Icon of Buy-and-Hold Is Flush With Cash--as Well as Ideas
Say it isn’t so, Marty!
That was my reaction when, scanning the pages of the Value Line Mutual Fund Survey a few months ago, I came across the shocking news that Martin J. Whitman--the founder, manager and CEO of Third Avenue Value, one of America’s best-performing (and coolest) mutual funds and an icon to buy-and-hold value-hunters around the globe--had moved 45% of his assets out of stocks and into cash and short-term Treasury bonds.
Had Marty become a market-timer? Was he trying to guess where stocks will head in the short-term rather than buying great companies at low prices and keeping them forever? Had he gone the way of such fallen idols as Jeff Vinik of Fidelity Magellan fund and Foster Friess of Brandywine?
Both Vinik and Friess had moved boldly into cash, guessing that the market was going south. Both were terribly wrong. The maneuver cost Vinik his job and Friess his respect. Magellan has a new, more conventional manager, and Brandywine has been creamed, returning only 4% for its shareholders in the past 12 months, compared with 32% for the Standard & Poor’s 500 stock index.
Friess made an amateur’s mistake. After his portfolio was burned when the market fell last October, he sold billions in stocks and moved 54% of his assets into cash and short-term commercial paper. Since then, many of the companies he dumped have rallied, including Cisco Systems Inc., which has risen 41%. Friess is a superb stock-picker, but his experience is a good lesson to small investors--don’t try to outsmart the market.
But what about Marty? Had he turned timer on me?
It was the first question I asked when I interviewed him recently in New York at his offices on (where else?) Third Avenue.
“No!” he said. Of course, he wasn’t timing the market. He wasn’t even selling stocks. He was building up the cash that was flowing into his fund from new investors and from buyouts of companies he owned to use it for a typically Whitmanesque purchase.
And what would that be?
Now, there’s a contrarian investment. The Japanese banking system is a sordid mess, burdened with bad loans and bad managements that don’t know how bad they are. Whitman thinks he can buy into these banks cheaply--as he did in the early 1990s here at home, where he scored a major coup.
In the first three months of this year, Whitman took tiny positions (totaling $6 million, or 0.4% of his fund’s assets) in Chuo Trust & Banking Co., Sakura Bank, and Long-Term Credit Bank of Japan.
These banks have had severe problems, and their prices reflect that fact. Long-Term Credit, for instance, is down 52% in the past 12 months, and just last week the bank sued a magazine for writing that it would collapse without help from Japan’s central bank.
Buying larger chunks of Japanese banks isn’t easy, especially if you want to do so the way Whitman does--making sure that the cash he provides goes to the bank itself, as new capital, and that management is inspired to change its ways. So, he’s negotiating.
In the short-term, the returns of his fund are suffering, mainly because cash only returns 5% while the stock market has been returning 25%-plus. Third Avenue ( 443-1021) is up a mere 15% in the past year and its three-year average return has fallen to 21%, compared with 30% for the S&P.;
But investing with Whitman is a long-term proposition. He’s willing to wait and wait, and so should you. Over the past four years, his fund’s average turnover has been just 6% annually, meaning that he holds the typical stock for 16 years; that compares with just 15 months for the average fund.
What is so remarkable about Third Avenue is that, despite what appear to be wild investments, Whitman’s risk ratings are extremely low. Standard deviation, a measure of the fund’s volatility (its ups and downs), is 39% below average.
The reason is simple. Whitman, following the admonition of Benjamin Graham, looks for a “margin of safety” when he buys. In other words, he loves cheap stocks. “Unfortunately,” he recently wrote to shareholders, “there are no guarantees, and there may not even be accurate guesses.” In such a world, the best approach is to buy low, so the downside risk is limited. “Guys buying Coca-Cola are not price-conscious. We’re price-conscious.”
What has Whitman bought? His largest holding is Tejon Ranch Co. (symbol: TRC), which owns 270,000 acres of valuable land near Los Angeles. Third Avenue, along with other Whitman institutions, owns more than one-quarter of Tejon, which has returned 53% in the past year.
Tejon is a special situation. He got the stock at a good price when the Times Mirror Co., owner of the Los Angeles Times, decided to unload it. While Whitman does own other real-estate companies--including Koger Equity Inc. (KE), a REIT that specializes in suburban office buildings, and Alexander & Baldwin Inc. (ALEX), which owns land in Hawaii--he generally searches for values within industries that are flat on their backs.
“We’ve had a 20-to-30-year bull market,” he told me, “but all during that time certain industries have suffered through depressions as bad as anything in the 1930s.” The trick is to buy solid stocks during these “rolling depressions” and hold them as they recover. “We concentrate on the quality of balance sheets,” he says. “It’s not that hard.”
One depression-style sector that interests him now is semiconductor equipment--that is, firms that make stuff that microchip manufacturers use.
He owns shares of 11 such companies, headed by FSI International Inc. (FSII), Electro Scientific Industries Inc. (ESIO), and Silicon Valley Group Inc. (SVGI). Each of the three is down at least 50% from its high last fall but each, says Whitman, has an excellent balance sheet and a bargain price.
“The underpinning of the semiconductor business is that it has to experience explosive growth,” he says. “You ain’t seen nothing yet.” But he emphasizes that the best deals are in equipment makers rather than chip makers.
Another sector in a depression mode is petroleum service, a sector battered as the price of oil has dropped. Third Avenue recently bought shares of Nabors Industries Inc. (NBR), a contract driller for oil and gas, for $21--a purchase that especially pleased Whitman, since he founded the company in 1989 and sold out at $46.
Nabors trades at a P/E of 16, with a long-term growth rate, according to Bloomberg Business News, of 26% annually.