3Q 2014 T h i r d Av e nue F u n d s Por t f ol i o Ma na g e r Comme n t a r y

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ThirdAvenueValueFund
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ThirdAvenueSmallCapValueFund
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ThirdAvenueRealEstateValueFund
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ThirdAvenueInternationalValueFund
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ThirdAvenueFocusedCreditFund
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THI RD AVENUE FUNDS
PortfolioManagerCommentary
July31,2014
Letter from the Chairman
Inside
PortfolioManagerCommentaryfrom
DearFellowShareholders,
Mostbusinesses(andgovernments)whicharesuccessfulachievesuccessbycreating
wealthwhileconsumingcash.Inmostcases,consumingcashcarriesafairamountof
investmentriskbecauseconsumingcashrequiresthebusinesstohaveaccesstocapital
markets,sometimescontinuouslyasisthecaseforcommercialbanksandbrokerdealers.
Capitalmarketsarenotoriouslycapricious, sometimesnotavailableatall seethe2008
2009financialmeltdown;andsometimesareasourceofalmostfreemoney seethe
1999 2000IPObubble.
Otherbusinesses,aminorityIexpect,aredesignedtocreatewealthbyhavingpositive
cashflowsfromoperations;forexamplesingleincomeproducingrealestateprojects,
investmentcompaniesandinvestmentmanagementcompanies.Otherthingsbeing
equal,orclosetoequal,ThirdAvenueManagement(TAM)analystsandportfolio
managersprefertoinvestinthecommonstocksofcompanieswithpositivecashflows
fromoperations,butnottotheexclusionofthecommonstocksofcompaniescreating
wealthwhileconsumingcash.Asapracticalmatter,TAMisverypriceconsciousandgives
price,especiallyasrelatedtoestimatedNetAssetValue(NAV),greatweightinmaking
buy,hold,orselldecisionswhetherthebusinesscreateswealthbyconsumingcashorisa
cashgenerator.
Inanalyzingcashflows,itissuperimportantthattheanalystdistinguishbetweenproject
financeandcorporatefinance.Projectfinancelooksatperiodicnetcashflowswitha
definedterminationdate.Foranyprojecttomakesenseithastobebasedonforecastsof
apositiveNetPresentValue(NPV),i.e.,thepresentworthofthecashflowstobereceived
overthelifeoftheprojectpluscashtobereceivedattheterminationoftheproject,if
any,hastobegreaterthanthepresentworthofthecashcostsinvolvedwiththeproject.
Incontrast,incorporatefinance,onelooksatthewealthcreationtoberealizedbya
businessentitywithaperpetuallife.Wealthcreationisaresultnotonlyofsuccessful
operationsbutalsojudiciousinvestingandhavingattractiveaccesstocapitalmarkets.
WhileindividualprojectshavetohaveapositiveNPVtomakesense,corporationswitha
perpetuallifedont.CITandGECapitalprovidegoodexamplesoftheinterplaybetween
projectfinanceandcorporatefinance.EachreceivableissuedbyCITorGECapital(i.e.,
loanstocustomers)isdesignedtohaveapositiveNPV.Thisisprojectfinance.Butasthe
CITorGECapitalreceivablesportfolioexpandsasnetnewloansarewritten,the
companiesbecomecashnegative.Thisiscorporatefinance.Thecash
Martin J. Whitman
ChairmanoftheBoard
3Q 2014 T h i r d Av e nue F u n d s Por t f ol i o Ma na g e r Comme n t a r y
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LetterfromtheChairman
shortfallsaremetbyCITorGECapitalbyaccessingcapitalmarkets issuingnewdebt,commercial
paper,bankloansandsometimesequity.
TheTAMinvestmentformulaformanycommonstocksistobuyintothecommonstocksof
companieswithsuperstrongfinancialpositionspricedatmeaningfuldiscountsfromreadily
ascertainableNAV,whereanalysisindicatesstrongprobabilitiesthattheNAVwillgrowoverthelong
termbynotlessthan10%perannumcompoundedafteraddingbackdividends.Advantagesof
strongfinancialpositionsincludethefactsthatcompetentmanagementscanbeopportunisticand
alsotendtoavoidbecomingsupplicantstohavingtoaccesscapitalmarketsunderconditionswhere
managementshavelittle,ornocontrolofthetimingofsuchaccess.
AninvestmentinthecommonstocksofcompaniesmeetingtheTAMinvestmentcriteriadoesnot,
ofcourse,guaranteegoodinvestmentperformancebutitcertainlyseemstoputtheoddsinfavorof
goodinvestmentperformanceoverthelongerterm,sayatleastthreeyears.Ibelieve,basedon
severalstudiesthatforatleast80%ofthecompaniesatleast80%ofthetime,NAVswillbelargerin
thenextreportingperiodthaninthepriorreportingperiod.IfthoseincreasesinNAVcontinueto
becreated,theonlywaytolosemoneyistohavethediscountsfromNAVatwhichpricethe
securitywasacquired,widenandstaywidened.
TAManalystsrecentlyranastatisticalanalysis,
1
i.e.,ascreen,forabroaduniverseofglobalstocks,
2
basedonthefollowingthreecriteria:
1)Tenyearbookvaluepershareincreasedbyatleast10%perannum
2)Thecommonstockwassellingat1timestangiblebookvalue,orless
3)Marketcap>$1billion
Forthetop100mostwellcapitalizedcompaniesonthislistbasedontotaldebttocapitalization
(whichrangedfrom0%to30%),theresultswereveryinteresting:
o Forthetenyearperiod,allbuttenofthecommonstocksinthescreenhadapositivetotal
return
o Ofthetencommonstockswithoutpositivepriceappreciation,thelargestannualizedloss
wasonly6.7%
3
o 55%ofthecompaniesinthescreenenjoyed,atleast,doubledigitannualizedreturns.
Thirteenoftheissuesinthescreenenjoyedtenyearannualizedreturnsinexcessof20%
UsingTAManalytictalent,theThirdAvenueFundsseektoidentifysecuritiesthathavetheseand
similarcharacteristics,whichwebelievewillincreasetheoddsthatourFundswillhaveimproved
longtermperformance.
IsNAV,orbookvalue,agoodindicatorofwealthinconservativelyfinancedcompanies?Theanswer
isyesandno.TAMfocusesverymuchonthecommonstocksofcompanieswheretheNAVis
readilyascertainable.Frequentlyitisnotreadilyascertainable.Therearetwowidelyused
accountingstandardsusedintheinvestmentworld:GenerallyAcceptedAccountingPrinciples
1 Bloomberg; data as of 7/22/2014.
2 Companies listed on the following countries exchanges: Australia, Austria, Belgium, Bermuda, Brazil, Canada, Chile, Denmark, Finland,
France, Germany, Greece, Hong Kong, Iceland, Ireland, India, Indonesia, Israel, Italy, Japan, Mexico, Netherlands, New Zealand, Norway,
Philippines, Poland, Portugal, Russia, Singapore, South Korea, Spain, Sweden, Switzerland, Taiwan, Thailand, Turkey, UAE, UK, US, Vietnam.
3 Price appreciation including reinvested dividends.
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LetterfromtheChairman
(GAAP)usedintheU.S.A.andInternationalFinancialReportingSystem(IFRS)usedintherestof
theworld.
DoesGAAPgivegoodapproximationofNAVforfinancialinstitutions?Mostlyyes.Theassetsof
financialinstitutionsaremostlypaperwhichcanbereadilyvalued.Theproblemwithmany
financialinstitutionsisnotvaluingassets,butthatitmaybehardtoascertainwhatthereal
liabilitiesare.Forexample,inthecaseofmanynonlifeinsurancecompanies,especiallycasualty
underwriters,thebulkoftheliabilitieswillbedeterminedbyfutureevents(e.g.,hurricanes)which
tendtobeunpredictable.
DoesIFRSgivegoodapproximationsofNAVforcompanieswhoseassetsconsistlargelyofincome
producingrealestate?Theanswerisyes.UnderIFRSincomeproducingrealestateiscarriedon
thebalancesheetatappraisedvaluewiththeappraisalsconductedbyrecognizedindependent
appraisalfirms.
DoGAAPorIFRSgivegoodapproximationsofNAVforgoingconcernsengagedinmanufacturing,
distribution,ortransportationwhereindividualassetsarenotseparableandsaleablewithout
jeopardizinggoingconcernoperations?Theanswerseemstobedefinitelynoinmostcases.
DoGAAPandIFRS,forcompaniesthatarenotwellfinanced,ordonothaveeasyaccesstocapital
markets,givegoodapproximationsofNAV?Theanswerisnoinmostcases.Indeedwhena
companyisnotwellfinanced,alargebookvaluemaybeanegativefactor.Frequentlylargebook
valuestiedupin,say,plantorequipmentorinventories,mayreflectverylargeoverheadsmore
thananythingelse.
InonesenselargeNAVsforincomeproducingrealestateasascertainedbyindependent
appraisers,maybeonepredictoroffuturecashflows.Independentappraiserstypicallyusethree
approachesinanappraisal theincomeapproach,themarketapproachandthereplacementcost
approach.Insofarastheincomeapproachisweighteditconsistsofthecapitalizationofestimated
futurecashflows.WheelockcommonstockatthiswritingissellingaroundHK$40;NAVat
December31,2013wasaroundHK$82.InsofarastheHK$82wasbasedontheincome
approach,theappraiserisstatingimplicitlythatWheelockCommonissellingataverylowprice
relativetoforecastedfuturecashflows.IfthereareinvestmentproblemswithWheelock,itdoes
notseemtoinvolvethelongtermprofitoutlookbasedonestimatesofperiodiccashflows.Rather
theproblemsforoutside,passiveinvestorsseemcenteredontheobservationthatforWheelockit
isextremelyunlikelythattherewilleverbeachangeofcontroloragoingprivatetransaction.
IshallwritetoyouagainwhenTAMreportsforthefiscalyeartoendOctober31,2014.
MartinJ.Whitman
ChairmanoftheBoard
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ValueFund
Por t f ol i o Manager Comment ar y
T HI RD AVE NUE
J UL Y 3 1 , 2 0 1 4
From the Portfolio Manager
Chip Rewey
LeadPortfolio Manager ofthe
ThirdAvenueValueFund
DearFellowShareholders,
IamhonoredtobetakingtheleadpositionontheThirdAvenuesValueFund(Fund),Third
Avenuesflagshipstrategyandahallmarkintheindustry.TheThirdAvenueManagement
(TAM)Valueteam,mycoPortfolioManagersandIwillcontinuetopursuetheconcentrated
approachtovalueinvestingthathasbeenthepledgeofthefirmsinceitsfounding.The
Fundhasbeenandinmyviewwillalwaysremaineclecticandopportunisticinitsmandate.
WhileIamnewtoTAM,IamnotnewtoMartyWhitmansinvestmentphilosophy.Infact,a
greatdealofmyowninvestmentphilosophyandprocesshasbeenbuiltontheteachingsin
hisbooksandinvestorletters.IembraceMartyWhitmansandtheFundsdisciplinedand
systematicapproach.Asvalueinvestorswescourtheinvestmentuniverseseeking
companieswithstrongcreditworthiness,ameaningfuldiscounttonetassetvalue(NAV)and
theabilitytoconsistentlycompoundNAVgrowth.Inourrelentlesssearchforvalue,we
pursueopportunitiesacrossgeography,industry,assetclassandmarketcap.Additionally,
reflectiveofThirdAvenuesculture,theFundhasahistoryofsuccessfuldistressedcredit
investmentsalongsidewellcapitalizedequityholdingsaswesearchforvalueupanddown
thecapitalstructure.InMartyWhitmanswords,guidedbyanadherencetoprice
consciousnessandadeepunderstandingofunderlyingbusinessfundamentalsandasset
values,ThirdAvenuerarely,ifever,investsalongsidethegallopingherds.Thisapproach
hasshowntimetestedsuccessforovertwentyfouryearsandacrossdifferentmarket
cycles.
Apriceconsciousbuyisthecriticallynchpinforourstrategy,asitnotonlysetsthebasis
forfuturereturnpotential,butasimportantlyprovidesdownsideprotectiontoavoida
returnsappingcapitalloss.Itissaidthatpatienceisavirtue,andindeedforourstrategy,
patienceforanappropriatediscountisessentialforourpurchasedecisions.Aswescour
ourbroadandeclecticinvestmentuniverse,weanalyzemanymorecompaniesthanwewill
everown.Itisthiscontinuingduediligenceofmanagementdiscussions,supplier,vendor
andcompetitorinterviewsandfinancialstatementanalysisthathelpsusbuildourindustry
knowledgeandformouruniqueviewonwhatanenterpriseanditsassetsareworth.We
analyzemanygoodcompanies,butitiscriticalthatwearepatient andbuy
opportunistically whenthediscounttoassetvalueprovidesanacceptablereturnanda
mitigationofrisk.
ManyinvestorshaveaskedmewhatwillchangeasItakeontheroleofLeadPortfolio
Manager.WhileIlookforwardtofosteringtheinvestmentphilosophyofthefirm,Ibelieve
thatthereisalwaysroomforcontinuousimprovementintheprocessofhowwecan
executethisstrategy.Therearemanytoolsandbestpracticesalongthelinesofidea
ThirdAvenueValueTeam
ChipRewey,CFA
LeadPortfolioManager
VicCunningham,CFA
PortfolioManager
MichaelLehmann
PortfolioManager
YangLie
PortfolioManager
AndreaSharkey,CFA
ResearchAnalyst
Portfolioholdingsaresubjecttochange
withoutnotice.Thefollowingisalistof
ThirdAvenueValueFunds10largest
issuers,andthepercentageofthetotal
netassetseachrepresented,asofJuly
31,2014:
CovantaHoldingCorp.,5.12%;BankOf
NewYorkMellonCorp.,4.98%;POSCO,
4.87%;Cavco IndustriesInc.,4.78%;
Wheelock&Co.,Ltd.,4.53%;Apache
Corp.,4.28%;DevonEnergyCorp.,3.96%;
HangLungGroupLtd.,3.64%;TotalS.A.,
3.53%;DaiwaSecuritiesGroupInc.,
3.49%
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ValueFund
generationtechniques,riskcorrelationmatrices,investorexpectationstudiesandselldiscipline
thatIhavefoundtobeusefulintheportfolioconstructionprocess.Allofthesetoolsorbest
practicesarehelpfulindeterminingthemostappropriatepositionsizeforanygiveninvestment.
OvermytwentythreeyearsintheindustryIhavelearnedthatdeterminingwhichsecurities
shouldopportunisticallybetopweightingsandatwhatpricefrombothabuyandsellperspective,
iscriticalinharvestingtopinvestmentperformance.Theconvictiontopurchasediscounted
securitiesmustbepairedwithaneffectiveprocesstoexecutethedecision.Likewise,thedecision
tosellasecuritytoharvestagain,orrecognizeasignificantchangeintheinvestmentcaserelies
oneffectiveresearchandvaluation,butalsoaprocesstoidentifyandreviewthesesecuritiesona
timelybasis.Inmyroleasleadofthevaluestrategy,Iwillpursuecontinuousimprovementinour
processessoastoharvesttheinvestmentoutperformancethatourphilosophycandeliver.
Ibelievethatahighlycollaborativeteambasedprocessbuildshigherlevelsofconvictionand
superiorinvestmentresults.MycoPortfolioManagersontheValueFundarenotonlydeepin
theiryearsofexperience,butalsotenuredintheircareersatTAM.
Inadditiontotheimmediateteam,thestrategyissupportedbythebreadthanddepthofthe
entireTAMresearchstaffofovertwentyfiveanalysts,spanningSmallCap,International,Real
EstateandCreditmandatesintheU.S.andglobally.TheFundwillretainthespiritoftheflagship
TAMstrategy,andcontinuetodrawonandcontributetothefirmsvastresourcesandanalyst
team.
Sincerely,
ChipRewey,LeadPortfolioManager
ThirdAvenueValueFund
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DearFellowShareholders,
Oneofthecommonquestionsourfellowshareholdershaveaskedrecentlyiswhetherweareable
tofindgoodvalueinvestmentsgiventhestrengthofthemarkets,especiallyintheU.S.wherethe
broadmarketindexesarenearalltimehighs.Theshortanswerisabsolutely.Whilecurrent
earningsandpricetrendsareimportant,ourinvestmentprocessextendswellbeyondthem.Our
processisrootedinevaluatingtheentireenterprise,asopposedtofocusingonmoreidiosyncratic
quarterlyearningsreports.Inouranalysisweareessentiallycountinguptheassetsand
ascertainingafairNAVforacompanyasifwewerepurchasingtheentirebusiness.Fromtherewe
assessthecompany'sbalancesheetandcreditprofile,toensurethatithasthefinancialcapacity
tomeetobligationsandinvestmentopportunities,aswellastheabilitytosurvivemarketstorms.
OurfocusontheabilitytocompoundNAVprovidesadistinctionbetweenhigherquality
companies,andthosethatcouldbeinseculardeclineorothervaluetrapsandrevealsalotmore
opportunitiesthatmayappearobscuredbyastandardizedandgenericapproachtovaluation.We
askourselveswhatwewoulddotogrowthebusinessandcreateshareholdervalueifwewerethe
CEO.Wefocusourcompanyandindustryresearchandourassessmentofthecompanys
managementteamagainstouranswertothisquestion.Thus,byfocusingonalongerterm
horizon,weseelongertermopportunitiesthatinvestorsabsorbedbytheshortertermoverlook
and/orignore.
AstheU.S.FederalReservesquantitativeeasingprogramwindsdown,wehaveseenadeclinein
correlationswithinequitymarkets.Investorsarenowforcedtoevaluatetheriskandreturn
metricsofindividualsecurities.Thisissignificantlydifferentfromthebroaderriskonversusrisk
offmacromindsetthathasdominatedmarketsoverthelastfewyears.Inaddition,thecoupling
ofcashavailabilitywithanimprovementinconfidenceofcorporatedecisionmakers,CEOsand
CFOs,hasledtoaresurgenceinM&Aandotherresourceconversionopportunities.Theseactions
areapositiveforourconceptionofvalueinvesting,astheyilluminatetheundervalued
opportunitieswehaveidentifiedthroughourresearch.Inmarketenvironmentssuchasthe
currentone,itisnotsurprisingresourceconversionisacommonthemeformanyoftheFunds
topperformersduringthequarter.
Intheremainderoftheletterwewilldiscussanumberofinvestments,allamongthetop
contributorstoreturns,whichhighlighthowourdisciplinedinvestmentprocesshasenabledusto
unveilopportunitiesintheU.S.BankandTechnologysectors;andinresourceconversion
opportunities,withexamplesintheEnergyandRealEstatesectors.
