Tuesday, January 31, 2012

FPA Crescent Fund Q4 2011 Letter to Shareholders

After all the back and forth, we still fall into the camp that believes there will eventually be inflation, largely because of the unprecedented liquidity creation noted in our arguments for inflation. However, that doesn’t mean that deflationary pressure won’t rule the roost for the foreseeable future.


We don’t proffer a better ability to divine the future, but we do suggest that you resist putting too much confidence in what you read about the economy (here or anywhere else). We think the market is unlikely to experience a decline similar to that of 2008-09, if for no other reason than that people now view the world more fearfully than they did during the more sanguine pre-2008 period. Once one climbs a wall of worry, there isn’t as far to fall—an oxymoron, but consistent with our view that there’s less to fear when there’s fear. After considering all of the above and more, we still let price be our guide. If an investment discounts the present, allowing for a host of negative outcomes, you will see more equity exposure as our expected risk-adjusted return should be good. If a prospective investment discounts the future and hereafter, you will see more cash.


We find investing especially challenging today—not that it’s ever been easy. We feel like we are forced to bet on policy, and how does one do that? Particularly when we believe we are betting that too many of the wrong people will make the right decisions. We feel a little like explorers, blazing new trails, learning about the new world we’ve come upon, charting a different path with new information, all while trying to avoid being scalped. We continue to seek the best path, even if it’s new, to both protect your capital (first) and to provide a return on it (second). It’s as the Scottish missionary and explorer David Livingstone once declared: “I am prepared to go anywhere, provided it be forward.” Along the way though, we sometimes feel a bit like Daniel Boone, who said, “I have never been lost, but I will admit to being confused for several weeks.” We’re left with the hope that selfish and uneducated views coalesce somehow to form appropriate policy. But we’re not seeing it, so we maintain our cautious positioning, with net exposure to risk assets at 70.5%, which includes 5.0% of corporate bonds that are largely lower risk. As a result, we are not positioned for the world being great, and our performance will lag should that prove the case. We continue prudently, however, aware that the metaphor of ‘kicking the can down the road’ is misleading because it implies a problem of a constant proportion instead of what we see as more of a snowball, rolling downhill and gathering momentum and size with each advancing yard. Volatility is our friend. We anticipate more of it, and will commit capital accordingly.