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Examples of Excellent Shareholder Letters

 ... and the case for providing them.

Gregg Wolper, 06/19/2012

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.

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.

Interestingly, Romick went on to say he still hadn't sold Hewlett-Packard. He explained that, as the stock's price tumbled all the way to the low $20s, then it truly did enter bargain range. In fact, he had bought more at that level. One can admire his fortitude and flexibility, or one can decide he should have cut the cord on Hewlett-Packard once and for all. But at least shareholders are getting an honest and detailed answer to a question many doubtless were asking: "Why is this dog in my portfolio?" Believe it or not, many management letters fail to address such obvious issues.

Beyond the specifics of that one controversial stock, Romick's discussion provides important insights into his thought process and his tendencies. Armed with that knowledge, built through many such discussions in letter after letter, shareholders and potential shareholders alike are in a much better position to determine if FPA Crescent is an appropriate holding for them.

Beyond the Letters 
Important as they are, the shareholder letters contained in quarterly or annual reports aren't the only ways managers and fund companies can make their strategies clear. The development of sophisticated Internet sites for most mutual funds has multiplied the opportunities to communicate with shareholders.

As with the letters, not all fund shops take full advantage of this opportunity. But some do. Earlier this year, for example, Longleaf Partners posted a lengthy conference call, with managers and analysts candidly addressing the rationale behind specific securities along with larger issues including underperformance and controversial holdings. That shop produces detailed letters as well, but the call added more depth and a level of immediacy that the letters can't match. More recently, Longleaf posted audio highlights from its annual meeting, where similar questions were addressed.

Longleaf and other firms, such as International Value Advisers, also post one or more permanent pages on their sites (IVA's is here) that describe their investment philosophies in detail. Like good manager letters, these reviews--IVA's is labeled an "owner's manual"--help make it clear which investors would find the fund to be right for them and which would not, and just as critically, help set proper expectations for everyone.

Why Bother? 
This column is not arguing that managers who write strong shareholder letters (and there are many) are necessarily better investors than those who don't. But candid, detailed, well-written letters do allow shareholders and other interested investors to make much more informed decisions on which funds to own and which to shun. In addition, by comprehensively describing their investment strategy and explaining why they have or haven't taken certain actions, these managers can make shareholders more familiar and more comfortable with the fund's approach, and thus more likely to hold on (or add to their stakes) during periods of weakness--an essential component of successful long-term investing. In that sense, while good letters don't make for better fund performance, they could help improve long-term investor performance.

Finally, a fund manager simply owes a certain level of detail to shareholders. Sinking a good deal of money into a fund for long-term investment is a serious matter, and it's an ongoing partnership. Shareholders deserve much more than perfunctory market reviews or investment cliches. A solid report is not easy to write. But for all of these reasons, producing a high-quality manager letter is well worth the effort.

Gregg Wolper is an editorial director and senior mutual-fund analyst at Morningstar.

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