Keep looking in garbage cans and sometimes you will find hidden jewels.

That's the philosophy of Third Avenue Management, whose flagship is the Third Avenue Value Fund run by legendary value investor Marty Whitman, a bankruptcy specialist. The veteran money manager advocates a "safe and cheap" approach to investing in troubled companies. These could be companies close to or about to go through bankruptcy reorganization.

But Third Avenue also wants its companies to have sound balance sheet. Selecting from the entire universe of fallen securities, Third Avenue distills a universe of about 3,000 portfolio candidates down to about 400 securities, according to Tom Lapointe, senior research analyst.

"On those 400 securities, we look to not only our potential return, but more importantly the potential downside of any one of those securities," according to Lapointe.

Several rounds of further vetting will get this candidate group down to a portfolio of 50 to 60 securities. The key is to find a stock out of favor or a distressed debt with a margin of safety. "If we're wrong, we'll have limited downside, which is the most important way to construct a portfolio from our view," Lapointe says.

"We tend to look down before we look up. Our philosophy is capital preservation first," adds David M. Barse, president and chief executive officer of Third Avenue Management.

The four funds of the family, which also include the Third Avenue International Value, Third Avenue Small Cap Value and Third Avenue Real Estate Value funds, pick through financial landfills looking for formerly successful companies that are now shunned by most investors.  

"These funds generally have been very good performers," says Bridget Hughes, an analyst with Morningstar.

The funds buy lots of distressed securities, including senior obligations and what fund officials call "fulcrum securities." These are securities that could give the fund equity participation or control of the company if it continues into bankruptcy.

An example of what Third Avenue finds picking through Wall Street's dumpsters is privately owned Vought Aircraft Industries, an aircraft supplier that has been one of Third Avenue's success stories. Its debt obligations were bought earlier this year at a time of maximum pessimism.

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