Bank Investi ng and Downsi de Protecti on
TAMhasalonghistoryofinvestingincompaniesintheFinancialsector.Afterthemostrecent
globalfinancialcrisisouranalysisfoundregionalbanksmoreattractivethanmoneycenterbanks.
Thefocusonregionalbanksisdrivenbythreemaindimensions:
1.Attractivepricetotangiblebookbasiswithbetterreturnprofile
2.Wellcapitalized
3.Providedownsideprotectionwhenyouneeditmost
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TheFundsstrategyofinvestinginregionalbankshasbeenafrequenttopicofconversationwith
shareholdersasmoneycenterbankshavelowerpricetobookratios.Inourview,asimplepriceto
bookanalysisobscuressomeofthemostcompellingdifferencesacrossbanks.
ThechartbelowshowsfundamentalinformationfortheFundstworegionalbankholdings,Key
Bank(KEY)andComerica(CMA),displayedsidebysidewiththesameinformationforthreewidely
heldmoneycenterbanks(BankofAmerica(BAC),JPMorganChase(JPM)andCitigroup(C).Note
thatfromapricetobook(P/B)standpoint,thedifferencesamongthesebanks,rangingbetween
0.7and1.2,favorsthemoneycenterbanks.
ValueFund
FundamentalInformationonSelectedBanks
Company
Price
(P)
Book
Value
(BV)
Tangible
BV(TBV)
P/B P/TBV ROA
Tier1
Common
LevelIII
Asset%
S/E
Stressed
Capital
Ratio*
KeyBank 14.3 11.6 10.4 1.2 1.4 1.1% 11.3% 5.6% 8.0%
Comerica 50.2 40.7 37.1 1.2 1.4 0.9% 10.5% 2.0% 7.8%
BankofAmerica 15.4 21.2 14.0 0.7 1.1 0.4% 12.0% 11.7% 5.0%
JPMorganChase 57.6 55.2 42.2 1.0 1.4 0.7% 9.8% 27.8% 5.5%
Citigroup 47.1 66.8 56.9 0.7 0.8 0.5% 10.6% 20.7% 6.5%
Dataasof6/30/2014.ROAdataistrailing12months.
Source:CapitalIQandComprehensiveCapitalAnalysisandReview2014(*).
Wehavepreferredregionalbanksforthreereasons.First,atTAMwefocusonpricetotangible
bookvalue(P/TBV)asopposedtosimpleP/B.Tangiblebookvalueisabettermeasureofintrinsic
valueasitexcludesintangibleassetswhichwouldntcarrymuchvalueinliquidation.Asdiscussed
earlier,oneofthedimensionswefocusonasweevaluatecompaniesistheassets.Thevaluations
ofKEYandCMAaremuchclosertopeerslistedaboveonaP/TBVbasis.Evaluatingjustasingle
statisticmayprovidemisleadingconclusionswhenevaluatinganinvestment.Thus,wealso
considerhowwellacompanycancompounditsbookvalueovertime.Asseeninthetableabove,
bothKEYandCMAaregeneratinghigherreturnsonassets(ROA)thanpeers.Thisisimportantas
companiesthatgeneratehigherreturnsdeservepremiumvaluations.Again,wedistinguishamong
themanymetrics.WefocusonROAasthemeasureofROAdoesnotfavorcompaniesthatcarry
higherleverageandperhapshigherrisk.
Second,theTier1CommonEquityratiosforKEYandCMAcomparefavorablyagainstthemoney
centerpeers.ThismetricindicatesthattheFundsregionalbanksareaswell,ifnotbetter,
capitalizedthanmoneycenterbanks.Asdiscussedintheopeningparagraphsoftheletter,the
integrityofthebalancesheetisakeydimensiontoouranalysis.
Third,thechartabovealsoshowstheLevelIIIassetsforeachcompany.LevelIIIassetsarenot
tradedinliquidmarketssopricesaredeterminedusingacompanysinternalmodels.Thoseprices
couldbeentirelyaccurate,butasseenduringthefinancialcrisis,whenliquiditydriesup,asset
pricesofilliquidsecuritiescangetdistortedquickly.Wearentwillingtotakethatrisk.Byfocusing
onKEYandCMAsTBVandlowerexposuretoLevelIIIassets,wegainadditionalcomfortwiththeir
balancesheets.Theregulatorsagreewithourview.Thetableaboveshowsseverelystressed
capitalratiosfromtheFederalReservetestearlierthisyear.Thestresstestassumptionsare
extreme(deeprecession,highunemployment,50%declineinequitypricesand2001house
prices),buttheresultsdoprovideinsightintothestrengthoftheassetportfolios.
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KEYandCMAsaboveaverageresultsonthestresstestsareanotherindicationofthehigh
transparencyanddurabilityoftheirbalancesheets.
ThisanalysishasimportantimplicationsoverhowwemanagetheFundbecausewehaveahigh
levelofconvictiononthesecuritiesweselectandwescrutinizecompaniesalongseveral
dimensionsandfocusontheappropriatestatistics,.Oneofthekeyquestionsweaskourselves
whenmakinganinvestmentiswouldwebuymoreifthestockpricedeclined?Wementioned
earlierintheletterthatwecounttheassetswhendeterminingNAVs.Weneedtobesurethose
assetswillbetherewhenweneedthemmost,suchasintimesofmarketturmoil.Wewouldbe
reluctanttoaddtoourpositionsifwelostconfidenceinthevaluesoftheassets.Thisis
particularlyimportantwheninvestinginfinancialcompanieswheretheassetsvaluesareharderto
judge.
Insum,adiscounttobookvalueisntgoodenoughforusatTAMtoinvestinastock.Wealso
needconvictioninadequatedownsideprotection.Investingincompanieswithlowleverageand
highqualityassetshelpsusdevelopthatconviction.CMAandKEYfitourstrictcriteriaandhave
providedsolidreturnstoinvestorsthusfarandasbothgrowbookvalueplusdividendsinthe
future,weareconfidentthosereturnswillcontinue.
TheFundinvestedinthecommonstocksinKEYandCMAatdiscountstotangiblebookandwith
theexpectationthattheycouldgrowbookvalueatdoubledigitratesovertime.Giventhe
satisfactoryROAsandBVcompounding(trailingtwelvemonthBVgrowthincludingdividends:
CMA:12%,KEY:9.8%),wearehappywithhowourcompaniesareexecuting,despitepersistently
lowinterestratesandsluggishloangrowth.Whatsmoreimpressiveisthatourcompaniesare
abletogeneratehigherROAsdespitecarryingmoreexcesscapitalwhichweighsonreturns.Both
companiesarepositivecontributorstotheFundsperformanceyeartodate.
Val ue i n Technol ogy: Intel
SomeinvestmentsareNAVcompounders,i.e.,onesinwhichwewouldliketobuyandeffectively
ownforever.Otherinvestmentsaremoreopportunisticinnature.Theseareinvestmentswhich
wehopetoharvestfromtimetotime.Inbothcasesourinvestmentapproachremainsthesame.
Ourlongertermfocusontheentirebusinessanditsassetscanhelpusidentifyinvestmentswhere
theshorttermmindsetofthegallopingherdactuallycreatesopportunitiesforpatientand
thoughtfulinvestors.
AcaseinpointisIntel,awellfinancedleaderindesigningandmanufacturingmicroprocessor
chips.WeinvestedinIntelcommonstockearly2013whenthesharessoldoffmeaningfullyon
investorfearsofapoorneartermoutlookduetoweakPCenduserdemandandgeneralmacro
relatedweaknessinITspending.Inourview,theseshorterterm,moremacrorelatedconcerns
wereignoringIntelssolidfranchiseinmicroprocessorsforPCsandservers,whichithascontinued
toenhancethroughitstechnologicalandmanufacturingleadership.WhileIntelfaceschallengesin
tryingtocaptureshareinfastergrowingmobilemarkets,webelievethatthereissubstantialvalue
initscorebusinesses.Therearereportedlysome600millionPCsthatarefouryearsoldorolder
vs.typicalreplacementcycleataroundthreeyears.Giventheproliferationofnewapplications,
manyofwhichrequiregreatercomputingpower,anupgradeofone'sPC,particularlyinthe
workplace,eventuallybecomesanecessity.Foranyonewhohasexperiencedthefrustrationof
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tryingtoworkonanolderPC,watchingthehourglassorequivalentthereof,slowlyspinasan
applicationisloading,youknowwhatwemean!Further,wewerebeingpaidtowait,asthestock
paida4.3%dividend;theFundwasabletoacquiresharesataround4.6timesEBITDAand10
timesearnings.
ThestrengthsofIntelshowedthroughinitssecondquarter2014earningsreportwhichbenefitted
fromanimprovementinPCdemand,helpedbyupgradesdrivenbytheexpirationofsupportfor
WindowsXPandarealized11%increaseinpricinginitsdatacenterofferings,whereIntel
continuestobethemarketleader.Wedidtakeadvantageofariseinthestockpricetotrimthe
Fundspositionassharesroseapproximately30%yeartodateandmovedclosertoourNAV
target.
Resource Conversi on: A Val ue Creati on Theme
Managementteamshavemanyleverstopullfrominordertogeneratevalueforshareholders.At
TAM,weoftendescribethedifferenttypesofvaluecreationgenerally,underthecatchallphrase
resourceconversion,butitcanessentiallybedefinedasthemanywaysthatacompanyhasto
createvaluefortheunderlyingshareholder.Mergers,acquisitions,spinoffs,takeovers,asset
disposition,largedividendsorsharerepurchaseseachcanbeapowerfulmechanismtosurface
valuewhenitsnotfullyrecognizedbythemarket.Wehavefoundthattheoptimalsituationis
whenamanagementteamhasmanytoolstochoosefromandisabletocapturevaluefromthe
entiresetofchoices.Thisthemehasemergedinfullforceinourenergyholdings,whichafter
severalyearsofparticipatingintheindustrywidelandgrabnowarepositionedwithdiverse
portfoliosofassetsandessentiallytoomanyopportunitiestoefficientlydevelopwithinarational
capitalstructure.ResourceconversionwasakeydriverforthepositiveattributionfromtheFunds
energyholdingsinthethirdquarter,andalsoprovideduswiththeopportunitytoinitiatea
positioninWeyerhaeuser.
EnergyHoldings
EachoneoftheFundsIndependentEnergyandProduction(E&P)companyholdings,Apache,
DevonandEncana,movedforwardwithresourceconversionactivitiesinordertosurface
shareholdervalueandbetterfocustheirdrillingandproductionspending.Wewereabletobuild
eachofthesepositionswhenthecompaniesweredeployingcapitaltoacquireattractiveassets,
lookingthroughthemarketsskepticismonthetransformationofthesecompaniesandfocusing
onthevaluethatcouldbecreatedlongertermbyintegratingthesepropertiesandoptimizingthe
overallassetbase.WhatwascleartouswasthatthevaluationdisparitybetweenpureplayE&Ps
andmorediversifiedonesallowedustoacquiremanyattractiveassetswithinthesecompanies
essentiallyforfreeasthemarketfailedtorecognizethevalueoftheunderdevelopedassetsin
theirportfolios.Ineachcase,managementsabilitytorefocusonimprovingcapitalefficiencyand
abitofsuccessfulselfhelphastransformedtheprofileoftheseportfolioholdings.Wenotethat
wewelcomeandhavebenefittedfromtheriseofactivistinvestorspositionsinthesectorastheir
increasedpublicscrutinyhasacceleratedtheresourceconversionprocess.
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Encana wasapureplaynaturalgascompanywhenfrackingtechnologydramaticallyexpandedthe
supplyofnaturalgasontheNorthAmericanmarket.Thecompanyinitiallystruggledtooptimize
theircapitalallocationacrossaverybroadportfolioofassets,concentratedongas.Underthenew
leadershipofCEODougSuttles,thecompanyunveiledastrategicshifttofocusonitsfivecore
liquidsrichplaysinNorthAmerica.Suttles movedtomonetizeunderutilizedassetsincludingthe
saleoftheJonah,BigHornandEastTexaspropertiesforover$4billionandfocusonthehighest
returnassets.
DevonhasbenefittedfromthemergerofCrosstex EnergywithDevonsmidstreamassetstoform
theEnLink MLPwhichstrategicallyunlockedbillionsofdollarsofvaluethatwashiddeninthese
assets.Devonnowisfocusedonthedevelopmentandoptimizationofitsfivepremierassetplays,
includingitsprolificEagleFordassetsanditsPermianbasinacreage.Theseactionshave
transformedDevonfromaprimarilynaturalgasproducertoamorebalancedoilandgascompany.
ApacheistransformingitsholdingsfromadiversifiedarrayofE&Passetstoonethatismore
focusedonunconventionalonshoreliquidsplays.Weexpectthecompanytolivewithinitscash
flow,excludingtheCAPEXrequiredforitstwoliquidnaturalgas(LNG)projects,Wheatstoneand
Kitimat.Longerterm,wethinkApachewillatleastpartiallymonetizeLNGprojects,whichare
operatedbyChevron,tofocusonhigherreturnprojectsthatsupportproductionandcashflow
growth.Althoughnotexpectednorcentraltoourinvestmentthesis,therecentinvolvementfrom
JANAPartnersfurthervalidatesourviewthatsignificantvalueremainsunderappreciatedwithin
ApachesstillfairlydiverseportfolioofE&Passets.
Weyerhaeuser
TheFundinitiatedapositioninWeyerhaeuserasthecompanymovedtofinalizethedistributionof
itsWRECOhomebuildingsubsidiaryinanexchangeofferwithTriPointeHomesInc.
WeyerhaeuserisaRealEstateInvestmentTrustwithwoodproductsandwoodfiberbusinesses,
andthesecondlargestowneroftimberlandsintheU.S.ItisworthnotingthatWeyerhaeuserwas
sourcedwithTAMsRealEstateteamandisasolidexampleoftheabilityoftheFundtopullideas
fromacrosstheentireTAMresearchteam.TheReverseMorrisTrustdistributionofWRECOwas
structuredasanexchangeoffer,wherebyshareholderscouldchoosetoacceptsharesinthenew
TriPointe,ortoretaintheirinterestinWeyerhaeuser.WechosenottoindicateforTriPointe
shares,andwerepleasedthattheexchangeofferwasoversubscribedsothatweretainedourfull
positioninWeyerhaeuser.Theneteffectofthetransactionfromourperspectivewasaresource
conversioneventinwhichWRECOwastradedforalargerepurchasetransaction,representing
roughly10%ofWeyerhaeusersharesplus$700millionincash.
WeseetheremainingbusinessesofWeyerhaeuser,ledbyCEODoyleSimons,tradingata
substantialdiscounttoourestimatedNAVcombinedwithasolidoutlookofseculargrowth,self
helpmarginimprovementinitiativesandagoodwaytogainexposuretoarecoveryintheU.S.
housingmarket.
ValueFund
3Q 2014 T h i r d Av e nue F u n d s Por t f ol i o Ma na g e r Comme n t a r y
11
PosttheWRECOdivestiture,theremainingoperationsareTimberlands(about46%ofoperating
income),WoodProducts(35%)andCelluloseFibers(19%).Thetimberdivisionownsforestsinthe
U.S.,CanadaandUruguay,andrecentlyadded645,000acresofstrategicPacificNorthwestforest
withthepurchaseofLongviewTimberinJuly2013.TheLongviewacquisitionnotonlyprovides
operationalscaleandcostreductionopportunities,butincreasesWeyerhaeusersexposuretothe
lucrativeAsianexportlogmarkets,primarilyChinaandJapan.Weyerhauser isabletoaccelerate
theharvestonitsacquiredLongviewacreage,astheaverageageoftheacquiredtreeswasover
theoptimaltwentyfivetofortyyeargrowthcyclethecompanytargets.TheWoodProducts
operationsproduceLumber,OrientedStrandBoard(OSB)andEngineeredWoodProductsand
haveclearupsidecyclicalleveragetothenascentrecoveryintheU.S.singlefamilyhousingmarket.
TheCelluloseFiberdivisionproducesfluffpulpandspecialtypulpsusedinawidevarietyof
consumerendmarkets.Divisionmanagementisfocusedonreducingcostsandincreasing
manufacturingefficiencytocompeteinthiscyclicalindustry.
Lookingforward,weremainpleasedwiththecurrentportfolioandoptimisticaboutprospectsfor
futuregrowth.Welookforwardtowritingyouagainafterthefourthfiscalquarterof2014.Thank
youforyourcontinuedinterestandsupportoftheFund.
Sincerely,
TheThirdAvenueValueTeam
ChipRewey,LeadPortfolioManager
MichaelLehmann,PortfolioManager
YangLie,PortfolioManager
VictorCunningham,PortfolioManager
ValueFund
3Q 2014 T h i r d Av e nue F u n d s Por t f ol i o Ma na g e r Comme n t a r y
12
SmallCapValueFund
Por t f ol i o Manager Comment ar y
T HI RD AVE NUE
J UL Y 3 1 , 2 0 1 4
DearFellowShareholders,
WearepleasedtowelcomeChipReweytoThirdAvenuesSmallCapteamasafellow
shareholderandCoLeadManager,workingcloselywithCurtisJensen.Asoutlinedin
ThirdAvenueValueFundsletter,ChiphasalsojoinedthatteamasLeadPortfolio
Manager.TheseappointmentsnotonlyspeaktoChipsdecadesofsuccessful
experienceatlikemindedinvestmentfirms,butalsotohisembracingofacollaborative,
teamapproachtoinvesting,aswellastoMartyWhitmanstimetesteddeepvalue
philosophy.Chipevidencesallthecharacteristicsweseekinourteammates:an
independentandcuriousmind;ahighlevelofenergyandasenseofurgencyinajob
thatweareprivilegedtodoeveryday.Chipsadditionwillhelpustobuildonthe
terrificmomentumthatthisteamhasdeveloped.
Portfol i o Performance and Acti vi ty
TheThirdAvenueSmallCapValueFund(Fund)generateda0.6%returnoverthelast
fiscalquarter,anda0.5%returnyeartodate,significantlyoutperformingits
benchmarkduringbothperiods.
1
TheRussell2000ValueIndexreturned1.27%and
2.1%forthequarterandyeartodate,respectively.
FundManagementaddedfournewpositionsduringthequarter,thethreemost
significantofwhicharediscussedbelow.Weaddedopportunisticallyandselectivelyto
severalexistingFundpositionsandexitedeightholdings,thelargestofwhicharealso
detailedbelow.
Thefullyinvestedportfolioendedtheperiodwithseventyeightholdings.Thelargest
newpositionsincludedPattersonCompaniesCommonStock(Patterson),Standard
MotorProductsCommonStock(SMP)andCooperTireandRubberCommonStock
(Cooper).
