[With the recent rotation away from growth stocks due to changing economic conditions, rising interest rates and a growing need to deleverage risk, value investing has come back into prominence. This is a good time to explore the state of value management. An interesting question we discovered was whether the many years of growth style dominance affected and brought changes to value investing methodologies and processes?
To better understand the evolutionary pressures on value investing and where we stand today, we were introduced to Matthew Fine, portfolio manager, Global Value and Victor Cunningham, portfolio manager, Small-Cap Value of Third Avenue Management — a NYC-based asset management firm founded by legendary value investor Martin Whitman with a family of 40-Act mutual funds, institutional separately managed accounts, and UCITs for non-US investors. For more than three decades the firm has consistently pursued a fundamental, bottom-up approach to deep value and distressed investing.]
Bill Hortz: How would you summarize the Third Avenue investment philosophy? Does it vary from strategy to strategy within the firm?
Matthew Fine: The highly summarized version is that we fall into the camp of long-term, opportunistic, fundamental value investors. We are investing with a three-to-five-year investment horizon, manage relatively concentrated portfolios, and tend not to care very much about whether our portfolios mirror a benchmark or not. Unlike other value managers, Third Avenue tends to be an outlier in its emphasis on the price of the security - meaning the size of the discount to a conservative net asset value - rather than that outlook of the business, which frankly can be quite fluid.
Further, given that finding deeply undervalued securities very frequently entails contrarianism, and investing in situations where the outlook is challenging, we also place a heavy emphasis on the quality of a company’s financial position. We need to ensure companies can survive until the clouds recede and do so without needing to raise capital in a way that diminishes the value of our ownership interest. This identical approach is applied to each of Third Avenue’s strategies – Global Value, Small-Cap Value, Global Real Estate, and International Real Estate.
Victor Cunningham: As an aside, over the most recent decade of falling interest rates and free capital available to anyone, our focus on financial wherewithal has not been a particular benefit to our results, but in the rapidly rising rate environment we now find ourselves in, some younger investors will learn for the first time in their careers why it matters a great deal.
Hortz: From your perspective, what are your observations on how value managers may have been impacted by the extended investment focus and flows to growth investing and what might be some of the consequences investors should be aware of?
Fine: One major consequence of the relative performance dynamic of growth versus value strategies has been that many value managers have struggled to hold on to their clients and, in turn, their jobs. A number have closed up shop. Others have quietly redefined how they think about value in search of a path of less resistance. This is also perfectly analogous to the late 1990s when a number of investing Hall of Famers nearly lost their jobs and the value herd was substantially thinned. I think that a philosophical shift to a path of less resistance over the last few years is on display in the early part of 2022 in the sense that a number of notable value managers have not performed particularly well in spite of value strategies, statistically speaking, showing a strong resurgence.
Cunningham: We feel that growth investing has been in favor so long that a cross-section of historically deep value investors that have been under pressure have morphed from traditional value to more GARPY Growth-At-A-Reasonable-Price orientation. Their definition of value and operating methodology may have morphed from traditional value investing. This is not a criticism, but an observation.
If someone is looking for value investing today, you might want to spend a little more time digging into the processes and operations of the firm to determine where in the more enlarged spectrum of value the firm actually resides or operates from.
Hortz: How would you characterize your position in the spectrum of available value management firms?
Fine: Marty Whitman was the quintessential maverick, not different for the sake of being different, but a genuine independent thinker. Like some other great value managers, he was not born with that inhibiting gene that causes most people to take comfort in being part of some type of herd. In order to be a thoughtful and successful contrarian, you have to be completely comfortable with most people telling you that you are wrong – or even a little nuts – for a while, until they later come around to your point of view. It is for that reason that the current iteration of Third Avenue’s management is deliberately comprised of members of the investment team and decision-making really revolves around working to produce great investment results.
As a result of this heritage of independent thought, avoidance of the herd, and seeking investment excellence with a focus on the quality of the results rather than collecting a huge quantity of assets under management, we feel the portfolios managed by Third Avenue today are very unusual in the context of the investment industry. We would point to our active share – a measure of the percentage of stock holdings in a manager’s portfolio that differs from the benchmark index – which stands at over 90% across all our equity funds, including our Value Fund and Small Cap Value Fund being over 98%. Most importantly however, we have been able to demonstrate that our strategy is capable of producing substantial long-term outperformance for clients.
Cunningham: Although Marty is no longer with us, his legacy is carried out in our research processes today. Two distinctive attributes are Third Avenue’s reliance on net asset values and the written word. We value companies differently than most peers. It is one of the reasons our portfolios have high active share measures.
Many peers use static metrics such as Price/Earnings ratios when valuing companies. We add up the assets (which includes a conservative independent assessment of each business unit) and subtract all liabilities (off balance sheet and on balance sheet) to determine net asset value. This approach requires a deep dive into each of the businesses and often leads to different investment conclusions versus the crowd.