale. While the stock market continues to migrate higher, earnings haven't kept pace at the same rate, making the market more expensive.
Price matters. Overpaying for a business (or other asset) will hurt returns. It should, therefore, be of little surprise that Crescent's net risk exposure moves inversely with the stock market. We generally look forward to and lean into market weakness that brings lower valuations and pull back when valuations make risk/reward less attractive. Using Price/Earnings (P/E) as an imperfect proxy for market valuations, the chart below reflects that general causation. Exceptions have been when parts of the market that were cheaper than the Indices, e.g., inexpensive small and mid-cap value stocks at the turn of the century internet bubble and then cheaper international stocks a decade later. Today, with P/E's higher (green line), the Fund's net risk exposure has declined (blue line).
Exposure is nuanced. It's not just a number. It is also a function of many squishy considerations that define business quality. Investing in higher quality businesses- e.g., those with a protective moat, good returns on capital, opportunities to attractively reinvest that capital, and an exemplary management team at its helm, should serve investors well over time. There was a time when it was easier to make money from lower quality businesses, but that is less the case today, thanks to the many disruptive businesses and new technologies that challenge them. Crescent has, therefore, migrated over time to businesses of higher quality, which is reflected in the Fund's higher average return on equity (“ROE”) of its portfolio companies. What used to be price first and quality second has now reversed, with a business's quality being the first line of defense. Crescent often purchases shares in companies with depressed earnings, which temporarily lowers its ROE. As a result, this chart should be viewed more directionally rather than with any exactness.
The equities held in Crescent have largely risen in price in concert with the stock market, as measured by both Price/Earnings and Price/Book, as exhibited below. While look- through valuations are higher, the Fund's holdings continue to trade less expensively and, according to consensus estimates, have better expected growth than both the MSCI ACWI and S&P 500.
We manage a diverse portfolio primarily comprised of stocks (as well as higher-yielding bonds and a smattering of other risk assets), but do not advocate having an overabundance of positions. While we think owning too many stocks will likely ensure poor to middling performance, having too many eggs in one basket can lead to debilitating losses when all doesn't go as planned. The Fund generally owns 40 to 60 stocks in different industries (vs an average of 204 for Large Blend Funds that own both Value and Growth stocks), and we consider the exposure to any one business or industry.14 However, Crescent will run with some concentration — its top 10 holdings account for 30% of Fund exposure. Investors can expect to find a large “active share” in the Crescent portfolio. Active share reflects how a fund differs from an index, and
Crescent embodies that as the Fund will frequently have more or less exposure to an industry group compared to the stock market as a function of its benchmark agnostic, absolute value investment philosophy.
Closing
We sincerely appreciate our investors' continued support. We commit to working as hard as ever, and hopefully more intelligently than before, as we incorporate the many new lessons gleaned from our constant reading (and listening to podcasts), our peers, the markets, and our successes and failures. We hope to guide the successful extension of our long track record by keeping front of mind the British Army's 7 P's maxim: Proper Planning and Preparation Prevents Piss Poor Performance.
Respectfully submitted,
FPA Crescent Portfolio Managers
July 25, 2024
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 June 30, 2024 was 69.5%.
3 Source: FPA, Morningstar. 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 Source: Factset. As of June 30, 2024. “YTD” stands for year-to-date.
5 Source: Morningstar. As of June 30, 2024.
6 Source: Morningstar. Over the past ten years through June 30, 2024, the cumulative return of the S&P 500 Value Index was 157% vs 303% for the S&P 500 Growth Index, and the cumulative return of the MSCI ACWI Value Index was 69% vs 188% of the MSCI ACWI Growth Index.
7 Source: Morningstar. As of June 30, 2024. Large refers to large capitalization. Large Value and Large Growth refer to Morningstar categories.
8 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 or will equal the performance of the securities listed.
9 The company data and statistics referenced in this section, including competitor data, are sourced from company press releases, investor presentations, financial disclosures, SEC filings, or company websites, unless otherwise noted. You can find the Fund's other positions addressed previously in our archived commentaries.
10 Source: Factset. As of June 30, 2024.
11 Source: FPA, Shillerdata.com. As of June 30, 2024. The CAPE Shiller ratio is a valuation measure that uses real earnings per share (EPS) over a 10-year period to smooth out fluctuations in corporate profits that occur over different periods of a business cycle.
12 Source: FPA, Factset. As of June 30, 2024. Data reflects the ROE for Crescent long equity holdings, excluding cash and equivalents. Past performance is no guarantee, nor is it indicative, of future results.
13 3-Year Forward Estimated EPS Growth is based on FPA calculations using consensus data from Factset. Forward Price/Earnings and 3-Year Forward Estimated EPS Growth are estimates and subject to change. Comparison to the S&P 500 and MSCI ACWI Indices is being used as a representation of the "market” and is for illustrative purposes only. The Fund does not include outperformance of any index or benchmark in its investment objectives. References to FPA Crescent Fund's (“Fund”) “long equity holdings valuations” refers to the valuations of the Fund's long equity holdings only. The long equity holdings average weight in the
Fund was 62.4% and 63.6% for Q2 2024 and TTM through June 30, 2024, respectively. The long equity statistics shown herein are 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 results similar to those shown. Long equity statistics noted herein do not represent the results that the Fund or an investor can or should expect to receive. Fund shareholders can only purchase and redeem shares at net asset value. Portfolio composition will change due to ongoing management of the Fund.
14 Source: Morningstar. As of June 30, 2024. Reflects the Morningstar Large Blend Category.
Past performance is no guarantee, nor is it indicative, of future results.
You should consider the Fund's investment objectives, risks, and charges and expenses carefully before you invest. The Prospectus details the Fund's objective and policies and other matters of interest to the prospective investor. Please read the Prospectus carefully before investing. The Prospectus may be obtained by visiting the website at fpa.com, by calling toll-free, 1-800-982-4372, or by contacting the Fund in writing.
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 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 1.08%, and net expense ratio is 1.05% (both including dividend and interest expense on short sales).