Pattersonisthesecondlargestdistributorofdental,veterinary,andrehabilitation
suppliesintheU.S.Togetherwithitschiefcompetitor,HenrySchein,Pattersonenjoys
leadingmarketsharesacrossitsservedmarkets.Byvirtueofitsscale,Pattersonbrings
valuetoitscustomersbyprovidingturnkeyofficesolutionsandbydeliveringhighlevels
ofservice.Thecombinationofanagingdemographic,agrowingpetpopulation,more
ThirdAvenueSmallCapTeam
ChipRewey,CFA
CoLeadPortfolioManager
CurtisR.Jensen,
CoLeadPortfolioManager
TimBui,CFA
PortfolioManager
CharliePage,CFA
PortfolioManager
EvanStrain,CFA
ResearchAnalyst
Portfolioholdingsaresubjecttochange
withoutnotice.Thefollowingisalistof
ThirdAvenueSmallCapValueFunds10
largestissuers,andthepercentageofthe
totalnetassetseachrepresented,asofJuly
31,2014:
HCCInsuranceHoldings,Inc.,2.80%;JZ
CapitalPartnersLtd.,2.59%;Axiall Corp.,
2.50%;ProgressSoftwareCorp.,2.28%;
Syntel,Inc.,2.22%;Semgroup Corp.,2.11%;
Unifirst Corp.,2.08%;Genpact,Ltd.,1.99%;
WorldFuelServicesCorp.,1.95%;Emcor
Group,Inc.,1.94%
1 TheFundsone,fiveand10yearperformancewas17.20%,13.71%and7.35%,respectively.
ThirdAvenueSmallCapValueFundisofferedbyprospectusonly.Theprospectuscontainsmorecompleteinformation
onadvisoryfees,distributioncharges,andotherexpensesandshouldbereadcarefullybeforeinvestingorsending
money.Pastperformanceisnoguaranteeoffutureresults.Investmentreturnandprincipalvaluewillfluctuatesothat
aninvestorsshares,whenredeemed,maybeworthmoreorlessthanoriginalcost.TheFundsreturnsshouldbeviewed
inlightofitsinvestmentpolicyandobjectivesandqualityofitsportfoliosecuritiesandtheperiodsselected.M.J.Whitman
LLCDistributor.Ifyoushouldhaveanyquestions,orforupdatedinformation(includingperformancedatacurrenttothe
mostrecentmonthend)oracopyofourprospectus,pleasecall18004431021orgotoourwebsiteat
www.thirdave.com.Currentperformancemaybelowerorhigherthanperformancequoted.
TheRussell2000Indexmeasurestheperformanceofsmallcompanies.TheRussell2000ValueIndexmeasuresthe
performanceofthoseRussell2000companieswithlowerpricetobookratiosandlowerforecastedgrowthvalues.
3Q 2014 T h i r d Av e nue F u n d s Por t f ol i o Ma na g e r Comme n t a r y
13
SmallCapValueFund
physicalandoccupationaltherapies,withinternationalexpansionprovidesastablegrowth
backdropforthecompany.Wealsobelievethereisroomforoperationalimprovementsthatcan
enhancethereturnonthecompanysassets.Managementhas,steadilyreturnedcapitalto
shareholders,boththroughsignificantsharerepurchasesaswellasagrowingdividend.Withthe
sharesyielding5%to6%basedonfreecashflow,thecurrentsharepricereflectsanestimated
20%upsidetoourconservativeestimateofNetAssetValue(NAV).
FoundednearlyonehundredyearsagobyaLithuanianimmigrantwhosegrandsonisthecurrent
CEO,SMPtodayisanaftermarketautopartsmanufactureranddistributorspecializinginengine
managementandtemperaturecontrolproducts.Longerterm,webelievethattheincreasing
numberofoldermodelcarsontheroadwithevermorecomplexelectronicanddigitalsystems
createadefensiveandgrowingrevenuebaseforthecompany.ManagementaugmentsSMPs
growthbyacquiringsmallercompetitorstoexpanditsproductportfolioandhassteadilyimproved
thecompanysmarginsandreturnsthroughvariouscostinitiatives.LikePatterson,SMPhas
returnedcapitaltoshareholdersviasharerepurchasesandgrowingdividends withoutsacrificing
thebalancesheet.TheFundsentrypointapproximatedafreecashflowyieldof8%,reflectinga
potentialupsidetoourestimatedNAVofatleast20%.
Cooper,thefourthlargestlightvehicletiremakerintheUnitedStates,hadbeenthesubjectofa
failedtakeoverbidbyIndiasApolloTyre,adealthatunraveledlatelastyearowingtotheparties
inabilitytoresolveadisputerelatedtoCoopersChinesejointventure.Cooperappearstobewell
managed;inthepast10yearsoperatingmarginshavemorethandoubled,returnsoncapitalhave
spikedandthebalancesheethasbeensteadilydelevered.Thebusinessshouldbenefitfrom
improvingtirereplacementtrends,agrowingbusinessinChinaandasupportiverawmaterialprice
environment.RecentlyCooperannounceditsfirstOriginalEquipmentdealtosupplycertainFord
Motormodels.
BasedontheFundsinitialpurchases,equatingtoaboutfivetimesEBITDA,weestimatethatthe
publicmarkethaddiscountedthecompanyssharesbyasmuchas25%ormorefromour
conservativeestimateoffairvalue.Asanotherpointofreference,ouranalysissuggestsa
replacementcostforthecompanyscapacity($75to$100pertire)thatismorethantwicethat
valueimpliedbythecompanyscurrentmarketprice,enhancingthedownsideprotectionofthe
investment.
Notably,aresolutiontothedisputeinitsChinesejointventureislikelyvalueenhancingandis
expectedbeforeyearend.SeveralpartiesexpressedinterestinbuyingCooperlastyear,opening
upthepossibilitythatthecompanybecomesanattractivepartnerforaglobaltirecompany
lookingtogainscaleeitherintheUnitedStatesorChina.
TheFundrealizedanumberoffavorableoutcomesamongitsmajordispositionsduringtheperiod.
TheseincludeBigLots,CompassMinerals,Sensient TechnologiesandSusser Holdings,eachof
whichwereamongthebestcontributorstoperformanceinrecentperiods.Theoutperformance
ledustoharvestgainsinthesepositionswherevaluationsgoteitherinlinewithoraheadofour
fairvalueNAVestimates.
3Q 2014 T h i r d Av e nue F u n d s Por t f ol i o Ma na g e r Comme n t a r y
14
SmallCapValueFund
BigLots,oneofthenationslargestcloseoutretailersandoperatingmorethanonethousandand
fivehundredstoresintheU.S.andCanada,respectively,initiallygainedourattentionasa
turnaroundstory.Despiteweaktoplineresultsduringthelastcoupleofyears,wewereattracted
tothecompanysrelativelystablemargins,evenduringrecessionaryperiods,andhighlycash
generativeoperations.Webelievedtheproblemsinthebusiness,suchasmerchandisingand
sourcing,werelikelytemporaryandfixable,thatthecompanyhadnotlostitscorecustomeranda
newCEOhadadecentchanceofsuccessintheturnaround.Managementsrestructuringdoes
appeartobegainingtractionthisyearandthesharepricehasrespondedaccordingly.Skepticalof
apersistentlydifficultretailenvironmentandmindfulofwhatweviewedasafullvaluation,
however,FundManagementsolditsshares,realizinganIRRof42%.
FundManagementexiteditspositioninCompassMinerals,oneofNorthAmericaslargestand
lowestcostsaltproducers,followingvastlyimprovedbusinessconditionsfromtheinvestments
inceptioninlate2011,atavaluationthatapproximatedthehighendofourestimateofNetAsset
Value.TheinvestmentproducedanannualizedIRRof17%.
Sensient Technologies,amanufacturerofcolors,additives,flavorsandfragrancestoawidevariety
ofindustries,benefitedfromsteady,albeituninspiring,operationalresultsthateventuallycame
underquestionfromanactivistshareholder.Sensients sharepricerespondedpositivelytothe
presenceofthedissidentshareholderandwhenthesharepricereachedthehighendofourNAV,
weexitedourposition,resultinginanIRRof23%.
Asnotedinlastquartersletter,FundManagementelectedtosellitspositioninSusser Holdings
whenthatcompanybecamethesubjectofatakeoverbyEnergyTransferPartners.The
investmentthesisinSusser,agrowingconveniencestorechaininTexas,wasbasedonitsunique
LaredoTacofoodserviceoperation,exceptionalmanagementteam,andownershipinavaluable,
publiclylistedfueldistributionfranchise.Saleoftheinvestment,onewithanunusuallyshort
tenure,wascompletedthisquarterandresultedinanIRRof81%.
Outl ook
Oneofthecommonquestionsourfellowshareholdershaveaskedrecentlyiswhetherwearestill
abletofindgoodvalueinvestmentsgiventheoutperformancebysmallcapitalizationstocks
relativetootherassetsandespeciallyinviewoftheirrelativelyrichvaluations.Theshortansweris
absolutely.Whilecurrentearningstrendsareimportant,theyarenotourstartingpoint.Our
processisrootedinevaluatingtheentirebusinessenterprise,essentiallycountinguptheassets
andascertainingafairvalueNAV.Fromthereweassessthebalancesheetandcreditprofileofa
company,toensurethecompanyhasthefinancialabilitytomeetitsobligationsandinvestment
opportunities,andtheabilitytosurvivemarketstorms.
Stocksgetmispricedbythepublicmarketsforvariousreasons,including,forexample,investor
shorttermism,aperceivedlackofcatalystsoranignoranceofinherentassetvaluesthatmaynot
befullyexploited.Ourindepth,fundamentalresearchhelpstoseparatethisnoisefromlonger
termfundamentalvaluewhileourfocusontheabilitytocompoundNAVprovidesadistinction
betweenhigherqualitycompanies,andthosethatcouldbeinseculardeclineorothervalue
traps.
3Q 2014 T h i r d Av e nue F u n d s Por t f ol i o Ma na g e r Comme n t a r y
15
AstheU.S.FederalReservesquantitativeeasingprogramwindsdown,wehaveseenadeclinein
correlationwithinequitymarkets.Correlationsacrossstocksaredecliningasdispersioninthe
performanceacrossstocksisincreasing.Equitymarketsappeartobelessdrivenbythebroadrisk
on/riskoffinvestormindsetthathasbeendominantsincetheonsetoftheglobalfinancialcrisis.
Instead,overthelastfewmonths,fundamentalcharacteristicsofcompaniesarehavingmore
influenceonstockreturns.Therenewedinterestofinvestorsinfundamentalsbodeswellforthe
Fund,asourinvestmentprocessthrivesintheseenvironments.
Thecurrentglobaleconomicandgeopoliticalsituationremainsfraughtwithuncertainty.We
recognizethisandindoingsofocusoureffortsonthosevariablesthatwecancontrol,namely
thevaluepropositionandqualityofthebusinessesinwhichtheFundinvests.Inthisvein,weseek
companiesthatarewellmanaged,haveasustainablecompetitiveadvantage,sensiblebalance
sheetsandawidegapbetweenstockpriceandourconservativeestimatesofNAV.
Whileweacknowledgethatfutureequitymarketreturnsmaybemoresubduedthanthoseofthe
pastfiveyears,weviewequitiesfavorablyandourdifferentiatedportfolioinparticular,wherethe
resultswebelievewillbemuchmoretiedtoindividualcompanyresultsthantotheresultsofthe
generalmarket.
Welooktothefuturewithconfidence,knowingthat:
o Wehavethetightestprocessandhighestqualityportfolioeverinthestrategy.Chips
additionbringsevenmoreexperience,moredepthoncompaniesandindustriesand
potentialfornewbestpracticesfromalikemindedfirmwehaveknownfordecades.
o Ourprocesstranscendsanyoneindividual;oursystemofchecksandbalancesmakessure
allvoicesareheardandquestionsansweredwhilemaintainingefficiencyinprocessing
ideas.
o Theevidenceofourimprovementsduringthepastyearinourprocessandportfoliois
deliveringattractivereturnsthisyear,particularlywhenviewedinthecontextofthe
investmentrisksassumedandtheresultantreturnperunitofriskthatwebelieve and
thedatasupports iswellinexcessoftheindex.
WethankyouforyoursupportoftheFundandlookforwardtowritingtoyouagainnextquarter.
Inthemeantimepleaseletusknowshouldyouhaveanyquestionsorcomments.
Sincerely,
TheThirdAvenueSmallCapValueTeam
ChipRewey,CoLeadPortfolioManager
CurtisJensen,CoLeadPortfolioManager
TimBui,PortfolioManager
CharliePage,PortfolioManager
SmallCapValueFund
3Q 2014 T h i r d Av e nue F u n d s Por t f ol i o Ma na g e r Comme n t a r y
16
RealEstateValueFund
Por t f ol i o Manager Comment ar y
T HI RD AVE NUE
J UL Y 3 1 , 2 0 1 4
DearFellowShareholders,
WearepleasedtoprovideyouwiththeThirdAvenueRealEstateValueFunds(Fund)
reportforthequarterendedJuly31,2014.
Portfol i o Acti vi ty
DuringthequartertheFundaddedtosomeofitscoreholdings(Weyerhaeuser,
Westfield,andCheungKong),fundeditsproratashareofColonialsrightsoffering,and
providedexitfinancingforIVGImmobilien asitmovedclosertoemergingfrom
bankruptcy.TheFundalsoeliminatedthreeRealEstateInvestmentTrusts(REITs),
(Derwent London,FederationCentres,andScentre Group)andonerealestaterelated
company(RayonierAdvancedMaterials)forvaluationpurposes,aswellasanother
position(ConsolidatedTomoka)forportfoliomanagementreasons.Theproceedsfrom
thesesaleswereprimarilyreallocatedtocompanieswithstrongtiestotheU.S.
residentialmarkets,includingsomeexistingholdings(PNCTARPWarrantsandStarwood
WaypointCommon)andtwonewpositions(Realogy CommonandZions Common).
WeyerhaeuserCommonwasincreasedpriortothecompanyseparatingitshomebuilding
businessviaasplitofftransactioninlateJuly.Inthattransaction,theFundelectedto
foregoreceivingsharesinthehomebuildingentity(nowlistedseparatelyasTriPointe
Homes),essentiallyincreasingitsinvestmentinthecompanystimberlandportfolioand
otherremainingassets(woodproductsandcellulosefibers).BothWeyerhaeuserandTri
PointeHomesseemwellpositionedasstandalonecompaniesthatshouldcontinueto
benefitfromarecoveryinU.S.housing(morebelow).However,atthetimeofthe
transactionWeyerhaeuserCommontradedatalargerdiscounttoourestimateofprivate
marketvalue,whileofferingsuperiorgrowthprospectsandresourceconversionpotential
relativetoTriPointecommonstock.Followingtheadditionalinvestment,Weyerhaeuser
CommonisthelargestsinglepositionintheFund.
TheFundspositioninWestfieldCommonwasincreasedduringthequarteraheadofa
corporaterestructuring.Thecompanypreviouslyownedaworldclassportfolioofmalls
inAustralia,theU.S.,andtheU.K.andalsocontrolledsomeofthepremierretailled
developmentprojectsinseveralgatewaycitiesglobally.Duringthequarter,Westfield
receivedthenecessaryapprovalstospinoffitsAustralianportfoliointoScentre Group,a
newlyformedAustralianREIT.Afterthespin,theFundelectedtosellitsnewpositionin
Scentre Commonasittradedatapremiumtonetassetvalue(NAV).TheFundretained
itsinvestmentinWestfieldCommon.Therenamedcompany(WestfieldCorp.)ownsthe
U.S.andU.K.mallportfoliosandhasanopportunitytomeaningfullyincreaseitsNAVover
thenextthreetofiveyearsasitdeliversitsmajordevelopmentandexpansionprojects,
including:theretailmallattheWorldTradeCentersiteinNewYorkCity,theexpansionof
theWestfieldLondonmallinWestLondon,abrownfielddevelopmentinMilan,andthe
continuedredevelopmentoftheCenturyCitysubmarketofLosAngeles.
ThirdAvenueRealEstateTeam
MichaelWiner
CoLeadPortfolioManager
JasonWolf,CFA
CoLeadPortfolioManager
RyanDobratz,CFA
PortfolioManager
LarryHedden,CFA
ResearchAnalyst
MohammadTabibian
ResearchAnalyst
KonYaoKwek
ResearchAssociate
Portfolioholdingsaresubjecttochange
withoutnotice.Thefollowingisalistof
ThirdAvenueRealEstateValueFunds10
largestissuers,andthepercentageofthe
totalnetassetseachrepresented,asofJuly
31,2014:
WeyerhaeuserCo.,4.74%;CheungKong
Holdings,Ltd.,4.57%;NewhallHoldingCo.
LLC,ClassA,4.38%;ForestCityEnterprises,
Inc.,ClassA,3.78%;SongbirdEstatesPLC,
3.45%;WestfieldCorp.,2.76%;Hammerson
PLC,2.71%;Lowe'sCos,Inc.,2.71%;First
IndustrialRealtyTrust,Inc.,2.55%;
Wereldhave NV,2.40%
3Q 2014 T h i r d Av e nue F u n d s Por t f ol i o Ma na g e r Comme n t a r y
17
RealEstateValueFund
TheFundtookadvantageofmarketvolatilitytoincreaseitsinvestmentinCheungKongCommon.
CheungKongisaHongKongbasedholdingcompanywithsubstantialinvestmentsinrealestate,
infrastructure,power,andotherprivateequitylikeinvestmentsthroughits50%ownershipstake
inseparatelylistedHutchisonWhampoa.SimilartoWeyerhaeuserandWestfield,CheungKong
hasradicallytransformeditsbusinessmodeloverrecentyears.InCheungKongscaseithas
activelymanageditsportfolioofinvestmentsbysellingdownexposuretoyieldorientedassetsin
Asia(ports,commercialrealestate,etc.)andreinvestedtheproceedsintorealassetsinEurope
onanopportunisticbasis.Theseinvestmentswillultimatelybestreamlinedintomoreefficient
andproductiveplatformsoverthenextfewyears.Itisourviewthatasthemanagementteamsof
allthreebusinessesexecuteontheirforwardthinkingbusinessplans,theearningspowerofeach
companywillmeaningfullyexceedexpectationsandresultinindustryleadinggrowthinNAVwhen
viewedonapersharebasis.
TheFundalsoincreaseditspositioninColonialCommonduringthequarter.Ashighlightedin
previousquarterlyletters,Colonialisarealestateoperatingcompany(REOC)basedinSpainthat
ownsahighqualityofficeportfolioinEurope,withholdingsinMadrid,Barcelona,andParis.
