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Rooting Out Value Across the Capital Structure

Christopher Davis

Christopher Davis: Hello, I'm Christopher Davis with Morningstar.com. Today I'm with Steven Romick, the manager of FPA Crescent Fund. Crescent Fund is a terrific fund; it has a great long-term record. And Steve is actually a nominee for the Fund Manager of the Decade award, which we'll be announcing later on, I believe in January. Steve, welcome. Thanks for joining me.

Steve Romick: Thank you.

Davis: Steve, you have a really unique strategy among mutual fund managers. Most mutual fund managers stick with a box in the style box. They stick with one asset class. But you do neither. Could you just briefly sum up what you're trying to accomplish and how you do it?

Romick: I guess we don't like the cages. We are like free range chickens, I guess. Our goal is to generate equity rates of return with less risk than the market over time. And we try and do that by investing across the capital structure of a company. So the common stocks, preferred stocks, convertible bonds, junior debt, senior debt, bank debt of a company, and in different asset classes, as well.

So we're really looking across the full range and spectrum in order to try and provide those equity rates of return, and trying to be agnostic along the way as to industry group and asset class.

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Davis: And so you're a dyed-in-the-wool value investor. You're always looking for a good bargain. Last fall and last winter, in the midst of the financial crisis, lots of value managers, it was their instinct to buy stocks, and they were especially interested in financial stocks, which were so beaten down. And you took sort of the opposite route. You especially were interested in distressed debt, high-yield debt, and much of it issued by financials. Could you talk about how you handled the financial crisis and maybe what you learned from it?

Romick: Well, the financial crisis, like every financial crisis that has come before, there is always an element of truth to what creates that. Then everything takes a little bit of fear that magnifies that. And we just felt at the end of the day that so much of the debt that we were buying of these financial companies, whether it be the debt collateralized by airplanes at International Lease Finance Corp. or the debt collateralized by automobiles at Ford Credit of Europe, or the debt collateralized by a host of different things at CIT Group, we just felt that asset coverage was there.

We felt that if we really stress-tested the portfolio of loans that were written and had ridiculously large default rates and very low recoveries, we felt, at the end of the day, that in so many instances of the debt that we were buying, we had terrific asset coverage.

And at the end of the day, as value investors, we want to make sure that we were protecting our capital. So we can protect our capital, as we were able to then, and have tremendous optionality for good things happening, and we set the stage for some pretty good performance.

Davis: As you mentioned, the market has rallied quite a bit, and Crescent has benefited handsomely from that. So after this big rally, just reading your shareholder reports, you seem a little less, or maybe much less enthusiastic. Are there any areas of opportunity that you could single out?

Romick: We still like energy. We still like the energy at longer term. As you and I were discussing prior to this interview, we like it for supply and demand characteristics that are attractive over time. It offers inflation protection, two. And three, it offers currency protection if you don't believe the U.S. dollar is going to be the currency of choice well into the future.

So we like it for those reasons, all three of those. We like health care. We've been increasing our health-care exposure of late because there is so much concern surrounding the health-care plan.

But it is not always just about what you like. It is about what you don't like. And we're still trying to stay away from the consumer. We're still trying to stay away from most financials on the equity side of the equation.

Davis: Thanks very much, Steve, for joining us.

Romick: Thanks for having me.

Davis: I'm Christopher Davis for Morninstar.com.