They make projections on a company’s earnings expectations over the next five to 10 years, and build their models on a base case, low case and high-case framework.
“In a base case we want to make some money; on a high case we want to make a lot of money,” Romick says. “We figure the base case is more likely than the low case, but if the low case occurs it won’t blow us up.”
Episodic Opportunism
There’s an obvious question for managers of a go-anywhere fund: How do they zero in on portfolio ideas when their investment universe is whatever’s available?
Romick uses the term “episodic” to explain the investing approach. The team listens for bad news in any sector that creates dislocations and mispriced assets.
“To use the wind metaphor, we’re looking for the wind in our face, because that’s what’s creating the opportunity that one day could turn around and be wind at our backs.”
He believes that one such wind-in-the-face sector is commercial real estate, where the rise of remote work has hurt occupancy rates and rents. He says his fund is building positions in a couple of firms with top-notch real estate portfolios and solid management teams with significant inside ownership. The FPA Crescent managers also have their eyes on certain asset-backed mortgage securities they hope to buy if prices reach an attractive level.
“The bad news in the commercial real estate sectors gives us the chance to do our work and buy when people are selling. We’ll see if we get the opportunity to buy those ABM securities,” he says.
America’s Cup
One of the fund’s features is that it’s nimble in making allocations. It has held common stocks in a historic range of 27% to 74% of the portfolio, whereas the bonds/credit category has ranged from zero to 34%, and cash and equivalents from 5% to 58%.
“We can allocate quickly when we see opportunities,” Romick says. “In 2008-2009 our high-yield exposure went from single digits to 34% in about four months. We’re not seeing that [favorable] risk/reward today.”
Indeed, the fund’s 3.3% weighting toward the bonds/credit category is currently at the low end of the historic range. In turn, the fund’s cash allocation had risen to 28% as of this year’s third quarter.
Romick says the fund’s increased focus on global stocks since 2011 prompted the managers to shift from the S&P 500 to the MSCI ACWI as their primary benchmark for the fund’s equity allocation. The former index is still used primarily to measure the fund’s pre-2011 performance. As of the third quarter, the fund’s geographic allocation was 62% domestic securities, 34% international developed names and 4% emerging markets.
Romick points out that the fund’s stock selection process has changed through the years. “A lot of the old businesses we used to like” … he says before abruptly stopping and then shifting in another direction … “at the end of the day we need growing businesses. We like some wind in our sails. We’re not looking for gale-force winds to compete in the America’s Cup, but we don’t want to be out there in the calm. And we also don’t want to be thrashed against the rocks.”
For that reason, the fund has turned to some big names in the technology sector. Among the fund’s recent top 10 holdings were Google’s parent company Alphabet, Analog Devices and Meta Platforms.
The fund has a very low turnover rate of 8%, which is surprising given its variegated portfolio containing securities in different asset classes that seemingly require substantial fine-tuning to stay on course.
“Our turnover can be low when we find horses like Google that we can ride for a long time before they go to the glue factory,” Romick says. The fund initiated its position in the company in 2011.
In late October, Alphabet’s stock took a big hit after it announced less-than-expected revenue in its cloud computing division. For Romick, that’s a distraction that doesn’t dim his positive long-term outlook on the stock.
“In 10 years Alphabet will probably still be Alphabet and will have more success than we suspect in some areas and not as much success in others, but net-net it’ll be a more profitable business 10 years from now than it is today.”
The “Other” Category
The fund usually has a small allocation (less than 5%) to its “other” asset class. This can include illiquid, nontraditional investments, as well as short positions, including pair trades. The fund did such a trade with a couple of automakers when it went long Renault but shorted its strategic partner Nissan.
Other vehicles in this category have included private credit, a position in container ships, and some total-return swaps in the cannabis space.
“We do it as a basket position,” Romick explains. “We take the position that in five years these things should be worth three to five times what they’re trading now.”
He says his fund tends to do best during periods of dislocation, and not as well when the market rises parabolically. “Our downside protection tends to be better, and that’s what drives our returns,” he says, emphasizing that the fund’s calling card is its ability to generate positive returns over long market cycles.
“We’re not trying to knock the cover off the ball every quarter,” Romick says. “We don’t want to talk about quarterly returns; we look at things across full market cycles.”