Previously,Colonialhadbeensaddledwithunsustainablelevelsofdebt.Topaydownthose
liabilitiesandrightsizeitscapitalstructure,thecompanycompleteda1.3billionrightsoffering
duringthequarterinwhichtheFundparticipatedbyexercisingtheColonialRightsithadreceived
afterpurchasingColonialCommonearlierintheyear.Furthermore,theFundalsopurchased
additionalColonialRightsastheybecamefreelytradableandultimatelyoversubscribedtothe
offering.ColonialCommonisnowatoppositionintheFundandwebelieveitofferssignificant
embeddedgrowthpotentialas(i)theportfolioiscurrentlymorethan20%vacant;withitsrecently
strengthenedfinancialpositionandimprovingmarketconditions,thecompanyshouldbeableto
increaseoccupancy,cashflowsandunderlyingvalue;and(ii)thecompanycouldacceleratethe
monetizationofitsdeferredtaxassetasitboostsprofitsofitsownportfolioandthrough
additionalacquisitionsasaconsolidatorintheSpanishofficemarkets.
IVGisanotherportfoliopositionthatofferssignificantgrowthpotential.Asoutlinedinprevious
letters,IVGisaREOCbasedinGermanythatownsoneofthelargestofficeportfoliosinthe
country.Italsohasalargeassetmanagementplatformandtherightstodevelopoilandgas
storagefacilitiesinNorthernGermany.LikeColonial,IVGownedvaluableassets,buttheywere
encumberedbytoomuchdebt.IVGannouncedinearly2013thatitwasgoingtobeunableto
refinanceanupcomingmaturity.ThisledtoadramaticselloffofallsecuritiesacrossIVGscapital
structure(debtandequity).Afterconductingextensiveanalysisofthecompanysassetsand
capitalstructure,wedeterminedthattheIVGConvertibleNotesshouldbethefulcrumsecurity
(i.e.,themostseniorissueinthecapitalstructuretoparticipateinareorganization).TheFund
ultimatelypurchasedalargestakeinIVGConvertibleNotesandparticipatedwithother
ConvertibleNoteholdersinanadhoccommitteetonegotiatewiththecompanyandother
stakeholderstoreachanoutofcourtrestructuring.Aconsensualdealwithallstakeholderscould
notbereached,forcingthecompanytofileinsolvencyproceedingsinGermany.Incourt,the
companyproposedadebtforequityrestructuringplanthatgranted80%oftheequityto
syndicatedlendersand20%oftheequitytoconvertiblebondholders.Thepreferredequityand
commonequityreceivednothingpursuanttotheplanandwereeffectivelywipedout.Theplan
3Q 2014 T h i r d Av e nue F u n d s Por t f ol i o Ma na g e r Comme n t a r y
18
wasapprovedbythenecessarystakeholdersaswellasbytheInsolvencyCourtinlateJuly.
ConsequentlytheFundspositionintheIVGConvertibleNoteswillbeconvertedtocommon
equityinSeptember.Afterthedebtforequityswap,IVGwillbeawellcapitalizedREOCwithan
opportunitytomeaningfullyincreasethecashflowsasitleasesupitsportfolio,whichisonly80%
leasedtoday.Thecompanycouldalsoseekstrategicalternativesforitsremainingassetstorealize
thehighestandbestuseoftheselegacyinvestments.
TheFundinitiatedtwonewpositions:Realogy CommonandZions Common.Realogy isthe
preeminentandmostintegratedproviderofresidentialrealestateservicesintheU.S.Asthe
nationslargestownerandfranchiserofresidentialrealestatebrokerages,ithasmorethan13,500
officesand247,000salesassociates.Toputthescaleofthecompanysplatforminperspective,
thecompanywasinvolvedinapproximately26%ofbrokereddomesticexistinghomesale
transactionvolumesin2013,representingamarketsharetwotimeslargerthanthatofRe/Max
Holdings,itsnearestcompetitor.Duringthequarter,thecompanysstockdeclinedbymorethan
20%followingreducedexpectationsforexistinghomesalesgrowthin2014,allowingtheFundto
establishthepositionatanattractiveprice.Whiletheshorttermoutlookmightbeuncertain,the
prospectsofRealogy continuingtoincreaseitsprofitabilityoverthelongtermseempromising.
Forinstance,existinghomesalesintheU.S.wereonly5.1millionin2013,wellbelowacyclehigh
of6.5millionin2005and15%belowpostcrisispeaksetinmid2013.Existinghomesalesasa
percentageoftotalinventoryarealsoatalltimelowsandthereexistssignificantpotentialupside
tothehousingrecovery,consideringtenyearsofpopulationgrowth,immigration,andhousehold
formation.Ashomesalesimprovefromsuchdepressedlevels,thebusinessshouldbecomemuch
moreprofitable.Andtheembeddedearningspowerisquitesubstantialwhenconsidering
Realogys cashflowismorethan30%belowpeaklevels.Thecompanyalsohassubstantial
deferredtaxassetsintheformofa$2.1billionnetoperatinglosscarryforwardthatwillminimize
futurecashtaxpayments.Uponachievingitstargetleveragelevels(threetimesdebttoEBITDA),
thecompanyislikelytoexplorevariouswaysofreturningthatcapitaltoshareholdersbyeither
institutingadividendorsharebuybackprogram.
Zions isabankholdingcompanythatconductsbankingoperationsthroughitseightsubsidiary
banksthatcontrolmorethan$45billionofdepositsintheWesternregionoftheUnitedStates.
TheCompanyhasmorethan50%ofitsassetsinresidentialloans,commercialloans,orloans
securedbyrealproperty.Zions isknowntohaveoneofthepremierfootprintsinthebanking
spacewithabout80%ofitsbusinessbeingderivedfromUtah,Texas,andcoastalCalifornia.Zions
alsocontrolsoneofthetopsmallbusinesslendingfranchisesinthecountry.Zions Commonhas
beentradingatadiscounttoitspeersandbookvalueasthebankhashadameaningfulshareof
itscapitalinvestedincollateralizeddebtobligations(CDO),whichrecentlyledtoZions failingthe
Fedsstresstest.Additionally,Zions isaveryassetsensitivebank,soitsearningshavebeen
disproportionatelyimpactedinthislowinterestrateenvironmentrelativetosomeofitspeers
whogenerateagreatershareofearningsfromfeeincomeversusinterestincome(asnetinterest
marginshavebeensqueezed).TheFundpurchasedZions Commonafterthecompanydisclosed
positivedevelopmentsincluding(i)theCDOportfoliohasbeenfurtherreducedduringthesecond
quarter,(ii)thecompanycompleteda$550millionfollowonequityoffering,and(iii)thecompany
haspassedthestresstestandtheFedhasapprovedthecompanysrevisedcapitalplan.After
thesedevelopmentssettlein,itisourviewthatZions willonceagainbeconsideredawell
RealEstateValueFund
3Q 2014 T h i r d Av e nue F u n d s Por t f ol i o Ma na g e r Comme n t a r y
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capitalizedbankwithoutsizedgrowthprospectsgivenitsgeographicfootprint. Asmanagement
takesstepstogenerateadditionalfeeincome,realizeotherefficiencies,andboostprofitability,the
discounttopeersandbookvalueshouldclose.Ifnot,itisnotinconceivablethatZions wouldbea
highlydesirableacquisitioncandidateforalargerbankorfinancialinstitutionthatcouldincrease
theproductivityoftheCompanysdepositbasewhilealsogainingexposuretosomeofthemost
highlysoughtafterbankingmarketsintheUnitedStates.
Resi denti al Markets
AfteraddingtotheinvestmentsinPNCTARPWarrantsandStarwoodWaypointCommon,aswell
asinitiatingpositionsinRealogy CommonandZions Common,theFundhasapproximately26%of
itsnetassetsinvestedinthecommonstocksofcompanieswithstrongtiestotheUSresidential
markets.Theseconsistofwellcapitalizedcompaniesinvolvedinnearlyeverylinkintheresidential
valuechain.Currentinvestmentsincludelanddevelopment(NewhallLand),timber
(Weyerhaeuser,Rayonier),buildingmaterials(Lowes),brokerage(Realogy),mortgagefinancing
(Zions,PNC,WellsFargo),mortgageoriginationandservicing(PHH),multifamilyrental(Post
Properties),singlefamilyrental(StarwoodWaypoint),seniorhousing(Brookdale),andurban
development(ForestCity).
WerecognizethattherehasbeensomerecentchoppinessintheU.S.residentialmarketsand
mostoftheaforementionedcompanieshavebeenimpactedasaresult.Oneissueisthatnew
homepurchaseshavefallenbyapproximately12%yearoveryearandmortgageapplicationshave
alsodeclinedbyabout30%duringthefirsthalfoftheyear.Alsoofconcernisthatannualized
homestartsintheU.S.remainbelowthe1.07millionlevelreachedbackinOctober2013.
However,weviewthispullbackasaspeedbumpinwhatshouldotherwisebeamultiyear
recoveryinU.S.housingwiththeprimaryupsidefromherestemmingfromarecoveryinvolumes
asopposedtopricing.ThisviewisbasedonFundManagementsbeliefthat:
1) theimplementationofQualifiedMortgageStandards(QMS)atthebeginningoftheyear
ledtoweaknessinmortgageactivityandhomesalesbuttheuncertaintyofQMShas
largelybeenremovedasthenewguidelineshavebeenintegratedintotheprocessat
everymajorlenderand
2) thattheexcessinventorythatwasbuiltduringthe20032006timeframe(morethantwo
millionannually)haslargelybeenabsorbednowasoccupancyratesforapartmentshave
climbedtoalltimehighs(95%)andinventoriesofforsalehomeshavefallentohistorically
lowlevels(fourmonthssupply)whichhasledtoasharprecoveryinhomepricesona
nationalbasis(upbynearly20%overthepasttwoyears).Therefore,asnewhouseholds
areformedfromthispointforwardtherewillneedtobemorenewconstruction,whether
singlefamilyhomesormultifamilydwellings,tomeetthisnewdemand.Basedupon
positivehouseholdformations,positivenetmigration,secondaryhomes,andnatural
obsolescencethereseemstobedemandforroughly1.5to1.6millionhomestarts
annually,whichiswellabovecurrentproductionlevels.Therefore,asnewconstruction
activitycontinuestoworkitswaybackfromthemultidecadelowlevelsreachedin2009
(539,000)tothislongtermneedof1.5to1.6millionunitsannually,ourportfolioof
companies,whichareuniquetomostglobalrealestatefunds,standstobenefitatnearly
everystageintheprocess.
RealEstateValueFund
3Q 2014 T h i r d Av e nue F u n d s Por t f ol i o Ma na g e r Comme n t a r y
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WhiletheFundhassubstantialcapitalinvestedincompaniestiedtoU.S.housing,investmentsinU.S.
homebuildersareconspicuouslymissingfromtheportfolio.Weevaluateeachcompanyonacaseby
casebasis,and,generallyspeaking,webelievethatpricesforU.S.homebuildercommonstocksalready
reflectafullrecovery(1.5to1.6millionhomestarts).Ontheotherhand,commonstocksof
companiesprovidinginputstothehomebuildingprocesscontinuetobeattractivelyvaluedandhave
substantialroomforimprovementasconditionsstrengthenfurther.Wearetakingfulladvantageof
theFundsflexiblemandatetoinvestinabroaduniverseofrealestatesecuritiesthatstilloffer
considerablevaluebothontheresidentialandcommercialside.
Attheendofthequarter,theFundhadapproximately35%ofnetassetsinvestedincommercialreal
estatecompanies,mostofwhichcontrolverystrategicdevelopmentpipelinesthatshouldprovetobe
quitevaluableasdemandfornewbuildingreturns;approximately26%ofnetassetsisinvestedinU.S.
residentialrelatedcompaniesasoutlinedabove;nearly20%ofnetassetsisinvestedinspecial
situationinvestmentssuchasrecapitalizationsandM&Acandidates;andtheremaining19%isincash
andcashequivalents.TheFundscashbalanceishigherthanhistoricalaverages,mostlyduetorecent
inflowsaswellasmorematureinvestmentsbeingsold.
HigherthannormalcashbalancesnaturallyleadtothequestionabouttheFundscapacity.Whilewe
takethisissueseriously,therecurrentlyarenoplanstoclosetheFundtonewinvestors.Asnotedin
previousquarterlyletters,wehavehistoricallyallowedcashbalancestoaccumulateduringperiods
whensecuritiesvaluationsdonotwarrantnewpurchases.Holdingdrypowderandpatientlywaiting
formorereasonablepriceshasworkedforusinthepast.LongterminvestorsintheFundmayrecall
whentheFundwasclosedtonewinvestorsin2005.Atthattime,theFundsinvestableuniversewasa
fractionofwhatitistoday,giventheresurgenceinthesecuritizationofrealestateandtheFunds
flexiblemandatewhichallowsustoexploitopportunitiesincommonstocksoftraditionalrealestate
companiesaswellasrealestaterelatedcompaniesandrealestatedebtsecurities.Weestimatethe
investableuniverseisnowinexcessof$3trillion(excludingdebtsecurities).
Wearecommittedtocontinuingoureffortsofscouringourexpansiveuniverseforsuitable
investments.OurT2portfoliocontinuestoexpandaswefindinterestingcompaniesthatwedesire
toincludeintheportfolio,butatlowerprices.Weperformrigorousfundamentalanalysisoneach
potentialinvestment,whichallowsustoquicklydeployintonewpositionsduringmarketdislocations.
Previousshareholderlettershavehighlightedouradvancepreparationandabilitytodeploysignificant
capitalinashortperiodoftime.MembersoftheFundmanagementteameachhavesignificant
portionsoftheirinvestiblepersonalassetsintheFund.Wearenotwillingtocompromisereturnsfor
thesakeofremainingfullyinvestedandtrustthatthevastmajorityofourfellowshareholdersare
likeminded.Whilewepursueamerehandfulofsuitableinvestments(wedontneeddozens),wewill
waitpatiently,protectourdownside,andthenbuywithconvictionwhenopportunitiesappear.
Wethankyouforyourcontinuedsupportandlookforwardtowritingtoyouagainnextquarter.
Sincerely,
TheThirdAvenueRealEstateValueTeam
MichaelWiner,CoLeadPortfolioManager
JasonWolf,CoLeadPortfolioManager
RyanDobratz,PortfolioManager
RealEstateValueFund
3Q 2014 T h i r d Av e nue F u n d s Por t f ol i o Ma na g e r Comme n t a r y
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InternationalValue
Por t f ol i o Manager Comment ar y
T HI RD AVE NUE
J UL Y 3 1 , 2 0 1 4
DearFellowShareholders,
Inthemostrecentquarter,theThirdAvenueInternationalValueFund(Fund)established
threenewpositionsandeliminatedtwopositions.BeforereviewingquarterlyactivityI
wouldliketosharesomeinsightsabouthowweuse(andhowwedontuse)
macroeconomicinformationinourinvestmentprocess.Asfundamentalbottomup
valueinvestorsitisoftencleartoourinvestorsthatwedonotproducemacroeconomic
forecasts.Whatmaybelessclearisthatthisdoesnotimplythatweareobliviousto,or
purposefullyignore,macroeconomicdevelopments.Macrohastwoprimaryrolesinour
investmentprocess.Thefirstoneisasatooltodeterminethesensitivityofour
investmentthesestoavarietyofmacroeconomicenvironments.Thisallowsustoreject
investmentopportunitiesforwhichourthesisplayingoutwouldrequireaveryspecificset
ofconditions.Thesecondoneisasafrequentsourceofinvestmentopportunities.Dire
economicoutlookshaveindeedbeenoneofourteamsmostfruitfulhuntinggrounds
overtheyears.Troublingmacroeconomicsituationscaneasilyshakeinvestors
(speculators)focusedontheneartermoutlookandparalyzethosewhorequireahigh
levelofconfidenceintheirabilitytoforecastthemacroeconomicfuture.Truthbetold,
ourhabitofseizingopportunityinthefaceofdiremacroeconomiccircumstanceshas
occasionallyappearedfoolhardyintheshortterm.Yet,theFundhasmademany
profitableinvestmentsinthiswayinthepast,andinfactthetopicofmacrodislocations
alsofactorsineachofthethreenewinvestmentswediscussindetaillateron.
ThemodusoperandioftheThirdAvenueInternationalValueFundinvestmentteamisto
identifybusinessesthatcanincreaseandcompoundintrinsicbusinessvaluethrougha
varietyofmeans assetdisposals,businesscombinations,industryattritionorother
formsofindustryconsolidation,reinvestmentswithinthebusinessatattractiveratesof
returnorsimplythroughearnings,justtonameafew.MartyWhitmanparlancecaptures
allofthesemethodsundertheumbrellaofwealthcreation.Aspartofthistask,we
intendtoidentifybusinessesandcompaniesthatcancompoundvalueinawiderangeof
economicenvironments,primarilymeaningtheydontneedanenablingtailwind.With
thisasourmission,itbecomescriticalforustoconsidervariousformsofdire
developmentsandtheimpacttheymayhaveonthebusinessinquestion.Wetypically
considerawidebandofinvestmentoutcomesanddevelopathoughtfulconsiderationof
businessriskandreturnacrossarangeofmacroeconomicscenarios.Theinsightsgained
fromthisefforthaveasignificantimpactonbothoursenseofbusinessvaluationandrisk
andiscompletelydistinctfromengaginginanytypeofmacroeconomicprediction.
