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Lapey: Much Better Opportunities in Equities

Jason Stipp

Jason Stipp: I'm Jason Stipp with Morningstar. With a lot of economic and political uncertainty still hanging around out there, yet a market that has run up quite a bit from March 2009 lows, a lot of investors may be wondering where the opportunity is today. Weighing in with us is Ian Lapey. He is a co-portfolio manager of Third Avenue Value. We are joining him in his New York offices. Thanks so much for being with us today.

Ian Lapey: My pleasure, Jason.

Stipp: So just to start out, after the runup that we've seen, a lot of investors are looking at a market that maybe seems fairly valued to them. How would you characterize, as a value investor, the opportunity set that you are seeing when you look across the market? And are you seeing as many opportunities as maybe you were a year and a half ago?

Lapey: Sure. We're still definitely seeing great opportunities. The holdings in our portfolio currently trade at discounts that are very attractive, probably about 25-35 percent discounts from our conservative estimates of net asset value.

Now, certainly in March, at the market lows, the discounts were much larger, maybe around 50 percent. But we're still seeing securities that meet our safe and cheap criteria. Safe, for us, is three things.

The first is a strong financial position. The second is a competent management team. And the third is an understandable business. Cheap at Third Avenue is a significant discount from intrinsic value or private market value. And we also want our companies to have net asset value growth potential in the double digits, over a long-term basis.

Stipp: So when you are looking at your portfolio then, it still seems like a lot of your holdings have some more room to meet what you consider to be their fair value. Have you been trimming any of the positions? Have any actually reached what you think is the fair value? Or how is your portfolio looking from a valuation perspective, overall?

Lapey: It's still very attractive. We really haven't been trimming our equity positions. We have done some trimming in the last quarter, in particular, in some of our fixed-income investments that we made a year ago. In those cases, we were buying bonds at yields to maturity of between 25 and 40 percent--companies like Forest City Enterprises and GMAC. Those bond prices rallied significantly to where the yields to maturity where closer to 10 percent, so we sold those.

Also, we invested last year in the debt of Nortel, a telecom equipment company, after it filed for bankruptcy. We bought the bonds at 17 cents on the dollar. They more than tripled. So at that point, the risk reward was much more neutral, and we did sell that.

But on the equity side, we are still seeing very attractive discounts.

Stipp: Now, since you mentioned fixed income, I wanted to ask you. Morningstar data has shown a lot of money has moved into fixed-income funds, so it seems like investors are really seeking out that asset class right now. And I know that, as you had said, you had invested in some distressed debt in the past. So I was wondering your thoughts on sort of the risk reward profile that you are seeing in fixed income versus equity, and it is it as attractive as maybe it was?

A lot of investors maybe seem to think so, or maybe they are seeking the safety. But what is your take on that?

Lapey: We are currently seeing much better opportunities in equities. A year ago, we had about nine to 10 percent of the portfolio in fixed income. But as I mentioned, we've sold many of our fixed-income investments because the prices appreciated significantly.

So we're now with only about four percent of the portfolio in fixed income--much more heavily weighted in equities, and see much more long-term capital appreciation potential, which is what we are looking for in the value fund. We see those opportunities today in equities.

Stipp: Sure. And last question for you - a good portion of your portfolio is in East Asia. And you have written about that in some recent letters. And you see a lot of opportunities there.

I am wondering, from your perspective, what is your time horizon for those investments? And also, what do you see that might cause the market to fully appreciate the value of these assets that you're holding there?

Lapey: Our time horizon for any equity investment is a minimum of three to five years. But in fact, we tend to hold securities much longer than that. For example, last year, the value fund's turnover was only five percent. So we are really long-term investors.

In terms of our Asian holdings--which are primarily focused in extremely well financed, Hong Kong real estate operating companies trading at significant discounts from net asset value--we don't really know when the market will recognize the value. But we do think that, at a minimum, the stock prices should appreciate as net asset values grow. And we have been very pleased, in fact, in a global recession, at how well the underlying businesses of these holdings have been doing.

For example, for the first half of 2009, our Hong Kong real estate companies generated leasing income growth of between nine and 23 percent. Now, this was in a terrible real estate related global recession. So we're actually very pleased with that type of growth, and think that even if the discounts remain wide, the stock prices should at least reflect a growth in net asset value for our holdings.

Stipp: OK. Well, Ian, thanks so much for your insights and for joining us today. I really appreciate it.

Lapey: My pleasure, Jason. Thank you.

Stipp: For Morningstar, I'm Jason Stipp. Thanks for watching.