If you have been reading this blog for any sort of time, you would know I am a big fan of Marty Whitman and the Third Avenue family of fund (especially the new Third Avenue Focused Credit Fund). Marty has penned a number of fantastic books on value investing and distressed debt investing:
INVESTMENT OBJECTIVE AND FUND STRATEGYThe genesis for the Fund was driven by a market opportunity in credit that Third Avenue had not seen since the early 1990s. As our colleagues have written about in the other Third Avenue Funds Shareholder Letters, debt became a bigger focus in 2008 and early 2009. Indeed, due to our history and credit heritage, Third Avenue has always had a proclivity to invest in credit and special situations. However, what was occurring in the credit markets were, as Marty Whitman so aptly put it, “investments of a lifetime.” Similarly, it was clear that you, our shareholders, were making inquiries about a credit only product. We believed that a differentiated credit fund with daily liquidity where the Fund Manager would pick the best investments across the bank loan, high-yield bond and busted convertible bond universe was the best structure. Clients also wanted some exposure to distressed investments, given the higher default rates and Third Avenue’s twenty-three year track record of distressed investing.We designed the Fund to be differentiated from other credit and high-yield mutual funds in the following ways:1) The Fund utilizes a value-oriented investment process that relies on extremely thorough and intensive fundamental research;2) We focus our capital on our highest conviction ideas based upon our fundamental credit research – the Fund will normally have 50-70 investments;3) The Fund has an opportunistic mandate that can invest in any part of the credit spectrum;a. Bank loans, high-yield bonds, busted converts or distressed securities;b. Invest in the security with the best upside potential versus downside risk;4) The investment team must identify an event or catalyst to drive value and the security price higher.
Notwithstanding that the high-yield market returned 49% and the lowest-rated CCC debt issuances returned more than 90% in 2009, we believe there are significant investment opportunities for the Fund on the horizon. In particular, we believe we are still in the early-to-middle innings for distressed investment opportunities.The strong high-yield markets have certainly enabled some larger companies to temporarily delay the inevitable default, while giving others a chance to grow into their capital structure. During the first nine months of 2009, $121 billion of high-yield debt has been issued. This has predominately been used to repay existing shorter-dated bank and bond debt. As a result, the near-term maturities of some companies have been pushed out. Nonetheless, we note that the net debt position has not improved and, in fact, free cash flow has deteriorated due to the relatively higher interest rates associated with the new issuances. For some companies, this will provide enough time for their businesses to grow into their overleveraged capital structures. However, for others it will simply delay the liquidity event and need to restructure.