Further,oursenseofthemacroisintegralinourattempttoavoidamechanicalor
formulaicapproachtoestimatingbusinessvalue.Saiddifferently,webelieveittobe
insufficienttoestimatethevalueofabusinesstodaywithoutgivingseriousconsideringto
theenvironmentinwhichweareviewingit i.e.,whichcircumstanceshavegiven
ThirdAvenueInternationalTeam
MatthewFine,CFA
LeadPortfolioManager
JamesHounsel
ResearchAnalyst
JaneSpiegel
ResearchAnalyst
HarrisonVigersky
ResearchAnalyst
Portfolioholdingsaresubjecttochange
withoutnotice.Thefollowingisalistof
ThirdAvenueInternationalValueFunds10
largestissuers,andthepercentageofthe
totalnetassetseachrepresented,asofJuly
31,2014:
StraitsTradingCo.,Ltd.,8.94%;
WeyerhaeuserCo.,4.48%;WhiteMountains
InsuranceGroupLtd.,4.30%;Hutchison
WhampoaLtd.,3.99%;Telefonica
DeutschlandHoldingAG,3.50%;Rubicon,
Ltd.,3.49%;MunichRe,3.37%;Capstone
MiningCorp.,3.36%;Pargesa HoldingS.A.,
3.35%;DaimlerAG 3.24%
3Q 2014 T h i r d Av e nue F u n d s Por t f ol i o Ma na g e r Comme n t a r y
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InternationalValueFund
risetothecurrentvaluation.Forexample,inwaysspecifictoindividualbusinesses,lowinterest
ratesmaycauseperversionsbyprovidingaprofoundtailwindenablingpoorlyfinancedcompanies
tothriveandquestionableassetstobecoveted.Conversely,avarietyofotherwiseterrific
businessesmaybewitnessingdepressedoperatingperformanceasaresultofhistoricallylow
interestrates.Onefinancialservicesinvestmentwelaterdiscussindetailfitsthisdescriptionquite
well,webelieve.Inthistypeofmacroenvironment,onecaneasilybedeceivedbylargeapparent
discountstonetassetvaluetotheextenttheyhavenotconsideredwhetherchangesinadynamic
macroeconomicenvironmentwilldiminishoreliminatetheirperceiveddiscountnotthroughshare
priceappreciationbutviadeclinesinunderlyingassetvalue.Weofcourselovetopayhuge
discountstoourestimateofbusinessvaluebutwouldinprincipleprefertopayrelativelysmaller
discounttocheapunderlyingassetvaluesthanpayalargenominaldiscounttoinflatedasset
prices.Theideaisessentiallytoidentifyopportunitiestobuybusinessesatpricesthatwillallowus
toearnasatisfactoryreturnevenwithoutanimprovementinoperatingperformanceand
simultaneouslyhavetheoddsofimprovedoperatingperformanceandappreciationofthe
underlyingassetvaluestiltedsignificantlyinourfavor.Thisisessentiallythemechanismbywhich
themacroinfluencesmarginofsafety,simultaneouslyincreasingsafetyofonescapitaland
prospectivereturns.Inotherexamplesitmaybethatmacroorindustryconditionshave
depressedunderlyingassetvaluesasaresultoftheneartermoutlook.Ourcontainerterminal
investmentdescribedindetailbelowisaprimeexample.Thecriticalideaistoidentifynotjust
assetsthatcanbeboughtatadiscountbutratherassetsthatcanbeboughtatadiscountto
depressedassetvalues.Investorssometimesrefertoacompanyssingularnetassetvalueas
thoughitisidentifiablewithpinpointaccuracy.Webelievethatthenotionofasingularfixednet
assetvalueisincommensuratewiththefluctuatingnatureofassetvaluesovertimeandundera
varietyofhighlyfluidcircumstances.
Itshouldnotthenbesurprisingthatwhilewerefrainfrommakingpredictionsabout
macroeconomicoutcomes,ourexperiencehasrepeatedlyreinforcedthenotionthatadverse
macroeconomicfactorscanleadtoterrificinvestmentopportunities.Thesectionthatfollowswill
discussourthreenewinvestmentsandthemacroandindustryfactorsthatgaverisetothese
opportunitiesthoughthemeatofthediscussionwillremainweightedtowardsourprimary
concern,fundamentalbottomupinvestmentconsiderations.
New Investments Ini ti ated Duri ng the Quarter
BinckBank NV
TheFundinitiatedanewpositioninBinckBank NV(BinckBank),aDutchfinancialservicesfirm,at
whatwebelievetobeaveryinexpensiveprice.BinckBanks specialtyisonlinebrokerage.Inits
homemarketoftheNetherlandsBinckBank isthedominantretailbrokeragefirmasmeasuredby
volumeoftransactions.BinckBank isalsothemarketleaderinBelgium.Itsmarketpositionsin
FranceandItalyaremuchlesssignificant.GiventherelativelylacklusterstateoftheEuropean
economyandtheaccompanyinglackofretailinvestoractivity,itisnotsurprisingtoobservean
unusuallylowlevelofretailequitytradingvolumesinmostpartsofEurope.Thisiscertainlythe
caseintheNetherlandsandBelgium.TheeffectonBinckBank hasbeenacyclicallylowlevelof
operatingprofitabilitywithinitscorebusiness.
3Q 2014 T h i r d Av e nue F u n d s Por t f ol i o Ma na g e r Comme n t a r y
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Further,BinckBank obtainedabankinglicensesometimeagogivingittheabilitytoofferon
demandandinterestbearingdepositaccountstoitsbrokerageclientswhooccasionallyhaveidle
cashbalances.WhileBinckBank hasameaningfuldepositbase,ithasnevertakentheleapof
buildingatraditionallendingoperation,otherthanofferingmarginloanstoitsbrokerageclients.
Hereto,giventhelackofequitymarketoptimism,demandformarginloansiscurrentlymuted.
Therefore,theassetsideofBinckBanks balancesheet,wheretheaveragebankhousesloansand
alltypesofunsavorythings,iscomprisedalmostexclusivelyofshortdurationtripleAEuropean
sovereignbonds.Thecompanysbankingoperationtakesanatypicallylowlevelriskwhichoffers
comfortbutalsolowreturns,particularlysoatthemoment.Thusitcomesasnosurprisethatboth
itsbrokerageandbankingearningsarecyclicallydepressed.
However,in2007BinckBank purchasedafledglingassetmanagementbusinesswiththeideaof
furtheringthesuiteofinvestmentservicesitoffersitsclients.Thepurchaseandsubsequent
businessdevelopmenthasbeenaterrificsuccess.BinckBanks assetsundermanagementare
growingverynicelyturningtheassetmanagementbusinessintoanimportantandgrowingprofit
centerforthecompany,whichservestooffsetthecyclicallowsofBinckBanks brokerageand
bankingofferings.BinckBanks increasinglysignificantassetmanagementunitalsoprovidesthe
prospectofgrowingBinckBanks aggregatebusinessvalue,notwithstandingthedifficult
environmentinitstraditionallinesofbusiness.
BinckBank,likeallEuropeanbanks,isfacedwiththevirtualcertaintyofincreasinglystringent
capitalrequirements.BinckBank hasessentiallyselfimposedcapitallevelsmateriallymore
stringentthanwhatislikelytobeimposeduponit.Attheseveryconservativelevelsofleverage
andtieronecapital,thecompanyisovercapitalizedandcouldbeearningmuchmoreonits
equitywereittotakeabitmorerisk.Yet,evenwhileearningsarelowduetocyclicalfactorsand
highlevelsofriskaversion,thebusinessistradingatroughlytentimesearnings.Meanwhile,
becausethecompanyconsciouslysetitscapitalatlevelssufficientlyrobusttobothprotectitfrom
turmoilandsimultaneouslysupportfuturebusinessinitiatives,ithasnoneedtoretainfuture
earnings,whichwouldonlyaddtotheovercapitalization.Aspartofrecentlydisclosedcapital
policy,thecompanyannouncedthatitintendstodistributevirtuallyallfutureearningsvia
dividendsandsharebuybacks.Attodaysshareprice,thesedistributionsshouldtranslateto
somethingintheneighborhoodofa10%yield,whichhasareasonableprobabilityofgrowth.
Vard HoldingsLtd
WealsoinitiatedapositioninVard HoldingsLtd(Vard),aNorwaybasedbuilderofhighend
supportvesselsusedintheoffshoreoilandgasindustry,whosesharepricehasreachedvery
attractivepricelevelsoflateduetoacomplexrecentcorporatehistory,butmoreonthatina
minute. Thecompanyoperatestenshipyardsworldwideandfocusesonthedesignand
constructionofhighlyadvancedvesselscustomizedforserviceinsomeoftheworldsmost
challengingoperatingenvironments,suchastheNorthSea. WhilethenameVard willbe
unfamiliartomost,somelongtimereadersofourlettersmightrecallourownershipofanumber
ofoilservicecompaniesinthepast.Infact,theindustryenvironmentinwhichwepurchased
severalcompaniestogreatsuccessroughlytenyearsagohasmuchincommonwiththe
environmenttoday.OnesuchpreviousFundholdingwasAkerKvaerner,apositioninitiatedin
InternationalValueFund
3Q 2014 T h i r d Av e nue F u n d s Por t f ol i o Ma na g e r Comme n t a r y
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2004.Vard wasformerlypartofabusinesscalledAkerYards,whichwasasistercompanyofAker
Kvaerner,bothcontrolledbythesameNorwegianconglomerate,AkerASA.
Inmorerecentyears,theAkerYardsbusinesshastradedhandsseveraltimes twicesince2007.
HavingrestructuredAkerYardsintheearly2000s,AkerASAsoldAkerYardstoSTXofKoreain
2007.STXwaseagertopurchaseitswayintosomeofthemostsophisticatedareasofshipbuilding.
STXsubsequentlyfellonveryhardtimesandchosetoseparateandlistthehealthiestpartofthis
business,theoffshoreservicevesselbuildingbusiness.IntheinitialpublicofferingSTXnamedthe
businessSTXOSVandlisteditinSingapore.LifeforSTXdidnotgetanyeasierandthecompany
finallycrumbledunderamountainofdebt.Intheprocessoftryingtoextricateitselffromthedebt
load,itwasforcedtosellitsremainingstakeinSTXOSVtoFincantieri,atwohundredyearold
ItalianshipbuilderwhonaturallypreferredtomoveonfromtheSTXmoniker.Thus,thebusiness
wasagainrenamedinAprilof2013,thistimeVard.Notwithstandingtheinordinateamountof
corporateactivity,changesofcontrolandnamechanges,Vards managementteam,whodate
backtotheAkerdaysandearlier,hasbeenverystableandcontinuestomanagethebusiness
sensiblywithinthenicheofhighendoffshoreservicevesselsthatthecompanyhascometo
dominate.
Today,webelievewearepayingaverymodestmidsingledigitmultipleofnormalizedoperating
cashflowforVard andthatthedevelopmentofthecompanysorderbookisbothsupportiveof
oursenseofthequalityofthebusinessanditsabilitytogenerateattractiveshareholderreturns.
Thecombinationofthequalityofthebusinessandtheinexpensivepricemakeforquitean
appealingopportunity.Duringthelastcoupleofyears,moremutedorderflowsandaccounting
writedownsresultingfromtherestructuringofitstroubledBrazilianyardhadservedtomaska
veryhealthybusiness.WesuspectthatthelongtermvalueofVard wasrecognizedbyFincantieri
initsdecisiontopurchaseacontrollinginterest.WealsosuspectFincantieri wouldliketoownthe
entiretyofVard.Fincantieri hasalreadymadeoneattempttobuyoutthesharestheydonot
alreadyown.Wewouldnotbesurprisediftheytryagain.Depressedaccountingearnings
combinedwithtwochangesofcontrol,twonamechangesandaSingaporelistingillsuitedfora
Norwegianshipbuilderhaveallcooperatedtocreateanattractiveopportunity.
SantosBrasil Participacoes SA
OurthirdnewlyinitiatedpositionduringthequarterwasSantosBrasil Participacoes SA(Santos
Brasil),whicharoseprimarilyfromourresearchconductedinBrazilearlierthisyear.Inadditionto
avarietyofbusinessfactorsbelow,theopportunityalsoarisesfromafairlybleakmacroeconomic
pictureinBrazil.SantosBrasil istheoperatorofthreecontainerterminalsinBrazil.Thecompanys
primaryasset,Tecon Santos,isthelargestcontainerterminalinthePortofSantos.ThePortof
SantosisthelargestcontainerportinBrazil,whichisintuitivegiventhatitservicesthestateofSao
Paulo(includingthecityofSaoPaulo),whichrepresentsroughlyhalfofBrazilianGDP.Tecon
Santositselfhandles21%ofallBrazilianand7%ofallSouthAmericancontainervolumes.We
believeitissafetoassumethatTecon SantoswillbeacriticalpieceofBrazilianinfrastructurefor
manyyearstocome.
However,inadditiontowaningoptimismaboutthestateoftheBrazilianeconomy,severalissues
haveplaguedthecompanyanditsshares.First,votingcontrolofthecompanyliesinthehandsof
twoownerswhohavenotseeneyetoeyewithregardtotheoptimalpathtovaluecreation.
InternationalValueFund
3Q 2014 T h i r d Av e nue F u n d s Por t f ol i o Ma na g e r Comme n t a r y
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Separately,beginningseveralyearsago,inanefforttocreatecompetitioninthePortofSantos,
theBraziliangovernmentofferedmultiplenewcontainerterminalconcessionstonewentrants.
GiventheattractivenessofthePortofSantosandequallytheopportunitytoenterthecontainer
terminalbusinessinacountrywhichisdeeplyunderservedbycontainerhandlingcapacity,itisnot
surprisingthatwillinginvestorsmaterialized.Thenewlyconstructedcapacityisnowoperational
andSantosBrasils operatingresultshaveindeedshowntheeffectsofthepredictablyeroded
marketshare.Andfinally,SantosBrasil hasbeeninaholdingpatternwithregardtoasignificant
investmentprojectitwishestoundertakeatTecon Santosuntilitisgrantedanextensionofits
concessionbygovernmentagencies.SantosBrasil hasaterrificbalancesheetandiseagerto
deploythecapitalwhengrantedapproval.Alloftheseissueshavecreatedcloudsoverthe
companysufficientthatoneofthemostattractiveassetsintheentireglobalcontainerterminal
industryistradingatroughlysixtimeoperatingcashflow,whichisinexpensiveinabsoluteterms
andahugediscounttoitsglobalpeers,manyofwhichoperatelessdesirableassets.
HavingvisitedTecon Santos,itscompetingterminals,companymanagementandmanagementof
competingoperators,thevalueoftheassetwasglaringtousbutweremainedconcernedbythe
imponderableofhowtheshareholderdisputewouldberesolved.InAprilofthisyear,thetwo
controllingshareholdergroupspublicallyagreedtosetasidetheirdifferencesandmovetowards
eliminatingSantosBrasils multipleshareclassstructure.Asingleclassofsharesisaprerequisite
foralistingonNovoMercado,aBovespa classificationwhichrequiresthehighestlevelof
corporategovernance.ThecompanyhasannounceditsintentiontomovetoNovoMercado.
Separately,webelievethattheendoftheshareholderdisputeimprovestheprobabilitiesofa
renewaloftheTecon Santosconcession.Oursensethatthisisahighprobabilityeventisalso
supportedbyourconversationswiththeregulatorybodiesthemselves.
WhileourinvestmentinSantosBrasil isasomewhatcomplicatedone,webelievethateachofthe
majorissuessurroundingthecompanyissimultaneouslymovinginadesirabledirection.As
certaintydevelops,weexpectthatthecriticalnatureoftheassetanditslowlyvaluationwillthen
becomeinvestorsfocusanditwillbecomeapparentthatthishighlyattractiveassetistradingat
cheappricesinabsolutetermsletalonerelativetononBrazilianassetsofthisqualitywhichare
valuedatamassivepremiumtoSantosBrasil.
Posi ti ons Exi ted Duri ng the Quarter
Netia SA
ThelargerofourtwodispositionsduringthequarterwasNetia S.A.,aPolishtelecommunications
company.ThisdispositionclosesthebooksonwhathasbeenoneoftheFundslargestpositions
forsometime.Iwillattempttosummarizeaneightyearinvestmentassuccinctlyaspossible.Our
initialinvestmentthesis,datingbackto2006,wasessentiallytwofold.First,itseemedapparent
thenthatthebusinesscouldberunwithamuchmoreprofitmindedapproachasopposedtoits
singularfixationongrowth.Second,anyreasonableestimateofthereplacementcostthe
companysunderlyingassetbase,whichisprimarilycomprisedofaveryvaluablePolishfixedline
fibernetwork,waswellinexcessofthevalueatwhichthecompanywastradinginpublicmarkets.
Becauseofthepublicmarketsundervaluationoftheassetsandourbeliefthattheassetscouldbe
madetoproducemuchhigherfinancialreturns,webelievedthecompanywouldlikelybe
purchasedbyanynumberofindustryorfinancialbuyers.
InternationalValueFund
3Q 2014 T h i r d Av e nue F u n d s Por t f ol i o Ma na g e r Comme n t a r y
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RoughlytwoyearsintoourNetia investmentthefinancialcrisistookholdanddevastatedthethen
largestshareholderofNetia.Hewasheavilyindebtedtosaytheleast.Inarapidefforttopaydown
debt,thisdistressedsellersoldhisentirestakeinNetia inthemidstofthecrisisatpricesmuch
lowerthanwehadinitiallypaid.Weaddedmateriallytoourpositionwhichhadmultiple
implications.Ouraveragecostwasloweredconsiderablyandvirtuallyovernightwebecameoneof
Netias largestshareholders.ThisputusinapositiontoparticipateinthereconstructionofNetias
boardofdirectorsandhelpfacilitatethetransitiontoafocusonprofit.Iwouldcharacterizethis
effortassuccessful.Marginsandfreecashflowimprovedmarkedlyasaresultofthechangein
strategy.Withregardtothesecondlegofthethesis(i.e.,thetakeoverofNetia),wewere
frequentlyencouragedbyarapidlyconsolidatingindustryandwereoccasionallypartyto
conversationscoveringvarioustransactionpossibilities.Therecurringdealdiscussionscontinued
toprovideuswithalevelofconfidencethatachangeofcontrolwaslikelytoeventuate.Today,
Netia continuestooperateinaverydifficultenvironmentandmaintainingitslevelofprofitand
cashflowhasincreasinglybecomeachallenge.Ratherthancontinuetoawaitatransactionwith
imponderabletimingwhileoperatingperformancecontinuestodeteriorate,wechosetoavail
ourselvesofanopportunitytosellourentirestake,representing12.7%ofthecompany,ata
decentprice.TheentireexperiencenettedthefundanIRRofslightlymorethan5%,whichisabit
betterthantheFundsperformanceduringthattimeperiod.
LGCorp
WealsoexitedourpositioninLGCorp,whichwasinitiatedinMay2007.Attheoutset,wewere
excitedbythevaluationstowhichLGCorpsunderlyingoperatingbusinesseshadfallen(manyof
themarepublicallytraded),theadditionaldiscounttonetassetvalue(NAV)offeredthroughthe
holdingcompany,LGCorp,andbythesignificantsimplificationoftheholdingcompanystructure
thatwastakingplace.AsIlookbackonourLGCorpinvestment,Iwouldconcludethatouranalysis
oneachofthesefrontswasquitegoodandthatthevaluedriversoftheinvestmentgenerally
developedasexpected.Further,LGCorpcommonstockhashistoricallybeenfairlyvolatile,which
canprovidelongtermfocusedinvestorslikeuswithwonderfulopportunitiestobuyandsellwhen
pricebecomessufficientlydisjointedfromactualbusinessvalue.InthecaseofLGCorp,we
initiatedthepositionin2007butboughtandsolditduringourholdingperiodmorethanistypical
forus,owingtotheseperiodiclargedislocationsofpriceandvalue.Havingreducedtheposition
sizeovertime,wechosetoexitcompletelyaswehavefoundanumberofexcitingnewinvestment
opportunities.Inconclusion,thecombinationofourfocusonprice,agoodsenseofthe
developmentsthatwouldtranspireatthecorporatelevelandanopportunisticapproachtobuying
andsellingthepositionduringtheholdingperiodcombinedtoproduceapleasingIRRofroughly
11%overtheholdingperiod,materiallybetterthantheaverageFundholdingduringthattime
period.
