Examples of Excellent Shareholder Letters

In a recent Fund Spy column, I emphasized the importance of clarity, detail, and opinion in the letters that fund managers send to their shareholders. I explained why this is important and what elements a good shareholder letter should include. However, that column did not have room to highlight examples that met the standard. Therefore, today's column will look at a few that, though not perfect, do reach a level that all should aspire to.

At a basic level, these letters should provide a feeling that the author is an energized, thoughtful investor with a personality, holding opinions that don't simply repeat the consensus view. This might seem a low bar, but you'd be surprised how many letters are blandly written and have little of value to say. Moreover, asking for personality and opinion actually sets a higher standard than it might appear. Anecdotes or jokes alone do not demonstrate these qualities. Rather, detailed discussions of investment strategy and specific, well-supported views on securities in the portfolio--or those consciously excluded from the portfolio--tell a reader that a real person is at the helm.

At some firms, the managers themselves may not write every word of these letters. People on staff, often research analysts or former financial reporters, may help produce the language in the final version. There's nothing wrong with that--in fact, it can be beneficial to readers--as long as the thoughts and sentiments are those of the manager. In the best letters, there's no question whose ideas are being expressed.

Third Avenue 
Take a look at the letters from Third Avenue Value. No one who reads Marty Whitman's commentaries will have any doubt that he forms his own opinions, feels free to express them, and has a deep knowledge of investing. More specifically, and more important for shareholders, one emerges with a full understanding of his investment philosophy and how it differs from those of most other managers (and in some cases, academic theory).

For example, in the April quarterly letter, Whitman offers an extended discussion of whether share buybacks, dividends, or acquisitions are the preferred method of cash use for companies. The text includes details about how companies in the funds' portfolios have handled this issue, and the answers are not simple. From the level of the analysis and clarity of the argument, it is obvious Whitman and his colleagues have thought long and hard about these questions, have come to their own conclusions, and are using these convictions to shape their portfolios.

Whitman is now chairman of Third Avenue Management rather than a listed portfolio manager, but the individual managers' letters, from investors such as Ian Lapey of Third Avenue Value TAVFX and Michael Winer and Jason Wolf of Third Avenue Real Estate Value TAREX, are similarly thorough. These fund-specific letters tend to include even more detailed information about individual holdings, with less discussion of overarching issues. Reading them, one can not only learn much about the construction of the portfolios and convictions of the managers, but whether these strategies match one's preference.

FPA 
The management letters from First Pacific Advisors also allow readers to understand fully how these managers invest. In their lengthy, detailed, and clearly written letters, managers such as Steve Romick of FPA Crescent FPACX, Eric Ende and Steve Geist of FPA Perennial FPPFX, and Dennis Bryan and Rikard Ekstrand from FPA Capital FPPTX provide forthright opinions on economic conditions and government policies that affect their decisions and discuss why certain stocks are in the portfolio and why some have been jettisoned. Readers of these letters should have no difficulty ascertaining why the fund owns what it does, why it has performed as it has over the period under discussion, and most usefully, how it might perform under different market conditions in the future.

It's particularly noteworthy when a manager admits a mistake. In FPA Crescent’s 2011 annual report, manager Steve Romick shows how this can be done in a forthright manner without seeming overly apologetic or defensive. He explains how he erred in two different ways with Hewlett-Packard HPQ, first by making the initial purchase, when he says he overestimated the strength of two key business lines, and then when he failed to sell after recognizing that problem. He says he justified holding on to the stock at that point by thinking that the share price seemed cheap, but in hindsight it hadn't yet become cheap enough.