IwouldliketothankyouforyourcontinuedsupportoftheFundandlookforwardtowritingto
younextquarter.
Sincerely,
MatthewFine,LeadPortfolioManager
ThirdAvenueInternationalValueFund
InternationalValueFund
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FocusedCreditFund
Por t f ol i o Manager Comment ar y
T HI RD AVE NUE
J UL Y 3 1 , 2 0 1 4
DearFellowShareholders:
Sai l i ng on Shenandoah
ThirdAvenueFocused
CreditTeam
TomLapointe,CFA
LeadPortfolioManager
JosephZalewski
PortfolioManager
NathanielKirk
PortfolioManager
EdwinTai,CFA
PortfolioManager
BrianLennon
RestructuringAttorney
AndrewPelisek
ResearchAnalyst
CaseySavage
ResearchAnalyst
RobertSherman
Trader
TheShenandoah,myuncles158foottopsailschooner,hasbeenbravingthewatersoffthecoast
ofMarthasVineyardforthelastfiftyyears.Herhullformandrig,anchors,andallmaterialsof
constructionadherecloselytomid19thcenturypracticessheevencarriescannons.
AfewweeksagoIboardedtheShenandoahwithmyuncle(theCaptain),mykids,thirty
summercampersbetweenelevenandthirteenyearsold,acrewofsixcollegestudentsand
thesamesenseofadventurethatIhadthefirsttimeIsailedthisship.AndIvebeensailing
onShenandoaheverysummerforaslongasIcanremember.Theplanfortheweekwas
simple:sailoffMarthasVineyardtoNantucket,CapeCod,andsurroundings.Theonboard
experienceisunique;thevesselhasnoauxiliarypower,norunningwaterandnowifi.By
theendoftheweekallthekidsonboardlearnedhowtohandletheropesoftheboat;there
wasnootheroption.Theylearnedtoliftthetwotoncanvassails(together),toputcoalon
thestovetocook,andmanyothertasksthatareultimatelylessonsinteamwork,
persistence,andotherimportantskills.Hopefullytheycantranslatesomeoftheselessons
totheirlives.Alearningexperienceforall,andalotoftimetoreflect
Jumpi ng i n the Water
Watchingmykidsandthethirtycamperscontemplatetheseeminglysmalldecisionof
jumpingoffaboatandintotheoceanisaninterestinglessoninhumanpsychology.The
timeneededfromstandingontheedgetoactuallyjumpinginthewaterforthefirsttime
canrangebetweenafewfleetingsecondstoafull,tedious,halfhour.Manythoughtsare
goingthroughtheirheadsastheycontemplatethedecision,givingthempause.Atenfoot
jumpordiveorcannonballofftheboatandintothedarkgreenwater,mightbringupthe
mostterrifyingimagestomind;tiburones (sharks),jellyfish,freezingwatertemperatures
andotherunknowns.Allthesefearsareoffsetbythepleasuresofcoolingoffinthe90
degreeweather,laughingwithfriends,andavoidingtheembarrassmentofbeingtheonly
oneleftontheboat.
Portfolioholdingsaresubjecttochange
withoutnotice.Thefollowingisalistof
ThirdAvenueFocusedCreditFunds10
largestissuers,andthepercentageofthe
totalnetassetseachrepresented,asofJuly
31,2014:
LehmanBrothersInc,4.77%;ClearChannel
CommunicationsInc,4.67%;Affinion Group
Inc,4.14%;Altegrity Inc,3.55%;TheSun
ProductsCorp,3.26%;EnergyFuture
IntermediateHoldingCoLlc,3.24%;
Reichhold IndustriesInc,2.29%;New
EnterpriseStone&LimeCoInc,2.24%;
GlobalGeophysicalServicesInc,2.23%;
WesternExpressInc,2.05%
3Q 2014 T h i r d Av e nue F u n d s Por t f ol i o Ma na g e r Comme n t a r y
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FocusedCreditFund
Imconvincedthatourpersonalityandhowwedealwithchangeandtheuncertaintygeneratedby
ourfearsanddesiresis,forthemostpart,fullydevelopedbythetimeweexithighschool.The
eventsandchoicesweallfacethroughourliveswillbedifferent,butwehavealreadycraftedand
honedourskillsintheplaygroundsofourchildhood.
Noonewantstobethefirstonetojumpintothewater. Theyallwait. Then,whenonetriesit,
anotheronewillgoandthenanotherone,untiltheyareallinthewater. Somehowtheybelieve
thereissafetyinnumbers,eventhoughtherisks,asbigorassmallastheymightbe,arestillthere.
Somehowtheyallgetcomfortablewiththeideaofasharkshowingupaswellaswiththecold
watertemperatures,aslongasweareallinittogether.Infact,thekidsstayinthewateruntilthey
areforcedtocomeout,notbythethingstheyoriginallyfeared,butratherbythelunchbelloran
allhandsondeckcalltoraisethesails.Thisstoryfallsunderthecategoryofwhatwedcallmini
formativeexperiences.Webringitupbecauseithelpsformourbeliefofwhereweareinthe
presentmarketcycle.
Todayinvestorsaremostlyallinthewater. Investorshavenowbeenswimmingaroundforafew
years;enjoyingrewardsintheformofdoubledigitreturnsinequity,highyield,andevenbond
markets.Investorsacrosstheglobehavegrownaccustomedtothelowinterestrateenvironment.
Theyseemquitecomfortablewiththeelevatedmultiplesinequitymarkets.However,thelistof
thingsthatkeptthemonthesidelinesin2008andcontinuedtoscarethemoverthepastfew
yearsislong.HighdebtlevelsintheU.S.,unemployment,adoublediprecession,Chinese
economicgrowth(orlackthereof),risinginterestrates,arejustafewYouallknowthelist.The
listismuchlongerthantheonethatkeptthekidsoutofthewater!Yetagain,weseethat
somehowthereissafetyinnumbers.
Fearisstillinthebackofinvestorsmindsandcontinuestobeaubiquitoustopicofdiscussion
Andonthemargin,investorsdothingstheythinkmightprotectthemandtheirportfoliosshould
anyofthesefearsmaterialize.Manyinvestorshaveboughtshortdurationfundsorfloatingrate
funds.Theyhavealsoboughtgoanywherefundsthatpromisetogowhereyoucanmakemoney
andavoidtheobviouslosers. Theyhaveinvestedinhedgefundsorlong/shortfundsandmay
evenbesittingonextracash.Butforalltheattemptstohedgethedownside,investorsaremostly
allin.
Ithasntbeensuchabadride,afterallweareenteringthefifthyearofabullmarket.Thus,the
onequestiononeveryone'smind:whenshouldIgetoutofthewater?Or,atleast,whenshouldI
beheadingtowardstheshallowendsoIcangetoutbeforeothers?Everyoneisworriedabout
liquidity,andrightlyso,notjustinthesummerdoldrumsmonths.
ShiftingTide. Wehavestartedtoseeaturnintheflowsintohighyieldandfloatingratefunds,the
hottestassetclassesinthepastthreeyears.
1
Highvaluations,lowliquidityandshiftinginvestor
sentimentasaresultofaseeminglyinevitableriseinratescanbeapowerfulcombination. Weve
heardbroadoverarchingstatementsabouttheperformanceandliquidityoffixedincomeinthis
environment.Inourviewthesestatementsthattreatallfixedincomesegmentsequallyobscure
whatmayultimatelybethemostrelevantinformationforinvestors.Inthisletterwefocuson
someofthesefundamentaldistinctions.Differentsegmentsofthefixedincomemarketreact
1NetoutflowsfromHighYieldETFsinJuly2014were$3.1billion,whiletheannualnetinflowsoverthelastthreeyears (2011,2012and2013)
havebeen$6.8,$9.5and$3.3billion,respectively.NetoutflowsfromBankLoanETFsinJulywas$134million;whileannualnetinflowsoverthe
lastthreeyearsforavailabledata(sinceMarch2011)hasbeen$152million,$1.3billionand$5.7billion.Alldatafrom Morningstar.
3Q 2014 T h i r d Av e nue F u n d s Por t f ol i o Ma na g e r Comme n t a r y
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FocusedCreditFund
differentlytoariseininterestrates.Lowdurationandhighyieldfixedincomesecurities(suchas
ourFund)canbetterabsorbariseinrates.Infact,twothirdsofourFundshouldberelatively
uncorrelatedtointerestrates.Likewise,highyieldanddistressedinvestingarenotasynonym
forilliquidity.Manylinkthetwotermstogetherbuttheyarenotnecessarilyrelated.Liquidity
hinges(amongotherthings)onthesizeoftheissueandweareverymindfuloftheFunds
liquidityaswechooseinvestmentsfortheFund.
Rates Wi l l Ri se
TheU.S.economyisgrowing.GDPnumbersforthesecondquarteroftheyearhavebeensolid
at4%.Firstquarternumberswererevisedupwardfrom2.9%to2.1%.Theeconomygrewby
1.8%duringthefirsthalfoftheyear.In2015and2016,themedianestimateamongeightyfour
economistsisthatU.S.GDPwillgrowby3%.
2
Inlightoftheseauspiciousnumbers,andas
expressedonseveraloccasions,theU.S.FederalReserveispreparedtotakeitsfootoffthegas
thisfall.Thisisagoodsign.VotingmembersaresayingFedFundsrate(theovernightrate)
shouldbehigher,at4%.Theaverageovernighttargetedratesince1971was5.6%,includingthe
lastfiveyearswhereitwassetat0%.Econ101tellsusthatinanexpandingeconomy,theyield
curvetendstobeupwardsloping.ThereislittledoubtthatiftheFedFundsrateclimbsto4%or
5%(almosttwicethecurrent10yearU.S.Treasuryrateof2.5%),longertermrateswillbe
higher.
Thebackdropofaneventualriseininterestratesanditsimpactoverfinancialassetsisoneof
thefearshauntinginvestorstoday.Althoughrateshavebeenfallinggloballysofarthisyear(the
yieldonthehighquality10yearTreasuriesdroppedfrom3%to2.4%andevenPortugalhas
movedfrom6%to3%),nearzerointerestratesindevelopedcountries,coupledwiththeFeds
announcedchangestomonetarypolicymakeahikeinratesalmostcertaingoingforward.
Thefirstthingtoconsiderinarisingratesenvironmentisthatnotallfixedincomewillreactin
thesameway.Weexpecthighdurationassetstogivebackyearsofreturnsshouldratesriseby
200to300basispoints.Exhibit1belowcomparesreturnsacrossdifferentfixedincomeassets
duringlastsummerstapertantrumepisodeandcomparesittothedecreaseinrates
environmentduring2014.DuringthetapertantrumtheU.S.10yearTreasuryyieldroseby
about100basispoints,from1.63%to2.57%,andcreditspreadswidenedanother100basis
points.Sofarin2014theU.S.Treasuryyielddropped60basispoints,from3.0%to2.4%.The
reactionacrossdifferentassetswithinfixedincomevariedsubstantially.
Thisisnotsurprising;higherqualityassetswithlongerdurationunderperformedasratesrose,
justastheyareoutperformingnowasratesfall.TheFocusedCreditFund(Fund)suffered
smallerlossesthanmostofthefixedincomebenchmarksonthefollowingchartduringthelast
summerandoutperformedallofthemduringtheyeartodateperiod.
2EstimatesfromBloombergsurveyontheU.S.economy,August27,2014.
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Exhibit2providesanillustrativeexampleofhowthemathematicsofbonddurationandyield
wouldaffecthowdifferentsecuritiesabsorbrateincreases.Weanalyzethreehypothetical
scenarios:ariseof100,200and300basispointsinrates,fordifferentsecurities.Thenumbers
showthataratechangehasalargerimpactonpricethegreaterthedurationofthesecurity,
assumingthatpricingonlymovesinrelationtotheratechange.Inaddition,theanalysissuggests
thathigheryieldhelpsmitigatetheeffectofaraterise.Thus,theJ.P.MorganHighYieldIndex,
whichhasthelowestdurationandhighestyield,wouldgenerallyexperiencethesmallesteffectof
rateincreaseonprice.Ourcalculationsareconsistentwiththefactthatjunkbondshave
historicallybeenlesssensitivetointerestrateswingsthanTreasuriesorhighgradecorporate
debt.Thelogicbehindtheresultisthatpricesofhighyieldsecuritiesaremorecloselylinkedto
thecreditqualityofindividualissuers(althoughmacrofactorsaffectinginterestrates,andvice
versa,canhavesignificanteffectsonhighyieldbondpricinganddefaultrates).
10%
5%
0%
5%
10%
10yrTsy BarclaysAgg HY BB B CCC Loans TFCIX HFRIEventDriven:
Distressed/
Restructuring
Index
May1toJune25,2013
January1toJuly31,2014
Exhibit1:Returnsacrossfixedincomeinrisingandfallinginterestrateenvironments
Source:Bloomberg,HFRIandThirdAvenueManagementforFunddata.Notes:WedefinethetapertantrumperiodbetweenMay1
toJune25,2013asthiscapturesarisein100bpsininterestrateswhichallowsustoevaluatetheeffectofdurationonprice;theyear
todateperiodwasdefinedasthemostrecentperiodinwhichweveseenafallininterestrates.10yearU.S.GovernmentTreasury
Notes(10yrTsy)areadebtobligationissuedbytheUnitedStatesgovernmentthatmaturesin10years.TheBarclaysU.S.Aggregate
BondIndex(BarclaysAgg)isabroadbasedflagshipbenchmarkthatmeasurestheinvestmentgrade,USdollardenominatedbonds.
TheJ.P.MorganInstitutionalHighYieldIndexisdesignedtomirrortheinvestableuniverseoftheU.S.dollardomestichighyield
corporatebondmarket,excludingthemostaggressivelyratedbondsandthosetradingatdistressedlevels.J.P.MorganBB,B,CCCand
HighYieldIndexesaredesignedtomirrortheinvestableuniverseoftheU.S.dollardomesticBB,B,CCCandHighYieldcorporatedebt
markets,respectively.TheHFRIEventDriven:Distressed/RestructuringIndex(Distressed)iscomposedofstrategieswhichemployan
investmentprocessfocusedoncorporatefixedincomeinstruments,primarilyoncorporatecreditinstrumentsofcompaniestrading at
significantdiscountstotheirvalueatissuanceorobliged(parvalue)atmaturityasaresultofeitherformalbankruptcyproceedingor
financialmarketperceptionofneartermproceedings.
Exhibit2:InterestRatesandReturns
Duration Price Rate
Priceif
+100bp +200bp +300bp
JPMHighYield 3/2/2019 3.7 105.0 5.71% 101.2 97.3 93.5
%change 4% 7% 11%
BarclaysAggregate12/11/2022 6.5 108.3 1.75% 101.3 94.3 87.3
%change 6% 13% 19%
5 YearTreasury 1 07/31/19 4.8 99.3 1.77% 94.7 90.3 86.2
%change 5% 9% 13%
10 YearTreasury 205/15/24 8.7 99.5 2.55% 91.4 83.9 77.2
%change 8% 16% 22%
30 YearTreasury 305/15/44 19.0 101.2 3.31% 84.4 71.2 60.8
%change 17% 30% 40%
Source:DatafromBloomberg.AsofJuly31,2014Bloombergstatedmaturityof8.3yearsimplies12/11/22maturitydateforBarclaysAgg
andJPMHighYieldIndexis4.5yearstoYTWdate.PricechangecalculationsforTreasuriesfromBloomberg.Pricecalculations forJ.P.
MorganHighYieldIndexandBarclaysAgg byThirdAvenueManagementusingasimplifyingassumptionwheredurationiscalculated
linearly,notincorporatingconvexity.Theformulausedtocalculatethepriceimpactofachangeinratesis:price*(1(%changein
rates*(duration/100)).TheJ.P.MorganU.S.HighYieldIndex(HighYield)isdesignedtomirrortheinvestableuniverseoftheU.S.highyield
corporatedebtmarket.TheBarclaysU.S.AggregateBondIndex(BarclaysAggregate)isabroadbasedflagshipbenchmarkthatmeasures
theinvestmentgrade,USdollardenominatedbonds.U.S.GovernmentTreasuryNotes(5yr,10yrand30yr)aredebtobligationsissuedby
theUnitedStatesgovernmentthatmaturein5,10and30years,respectively.
FocusedCreditFund
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FocusedCreditFund
Thereturnsintheexhibitaboveassumeanimmediateshiftinrates.Inrealitytheshiftinrates
wouldoccurovertime.Thus,asinterestratesrisecouponswillbepaid(couponscurrentlyare
2.5%,3.3%and6.5%forthe10yearTreasury,theBarclaysAgg andJPMHighYield,respectively);
3
andspreadswillcompress,astheytypicallydointhesemarketenvironments.Boththecoupon
andthespreadcompressionaretailwindsforhighyield,furtherenhancingtheperformanceof
highyieldrelativetotheothersegmentsofthefixedincomemarket .Assumingagain,thatthese
changesarenotaccompaniedbymarketdislocationslikewehaveseenbefore.
Whileotherfactorsalsoaffecttheperformanceofbelowinvestmentgradesecurities,higheryield
andlowdurationaregenerallythemostimportantonesinarisingratesenvironment.Thus,the
yieldofferedbylowerratedstressedanddistressedsecuritiesappearsmoreattractiveinthese
environments,assumingthatdefaultratesdonotchangemateriallyorthatmarketsentimentfeels
thatitmustfleetosafety.
Mosthighyieldfunds,andpossiblyevenmostloanfunds,have90%oftheirholdingswith
moderatetomeaningfulinterestraterisk.Ahighyieldfundwithaportfoliothatyieldsonly5%will
stilllosemoneyinthequitelikelyscenarioofa2%increaseininterestratesinthe5to10yearpart
ofthecurve,allelseequal.TheFocusedCreditFundscurrentpositioningissuchthatinterestrate
riskismuchlessimportantthandefaultrisk.TheFundhasthebenefitofhavingalowportfolio
duration(1.9yearsoralmosthalfthedurationoftheJ.P.MorganHighYieldIndex)withahigh
dividendpayoutandSECyieldof8.71%asofJuly31,2014.
4
Thishelpscushionreturnswhenrates
riseandshouldprovideextrareturnwhentheyfall,asseeninExhibit1.
Why We Are Di fferent
Twothirdsoftheportfolioshouldberelativelyuncorrelatedwithrisinginterestrates.
5
TheFund
deployscapitalopportunisticallyandacrosstheriskspectrum.Thus,theportfolioistypicallya
combinationofopportunitiesin:
o PerformingBondsandLoans
o StressedPerformingCredits
o CapitalInfusions
o Distressed
6
o DebtforEquity
AsofJuly31,2014,theportfolioiscomposedasfollows:12%cash,36%specialsituations
(includingnamesthatwehavediscussedpreviously,suchasAltegrity,Affinion,LehmanandTXU),
17%stressed(includingVertellus andFirstDatadiscussedlaterintheletter),allofwhichare
almosttotallyuncorrelatedwithrisingrates.Theremaining35%oftheportfolioisinperforming
bondsandloans.Alloftheoftop10holdings(34%oftheportfolio)areunderthecategoryof
whatwewouldsaymakesthefunddifferent.
Whilethebusinessesweinvestinmaybenefitfromlowrates,ourinvestmentprocessfavors
opportunitieswheretheissueisnotaboutrefinancingatalowerrate.Thecompanieswe
3DatafromBloombergasofJuly31,2014.
4SECyieldaboveisfortheInstitutionalClass.SECyieldfortheInvestorclassis8.48%.
5Thisistheallocationoftheportfoliotocash,andstressedandspecialsituationssecurities.Stressedsecuritiesaresecuritiesthataremore
seniorinthedebtcapitalstructureofcompaniesthathaveahigherlevelofuncertainty.SpecialSituationsareissuersthatwebelievemay
experienceacorporateevent,suchas(1)arestructuring,recapitalization,orliquidation,(2)capitalinfusions,or(3)issuerswhosesecurities
tradeataspreadofgreaterthanorequalto1000bpsabovecorrespondingTreasuries.
6Distressedsecuritiesimpliesahigherprobabilityofdefaultandwherewebelievetheissuermayexperienceacorporateeventsuchasa
restructuring,recapitalizationorliquidation.
3Q 2014 T h i r d Av e nue F u n d s Por t f ol i o Ma na g e r Comme n t a r y
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typicallyinvestinarewhatwebelievearegoodbusinesseswithhighqualityassets,but
(temporarily)weakbalancesheets.Welookforcompaniesandindustriesundergoingstructural
turmoilorchangeduetomultiplefactors.Wetendtoinvestincomplicatedsituationsthat
involveuntanglingdifficultbalancesheets.Welikecompaniesandindustriesgoingthrough
cyclicaldownturnsoradverseproductpricingorcostofgoodssold.Wealsotakeadvantageof
opportunitiespresentedbyregulatorychanges,CLOs/rulesbasedinvestors,andforcedeconomic
sellers(sellerswhocannotholdunderperformingdebt,areunwillingtorestructure,orprefer
couponpayingsecurities).
Tobesure,wehaverealrisks.TheFundisveryconcentrated.Wetypicallyholdcreditsin
approximatelyseventyissuersandmanyhavesignificantcreditrisk.Werecognizethatthereisa
varietyoffactorsdrivingtheFundsperformance.Wewouldexpectthecurrentportfolioto
underperformiftheeconomyreenteredarecessionorgoesthroughaprolongedperiodwhere
capitalmarketsareshutdownorwhereequitymarketsdecline20%to30%.Ourportfolio
constructionprocesstakesbothcreditandinterestrateriskinconsideration.Webelievethe
currentportfoliomitigatesexposuretointerestraterisk,assumingthatarisinginterestrate
environmentdoesnotaccompanyorcauseachangeindefaultrates.
Cl eari ng Up a Mi sunderstandi ng: Di stressed
Il l i qui d
Weoftenhearaboutthehighyieldmarketandtheloanmarketbeinglessliquidthanotherhigher
qualityassetclasseswithinfixedincome.Anditgoestoreasonthatifyouinvestinthelower
qualitypartofthehighyieldandloanmarketyoushouldexpectevenlessliquidity.However,
whileintuitive,thisisnotnecessarilytrue.Infact,someoftheFundsmostdistressedinvestments
areamongthemostliquid.Caesars,TXUandLehmanarealmost10%oftheportfolioandare
someofthemostliquidandactivelytradedbondsandloansinthemarket.Thereasonissize.
Thesecreditshaveverylargeamountsofdebtoutstandingandthatdebtisheldbylargenumbers
ofinvestors.
Liquidityismostlyafunctionoftheamountofdebtoutstanding,howmanypeopleownthedebt
andultimatelythepriceatwhichyouaretryingtobuyorsell.AninvestmentgradeCorporateor
Municipalbondthathas$200to$500milliondebtoutstandingownedbyonlyahandfulof
investorsislikelytotradeatadiscountbecauseofitsilliquidity.Thesameistrueinthehighyield
andbankloanspace.Asaregulatedmutualfund,wehavealimitonsecuritieswedeemtobe
illiquidof15%oftheportfolio.Wegenerallytrytoavoidilliquidsecuritiesorwillrequireahigher
expectedIRRbeforeinvesting.Wepassonorselloutofmanyinvestmentsbecausetheyare
illiquid;ourreturnswouldlikelybehigherhadwebeenabletobuymoreoftheseopportunities.
Notallofourdistressedinvestmentsareinissuerswithlargeoutstandingdebt.Infact,wedofind
interestingopportunitiesinsmallerissuersbutseektobalancetheexpectedreturnwiththe
liquidityconstraintsthatariseduetosize.Onewayinwhichweresolvethistradeoffisby
managingpositionsize;weallocatelessweighttoopportunitieswheretheissueisnotsufficiently
large.Almostallofourportfolio(85%ofthetotalmarketvalueoftheportfolioasofJuly31,2014)
isindependentlypricedeverydaybyIDC(oneofthetwomajorpricingservicesmostmutualfunds
FocusedCreditFund
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33
FocusedCreditFund
fundsuse)andsowebelievethatournetassetvaluereflectstherealityofwherewecouldsellthe
securitiesinthemarketeveryday,absentsomemajordislocationinthemarket.
Wevealsobeenhearingthatthedealersarenottakingriskanymore,especiallyafter2008/9and
sincetheimplementationoftheVolckerRule.Wehearthatthereislittletrading.Whileitistrue
thatinrelativetermsthereislessliquidityinthemarketstodaythanfiveyearsago,thisdoesnt
meanthatliquidityhasdriedup.Thereisstill$6to$8billioninhighyieldbondstradingevery
day.
7
Themarketsweinvestinarelargeandgrowing,morethan$3trillionglobally.Whilewe
carefullymanagetheliquidityintheFundwealsoviewliquidityasanopportunity.Wehaveoften
usedtheFundscashopportunistically;whenalargeselleremergesandneedstosell$25to$50
millionofatroubledcompanywecanoftenprovidethatliquidityandpurchasesecuritiesat
attractivediscounts.
WhilewewerenotimmunefromthemostrecentJuly/Augustroundofheavymutualfundout
flows,webelievethatthelevelofoutflowsfromourFundwassomewhatmitigated,primarilywe
believeduetothequalityofourinvestorbase.TheyarenottheETFtype,lookingtomakeaquick
buckorinforatrade.InvestorsinourFundhavedonetheirhomeworkandhopefullywouldbe
investing,notselling,ifmarketsmovedlower.Butofcourseitiseveryonesrighttoaskfortheir
moneyanydaytheywant;mostdonot,butitisnicetohavetheoption.
Wealsotakeanumberofprecautionsthatenableustomitigatethenegativeimpactofoutflows
ontheportfolio.First,weconsider5%cashtobeafullyinvestedandoftenholdhigherlevelsof
cashwhichallowsustodeploycapitalwhenopportunitiesariseormeetredemptionneeds
withoutbeingaforcedseller.Onaverage,overthelastthreeyearswehavehadmorethan10%
cash.Second,asmallcreditlinethatamountsto3%oftheFundisavailable.Wehaveneverused
thiscreditline.Wearenotplanningtousethiscreditlinebuthavingitreadilyavailablehelpsto
mitigateliquidityrisk.Third,ourteamhasextensiveexperiencemanagingportfoliosthrough
differentmarketcyclesandhasbeenabletoraisecasheffectivelyandwithoutmajordisruptions
totheportfolioatdifferentpointsinthesecycles.Fourth,webelievethatwewillbeabletoraise
cashifnecessaryinmostmarketenvironments.Asstatedabove,wetypicallyhaveapproximately
seventyissuersintheportfoliowithdifferentlevelsofliquidity,andwegenerallybelievewecan
sellsmallpiecesofthevastmajorityofthesenamesquicklyandwithminimalpriceramifications.
Someofthisdiversificationcomesinhandytosomeextentinperiodsofmarketstress.Thisisthe
wayinwhichwetypicallyhandleflowsintotheFundaswell(i.e.,buyingandsellingsmallerlotsof
ourexistingpositions).Ourfinallevelofcomfortisourinvestorbase,formedbysophisticated
investorsthathaveagoodunderstandingofthestrategyandhowtoutilizeitwithintheirasset
allocation.
7DataprovidedbyTradeReportingandComplianceEngine(TRACE).
3Q 2014 T h i r d Av e nue F u n d s Por t f ol i o Ma na g e r Comme n t a r y
34
Fund Performance
Fortheyeartodateperiodendingourthirdfiscalquarter,July31,2014,theThirdAvenue
FocusedCreditFundreturned10.9%,
8
versus3.5%forMorningstarsHighYieldBondCategory
9
average,4.4%fortheJPMUSHighYieldindexand1.9%forMorningstarsBankLoanCategory
10
average.TheS&P500Indexreturned5.7%fortheperiod.ThestrongrallyinTreasuriesresulted
inhigherqualitybondsoutperforminglowerqualitybonds.Investmentgradebondsreturned
5.7%(JPMInvestmentGrade),BBbondsreturned4.8%,Breturned4.0%andCCCreturned3.7%.
WhiletheFunddoesnothavemuchexposuretothehighqualitysecuritiesthathavebenefitted
fromtherallyinTreasuries,performanceyeartodatecontinuestobepositive.TheFund
continuestooutperformitsbenchmarkandmostsegmentsofthefixedincomemarket,as
depictedinExhibit3below.NoteaswellthattheFundhashandilyoutperformedothersegments
ofthefixedincomemarketoverthethreeyearperiod.
8TheFundsoneyearandsinceinception(August31,2009)averageannualreturnsfortheperiodendedJuly31,2014were17.83%and
12.44%,respectively.
ThirdAvenueFocusedCreditFundisofferedbyprospectusonly.Theprospectuscontainsmorecompleteinformationonadvisoryfees,
distributioncharges,andotherexpensesandshouldbereadcarefullybeforeinvestingorsendingmoney.Pastperformanceisno
guaranteeoffutureresults.Investmentreturnandprincipalvaluewillfluctuatesothataninvestorsshares,whenredeemed,maybe
worthmoreorlessthanoriginalcost.TheFundsreturnsshouldbeviewedinlightofitsinvestmentpolicyandobjectivesandqualityof
itsportfoliosecuritiesandtheperiodsselected.M.J.WhitmanLLCDistributor.Ifyoushouldhaveanyquestions,orforupdated
information(includingperformancedatacurrenttothemostrecentmonthend)oracopyofourprospectus,pleasecall18004431021
orgotoourwebsiteatwww.thirdave.com.Currentperformancemaybelowerorhigherthanperformancequoted.
9Averageyeartodatereturnofthe720fundsincludedintheMorningstarHighYieldBondCategory,fortheperiodendedJuly31, 2014.
10Averageyeartodatereturnofthe240fundsincludedintheMorningstarBankLoanCategory,fortheperiodendedJuly31,2014.
Exhibit3:YeartoDate,3YearAnnualizedandCumulativeReturnasofJuly31,2014
11.58%
9.78%
32.92%
28.84% 28.84%
34.47%
17.85%
39.88%
24.99%
0%
5%
10%
15%
20%
25%
30%
35%
40%
10yrTsy BarclaysAgg HY BB B CCC Loans TFCIX HFRIDistressed&
EventDriven
YTD7/30/14 3Yr(Annualized) 3yrCumulativeReturn
Source:BloombergandThirdAvenueManagementforFunddata.Notes:10yearU.S.GovernmentTreasuryNotes(10yrTsy)area
debtobligationissuedbytheUnitedStatesgovernmentthatmaturesin10years.TheBarclaysU.S.AggregateBondIndex(Barclays
Agg)isabroadbasedflagshipbenchmarkthatmeasurestheinvestmentgrade,USdollardenominatedbonds.TheJ.P.Morgan
InstitutionalHighYieldIndexisdesignedtomirrortheinvestableuniverseoftheUSdollardomestichighyieldcorporatebond market,
excludingthemostaggressivelyratedbondsandthosetradingatdistressedlevels.J.P.MorganBB,B,CCCandHighYieldIndexesare
designedtomirrortheinvestableuniverseoftheU.S.dollardomesticBB,B,CCCandHighYieldcorporatedebtmarkets,respectively.
TheHFRIEventDriven:Distressed/RestructuringIndex(Distressed)iscomposedofstrategieswhichemployaninvestmentprocess
focusedoncorporatefixedincomeinstruments,primarilyoncorporatecreditinstrumentsofcompaniestradingatsignificantdiscounts
totheirvalueatissuanceorobliged(parvalue)atmaturityasaresultofeitherformalbankruptcyproceedingorfinancial market
perceptionofneartermproceedings.
FocusedCreditFund
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FocusedCreditFund
Some Mi stakes
LehmanSIPAclaims
LehmanSIPA(LBI)claimsareamongthetop10holdingsintheFund,witha4.8%weight.While
LBIhadafewpositivedevelopmentsandwasasolidcontributortoperformanceduringthe
quarter,thebignewshappenedafterquarterend. Wediscusseacheventinturn. First,LBI
reachedasettlementwithitsHongKongandSingaporeaffiliatesandwillreceiveover$300million
ofadditionalassets,whichwillimproveultimaterecoveriesby1to1.5points. Second,LBI
receivedBankruptcyCourtapprovaltobeginmakingperiodicdistributionstounsecuredclaim
holders.TheFundexpectsitsfirstdistributiontobeinearlySeptember,whichcouldbeaslargeas
aquarteroftheposition.Duetothereturnofcashandenhanceddownsideprotection,theFund
increaseditspositioninLBIinthequarter.
Asyoumayrecall,LehmanwassoldtoBarclaysinarushedsaleovertheweekendofSeptember
15,2008.Documentationandthesalescontractwerenotclearandincertainsituations
contradictedeachother.OuroriginalthesisontheLBIinvestmentwasbasedontheestatehaving
$0.40to$0.42centsofcashandacheapoptiononthelitigationwithBarclaysfordisputedassets
fromtherushedsaleinbankruptcy.IfLBIlostitslitigationwithBarclaysfor$7billionofdisputed
assets,weestimatedourmaximumdownsidewas5%to10%.IfLBIwasawardedjust$2.3billion
ofthe$7billionfromthelitigation,whichwastheoriginalbankruptcycourtruling,LBIhad50%
upside,inouropinion.Thus,weestimatedthelikelihoodoftheBarclayslitigationresultingina
negativeoutcomeforourinvestmentatlessthan20%.Basedonouranalysis,ourprobabilityof
winningwasmuchhigherthan20%butslightlylowerthan50%.ThuswepurchasedLBIclaims
withanaveragecostof$0.44.Itsubsequentlytradeduptoashighas$0.47thisquarterin
anticipationofaruling.
Afterquarterend,theCourtofAppealsfortheSecondCircuitruledagainsttheLBITrusteeand
awardedall$7billiontoBarclays.Wearedisappointedwiththerulingandthefactthatthe
AppellateJudgesignoredkeypiecesofinformationthataidedthebankruptcycourtsinitial
decisioninfavorofLBI.OurLBIclaimhastradeddowntothe$0.42range.However,our
expectationisthatLBIwillultimatelyrecover$0.44$0.46inayear,whichisbreakeventoslightly
aboveourcostbasis.Weexpecttoreducethepositionasitstartstradingtowardsourultimate
recoveryestimatesoverthenextseveralmonths.
WeunderwroteLBIasaninvestmentwithlimiteddownsideandveryattractiveupsidepotential.
Unfortunately,thelimiteddownsidepartcametrueandthecheapoptionfor50%upsideexpired.
Nosituationiscertain,eachhasitsuniquerisks,andindividualcatalystsmayormaynotplayout.
Nonetheless,aportfolioofwellunderwritteninvestmentswilldoverywellovertimeandhave
limitedcorrelationtothemarkets.Goingforward,ifweseeanewsituationthathassimilar
downsideandupsidepotentialandprobabilitiesasLBI,wewillinvestagain.Hopefullythe
attractiveupsidepotentialwillplayout.
Altegrity
Altegrity isamongthetoptenholdingsintheFund,witha4.1%weight.Thecompanyrecently
wentthroughanoutofcourtcapitalstructurereorganizationprocessbutitisstillstrugglingto
date.
3Q 2014 T h i r d Av e nue F u n d s Por t f ol i o Ma na g e r Comme n t a r y
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Altegrity isaglobal,diversifiedriskandinformationservicescompanyservingcommercial
customersandgovernmententities.Thecompanyincludesthreemajorbusinesssegmentsand
operatesviathreemainsubsidiaries.Krollofferscorporatebackgroundchecksandadvisory,
informationsecurity,ediscovery,loanverificationservices.HireRight specializesintechnology
enabledemploymentbackgroundscreening,drugandhealthscreeningandemploymenteligibility
checks.Finally,USISistheleadingproviderofsecurityclearanceandbackgroundinvestigationsto
theU.S.government.ProvidenceAssetManagementLLChasnearly$800millioninvestedinthe
company.Thisisoneofthelargestequityinvestmentsforthe$40billionassetmanagementfirm.
InitscurrentformAltegrity represents$2.4billionintransactions.USISwasboughtin2007for
$1.5billion,HireRight wasboughtfor$250millionin2008,andKrollfor$1.2billionin2010.
ExploreInformationServiceswassoldforabout$520millionin2011.Attodayspricesthese
assetsarevaluedin$1.5billion.
Therehasbeenplentyofheadlinerisk.Operationsandcashflowaretheweakestinrecenthistory.
Thegovernmenthascutandisscrutinizingwhatitispayingmanyserviceprovidersfrom
healthcaretoeducation,andUSISisnoexception.Asaresult,profitabilityhasbeencutinhalf.
Still,USIShasmaintaineditsleadershippositionwitha50%marketshareandmorerecentlywona
longterm$200millioncontractwiththegovernment,overacompetitorwhoiscurrently
contestingtheoutcome.Andgivenconcernsaboutsecurity,andissueslikeEdwardSnowden(a
USISsearch),webelievetheneedisformore,notless,backgroundchecks.Krollearningshave
alsosufferedforthelasttwoyears,butwebelievetheareaswherethecompanyhasrecently
focuseditshiringefforts(CyberSecurity&FinancialInvestigationsandGlobalCorporate
Compliance)willbearfruitinthenextcoupleyears.
Finally,theentirecapitalstructurewasduein2015($1.5billionofdebt),asignificantoverhang.
AsoneofthethreelargestholdersoftheSeniornotes,weworkedwithotherdebtholders,
includingProvidenceequity,andthecompanysfinancialadvisors(GoldmanSachsandEvercore)
toputinmotionandcompletethetransactionthatallowedAltegrity topushitsmaturitiesto
2019,whileprovidingSeniornoteholdersacouponbumpof200to250basispoints.Webelieve
thistemporalflexibilitywillallowthecompanytoworkthroughtransientproblems.
InearlyAugust,theU.S.governmentannouncedthatittemporarilysuspendedmuchofitswork
withUSISwhenthefirmdiscoveredthatitwasthevictimofacyberattack.Wetakesome
comfortinthefactthatthecyberattackwasknowndatingbacktomidJune,concurrentwiththe
sponsorsdecisiontomakeasignificantcapitaladditionintothecompany,andbeforethelawyers
signedthedocumentstoclosethetransactiononJuly1.
Asofwritingthisletter,ourdebttradesat$78(20%yield),belowourcost,henceourthesishas
notplayedoutyet.Ifthecompanygetsbacktowhereitoncewas(10%yield),ourbondsshould
tradeupto$115,whilecollectinga14%coupon,a60%totalreturn.Otherwise,webelieveweare
inthefulcrumsecurityinthenextreorganization.
NextelInternational
NextelisawirelessphoneproviderdomiciledintheU.S.butwiththemajorityofitsoperationsin
BrazilandMexico.Atthetimeofourinvestmentoveroneyearago,itlookedlikethecompany
hadseveralleversitcouldpulltoavoidabankruptcyfiling,andifnotwefeltgoodaboutbeingin
FocusedCreditFund
3Q 2014 T h i r d Av e nue F u n d s Por t f ol i o Ma na g e r Comme n t a r y
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FocusedCreditFund
thefulcrumsecurity.Sinceourinitialinvestment,thecompanyhascontinuedtodisappointand
nowwillmostlikelyrestructure.NextelisnowasmallpositionintheFund.
Cashflowhasbeenlowerthanexpecteddueinparttohigherthananticipatedchurn,andlower
averagerevenueperuser.Theswiftdeteriorationhurtliquidity,bondprices,andtheabilityof
bankstomarketthecompanyinordertokeepcapriciouscapitalmarketsopenforNextel.The
companydidinfactmonetizesomeofitsassetsbutatundisclosedlevels(ourread:discounted).
Still,theyformedstrategicallianceswithTelefonica(enterprisevalueofover$100billion),and
othersshowingfranchisevalue.Wealsomadeanaggressiveinvestmentdecisioninthiscase.We
movedoutofthesecuredbonds(113/8%notes)intotheunsecuredandlowestdollarprice7
5/8%notesinthe30sand40s.Atthetimewebelievedthatthispartofthecapitalstructure
wouldbethefulcrum,andthebestpotentialreturnprofile.Aswewritetoday,wedidshedsome
ofourposition,butnotenough.The75/8%notesarecurrentlytradingintheteens.Anadded
wrinkleisthateveninthesamelevelofsecurity,therearecomplexlegalanglesthatareplaying
outandimpactingtradinglevels.Westillwouldpointoutthatthemarketisseeingvalueinthe
upper60sforthe113/8%notes.
Some Successes
Vertellus Specialties
Vertellus producesandsuppliesspecialtychemicalproductsacrossawidevarietyofmarkets
(agricultural,industrial,nutrition,personalcare,pharmaceuticalandmedical,polymerandplastic,
sealantandadhesivemarkets;andcoatings,inks,andimagingmarkets).Itoffersitsproducts
throughdistributorstocustomersintheUnitedStatesandinternationally.Heresanexcerptfrom
ourdiscussionaboutVertellus inoursecondquarter2013letter.Westartedpurchasingtheonly
tradabledebtinthecapitalstructure,the93/8%bondsinthehigh70switha22%yield.The
bondswereashighas105inlate2011.Vertellus isamiddlemarketcompanywithabout$450
millionofdebtoutstanding.ThecompanygotintotroubleasnewsupplyofB3cameonlinein
Asia,depressingpricesforoneoftheirkeyproducts.Weexaminedthecapitalstructureanddug
deepintotheirotherbusiness,andbelievedtheyhadtheabilitytocontinuetomeettheir
obligationsonthebondsandthatinthecasewewereoffontimingorliquidity,therewasvery
littledebtaheadofourbondsandwewouldlovetoownthisbusinessthrougharestructuringof
thebalancesheet.Thesituationhasimprovedandisnowtradingat93,generatingabouta20%
returninthepastsixmonths.Wearecontinuingtoholdourinvestment,aswebelieveithasthe
potentialforsignificantadditionalreturnsoverthenextyear.
Recently,onthebackofgreatearnings(EBITDAincreasedover30%)thecompanyannounceda
comprehensiverefinancing.ThecompanyisconcurrentlyraisingincrementalcapitalforM&A.
Trusthasbeenrestoredwithmanagementasgoodstewardsofcapital.Ourbondsaresteadilybid
abovepar,andwehavecollectedoverninepointsofcouponannually.ThecontrastwithAltegrity
issignificant.Altegritys earningsarestillintransitionandthecompanyhadtopayahigher
coupontoextenditsmaturityprofile.Vertellus hasjustannounceditsplantorefinanceitsdebtat
acouponlowerthanitscurrentcouponof93/8%.Althoughthisissubjecttothemarket,we
believetherefinancingplanisattractiveforthecompanyandinvestors.
3Q 2014 T h i r d Av e nue F u n d s Por t f ol i o Ma na g e r Comme n t a r y
38
FirstDataCorp
FirstDataCorp(FDC)wasoneofourlargestholdingsduringthelast6to9months,andprovided
usa30%IRRinthepastyear.FirstDataCorporationprovideselectronicpaymentsprocessingto
customersinthirtyfivecountriesandoffersavarietyofprocessingsolutionsincludingcredit,
debit,check,andprepaidpayments,alongwithvalueaddedinformation,andinternetbased
services.Inthecompanysownwords:aroundtheworld,everysecondofeveryday,FirstData
makespaymenttransactionssecure,fastandeasyformerchants,financialinstitutionsandtheir
customers.Whetherthechoiceofpaymentisbydebitorcreditcard,giftcard,checkormobile
phone,onlineoratthecheckoutcounter,FirstDatatakeseveryopportunitytogobeyondthe
transaction.Welovethecompanysbusinessmodelandleadingmarketshare,andinvestedin
thesecuritythatwouldimprovethemostinvalue,ifitsheavilyleveredcapitalstructurewere
fixed.TheFundwasinvestedinthe12.625%and14.5%notes,weightedtothelargercoupon
issue.Thesenoteswereissuedat94.5inthebeginningof2014,andweaccumulatedmostofour
positionattheselevels.
OnJune19,thecompanyannouncedatransformativedeleveraging$3.5billioncapitalmarket
transaction.Thiswentalongwaytowardfixingthecompanywithover$20billionofdebtonits
balancesheet.The$3.5billionincluded$1.5billionfromexistinginvestorsand$2.0billionfrom
newinvestors,includingadiversegroupofpensionfunds,mutualfunds,assetmanagersand
wealthyindividuals.KKRprovidedapproximately$1.2billion,including$500millionfromits2006
Fundand$700millionfromitsbalancesheet.Afterclosingthetransaction,KKR'sbalancesheet
willhaveapproximately$1.0billioninvestedinFirstDatasequity,throughgeneralpartnerand
limitedpartnerinterests.Liquiditywasimprovedsignificantlyandinterestexpensewillbereduced
bynearly$400millionannually,asignificantnumberinthecontextof$2.6billionofearnings.
Looki ng Forward
WhiletheFundgeneratedalmost11%returnyeartodatethroughtheendofJuly,
11
wehavegiven
backsomeofthatinAugustasaresultofsomemistakesandsomemarktomarketlosses.Bothof
thesearetobeexpectedovertimeasaresultofthetypesofinvestmentsandthemarketsin
whichweinvest.
TheFundhasrankedinthetophalfofallhighyieldbondfundsforreturnsfromincome
12
forthe
lastthreecalendaryearsandyeartodate,andinthetopquartileofincomeforthelasttwo
calendaryearsandyeartodateasofJuly31,2014. Wearegettingpaidextraforthecredit/
defaultrisk(theprobabilitythatthecompanydoesn'tpayitscoupon)andtosomedegree
11 TheFundsoneyearandsinceinception(August31,2009)averageannualreturnsfortheperiodendedJuly31,2014were17.83%
and12.44%,respectively.ThirdAvenueFocusedCreditFundisofferedbyprospectusonly.Theprospectuscontainsmorecomplete
informationonadvisoryfees,distributioncharges,andotherexpensesandshouldbereadcarefullybeforeinvestingorsendingmoney.
Pastperformanceisnoguaranteeoffutureresults.Investmentreturnandprincipalvaluewillfluctuatesothataninvestorsshares,
whenredeemed,maybeworthmoreorlessthanoriginalcost.TheFundsreturnsshouldbeviewedinlightofitsinvestmentpolicyand
objectivesandqualityofitsportfoliosecuritiesandtheperiodsselected.M.J.WhitmanLLCDistributor.Ifyoushouldhaveanyquestions,
orforupdatedinformation(includingperformancedatacurrenttothemostrecentmonthend)oracopyofourprospectus,please call1
8004431021orgotoourwebsiteatwww.thirdave.com.Currentperformancemaybelowerorhigherthanperformancequoted.
TheS&P500IndexisawidelyrecognizedbenchmarkofU.S.stockmarketperformancethatisdominatedbythestocksoflargeU.S.
companies.
12Incomereturnistheportionoftheholdingperiodreturnthatisattributedtodividenddistributions.Thiscalculationassumesthatthe
investorincursnotransactionfees,paysnotaxesatthetimeofdistribution,andreinvestsalldistributionspaidduringtheperiod.Data
fromMorningstar.
FocusedCreditFund
3Q 2014 T h i r d Av e nue F u n d s Por t f ol i o Ma na g e r Comme n t a r y
39
FocusedCreditFund
illiquiditypremiumonsomeofoursmallerinvestments. Westillbelieve(aswehavewrittenfor
twotothreeyears)thattheUSeconomyisonthemend,andthattherewillalwaysbe
opportunitiesforinvestorsthatarepatientandtakeacontrarianview.
Soonafterpublishingthisletter,onAugust30,2014,theFundwillachieveanimportant
milestone:ourfiveyearanniversary.Asweprepareforthiseventitisinevitabletoreflectonthis
lastfiveyears.WedliketohighlightfivefeaturesthatspeaktothesuccessoftheFund:
1) Weofferauniqueanddifferentiatedproduct:theFundhaslowcorrelationtoitsbenchmark,
theBarclaysCapitalU.S.CorporateHighYieldIndex
13
(53%)andisinthebottomquartilefor
correlationversusitspeersintheMorningstarU.S.HighYieldBonduniverse;
14
2) Weveassembledaqualityteamwithvastexperience;
3) Weparticipatedinoverseventyfiverestructuringsinthepastfiveyears;
4) TheFundgeneratedtopquartilereturnsfortheoneandthreeyearperiods;
15
5) TheFundwasawardedtheMorningstarfivestarsratinginitsU.S.HighYieldBonduniverse,
16
pluswewerealsonameda2014RisingStarofMutualFundsbyInstitutionalInvestor.
17
Weknowthepastdoesntpredictthefuturebutthesearegoalswecommittedtoworkonaswe
launchedtheFundandoneswhichwecommittogoingforward.Andalthoughhardtoquantifyin
astatistic,oneoftheachievementsweareparticularlyproudofisbuildinglongtermrelationswith
ourinvestors.Wethankyou,asalways,foryourtrustandyoursupportoftheFocusedCredit
Fund.
13TheBarclaysCapitalU.S.CorporateHighYieldIndexcomprisesissuesthathaveatleast$150millionparvalueoutstanding,amaximum
creditratingofBa1orBB+(includingdefaultedissues)andatleastoneyeartomaturity.
14OneyeardailyreturnscorrelationsasofJuly31,2014.DatafromMorningstar.
15Fortheone,threeandsinceinception(August2009)periodstheFundrankedinthetopquartileofFundsoutofthe706,568and497
fundsincludedintheMorningstarHighYieldcategory.TherankingisbasedonaverageannualreturnsasofJuly31,2014.Source:
Morningstar.
16Foreachretailmutualfundwithatleastathree yearhistory,MorningstarcalculatesaMorningstarRatingbasedonaMorningstarRisk
AdjustedReturnmeasurethataccountsforvariationinafundsmonthlyperformance(includingtheeffectsofsalescharges,loads,and
redemptionfees),placingmoreemphasisondown wardvariationsandrewardingconsistentperformance.Thetop10%offundsineach
categoryreceivefivestars,thenext22.5%receivefourstars,thenext35%receivethreestars,thenext22.5%receivetwostarsandthe
bottom10%receiveonestar.(Eachshareclassiscountedasafractionofonefundwithinthisscaleandratedseparately,whichmaycause
slightvariationsinthedistributionpercentages.)TheOverallMorningstarRatingforaretailmutualfundisderivedfroma weightedaverage
oftheperformancefiguresassociatedwithitsthree,five andtenyear(ifapplicable)MorningstarRatingmetrics.ThirdAvenueRealEstate
ValueFundwasratedagainstthefollowingnumbersofU.S.domiciledfundsintheGlobalRealEstatecategoryoverthefollowing time
periods:159fundsinthelastthreeyears,134fundsinthelastfiveyears,and26fundsinthelasttenyears.WithrespecttotheseGlobal
RealEstatefunds,ThirdAvenueRealEstateValueFundreceivedaMorningstarratingoffivestars,fourstarsandfourstars forthethree,
fiveandtenyearperiods,respectively.MorningstarratingisfortheInstitutionalshareclassonly;otherclassesmayhavedifferent
performancecharacteristics.Ratingsare2013Morningstar,Inc.AllRightsReserved.Theinformationcontainedherein:(1)isproprietary
toMorningstarand/oritscontentproviders;(2)maynotbecopiedordistributed;and(3)isnotwarrantedtobeaccurate,completeor
timely. NeitherMorningstarnoritscontentprovidersareresponsibleforanydamagesorlossesarisingfromanyuseofthisinformation.For
moredetailedinformationaboutMorningstarsAnalystRating,includingitsmethodology,pleasegoto
http://corporate.morningstar.com/us/documents/MethodologyDocuments/AnalystRatingforFundsMethodology.pdf.DataasofJuly31,
2014.
17EveryyearFundIndustryIntelligence(FII)andFundDirectorIntelligence(FDI)scoutthemarketfornomineesfortheMutualFund
IndustryAwards.TheRisingStarsofMutualFundsareupandcomerswhoseaccomplishmentsin,andcontributionsto,theirfirms and/or
totheindustrymakethemstandoutamongtheirpeersandpositionthemasfutureleaders.Starsmayholdanypositioninany typeoffirm,
andshouldmeetsomeorallofthefollowingcriteria:(1)Leadershipintheirprofession,firmand/orindustry,(2)Outstandingcontributions
toinnovations,productdevelopment,clientservice,salesand/orgrowthinassetsorreturns,(3)Formalrecognitionbytheirfirmand/or
industrygroups,(4)Activecontributortothebroadermutualfundcommunity,and(5)Nomorethan10yearsworkinginthemutualfund
industry.
3Q 2014 T h i r d Av e nue F u n d s Por t f ol i o Ma na g e r Comme n t a r y
40
FocusedCreditFund
Finally,wewouldliketopointoutthattheFundhasgrownsignificantlyoverthepastyears,and
hasbeenoperatinginitscurrentsizeforsometimenow.Overthisperiodwehavebecomequite
comfortablewiththeFundssize.Boththeoperationalaswellastheperformancerecordofthe
Fundduring2014reflectthis.Aswehavesaidinthepast,thesizeoftheFundwillbeboundedby
ourlevelofcomfortandatthispointweareabletocontemplatefuturegrowth.
WelookforwardtowritingtoyouagainattheendoftheFundsfiscalyearonOctober31,2014.
Sincerely,
ThirdAvenueFocusedCreditFundTeam
ThomasLapointe,LeadPortfolioManager
JosephZalewski,PortfolioManager
NathanielKirk,PortfolioManager
EdwinTai,PortfolioManager
3Q 2014 T h i r d Av e nue F u n d s Por t f ol i o Ma na g e r Comme n t a r y
41
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3Q 2014 T h i r d Av e nue F u n d s Por t f ol i o Ma na g e r Comme n t a r y
42
This publication does not constitute an offer or solicitation of any transaction in any securities. Any recommendation
contained herein may not be suitable for all investors. Information contained in this publication has been obtained from
sources we believe to be reliable, but cannot be guaranteed.
The information in these portfolio manager letters represents the opinions of the individual portfolio manager and is not
intended to be a forecast of future events, a guarantee of future results or investment advice. Views expressed are those
of the portfolio manager and may differ from those of other portfolio managers or of the firm as a whole. Also, please note
that any discussion of the Funds holdings, the Funds performance, and the portfolio managers views are as of July 31,
2014 (except as otherwise stated), and are subject to change without notice. Certain information contained in the
following letters constitute forwardlooking statements, which can be identified by the use of forwardlooking
terminology such as may, will, should, expect, anticipate, project, estimate, intend, continue or
believe, or the negatives thereof (such as may not, should not, are not expected to, etc.) or other variations
thereon or comparable terminology. Due to various risks and uncertainties, actual events or results or the actual
performance of any fund may differ materially from those reflected or contemplated in such forwardlooking statement.
Third Avenue Funds are offered by prospectus only. Prospectuses contain more complete information on advisory fees,
distribution charges, and other expenses and should be read carefully before investing or sending money. Please read the
prospectus and carefully consider investment objectives, risks, charges and expenses before you send money. Past
performance is no guarantee of future results. Investment return and principal value will fluctuate so that an investors
shares, when redeemed, may be worth more or less than original cost.
If you should have any questions, please call 18004431021, or visit our web site at: www.thirdave.com, for the most
recent monthend performance data or a copy of the Funds prospectus. Current performance results may be lower or
higher than performance numbers quoted in certain letters to shareholders.
M.J. Whitman LLC, Distributor. Date of first use of portfolio manager commentary: August 29, 2014
622ThirdAvenue,31
st
floor|NewYork,NewYork10017
www.thirdave.com
About Third Avenue Management
Third Avenue Management LLC is a New Yorkbased global asset manager that has adhered to a proven value
investment philosophy since its founding in 1986. Third Avenues disciplined approach seeks to maximize long
term, riskadjusted returns by focusing on corporate financial stability, and price conscious, opportunistic
security selection throughout the capital structure. The firm offers its services to private and institutional clients,
and had approximately $13 billion in assets under management as of July 31, 2014.
If you would like further information about Third Avenue Funds, please
contact your relationship manager or email clientservice@thirdave.com