Bridget Hughes: Hi. I'm Bridget Hughes. I'm one of the analysts here at Morningstar, and I'm here with Ian Lapey, who is one of the co-managers of the Third Avenue Value Fund.
Ian thanks for coming in.
Ian Lapey: Thanks for having me, Bridget.
Hughes: It's nice that you are here now, because I know you just got back from Hong Kong, and Hong Kong is really represented in the Third Avenue Value portfolio. So, what were your key takeaways from your visit and how does that translate into the portfolio?
Lapey: Well, I was really impressed with the properties of our companies and particularly on the commercial real estate side. I visited shopping malls, including Harbour City, which is owned by Wharf, and also Wheelock, and it was very impressive. At a Chanel store at 3 o'clock in the afternoon on Wednesday, there is actually a long line just to even get into the store.
So, this somewhat supports what we've thought, because retail sales in Hong Kong in 2011 were actually up 25%, which of course is robust, and we actually had a chance in this case to see it on the ground.
The other sectors seemed to be very healthy, too; the office sector is impacted to some degree by some weakness in financial firms, but still the properties of our companies are very, very well located, and occupancy levels are very, very low, and new supply coming on in the market is very minimal. So, we expect fundamentals to remain very healthy there also.
I also visited Shenyang, which is a major city in Northeast China, where some of our companies have properties, and I was very impressed with the locations there. That market, there is certainly is a lot of supply. That's why I picked it to visit, but still with our good locations and a very healthy long-term outlook for that economy, I think generally our companies are making very good investments there as well.
Hughes: So, you went specifically thinking, OK, supply is a problem or there is a risk here that I need to investigate?
Lapey: Right, I think they are very different property markets. Hong Kong, where you have a really supply-constrained market is super attractive.
China is much more competitive. You do have a lot of supply, both in office and residential. So, I wanted to see, one, where our locations are for our companies, make sure they are reasonable, they are in healthy areas, and I certainly did come away very confident that our companies have made prudent long-term investments. Now, in the short term, leasing rates will probably not be robust, but on a longer-term basis, we feel very good about it.
Hughes: So, what you're really trying to do with these visits--because these are investments that have reported NAVs that you may or may not make adjustments to or that you have made adjustments to, and trading at a discount. But as a value investor, you're OK with the discount, but what you want to see is a continuing in the growth of the NAV?
Lapey: Right. We first got into Hong Kong-listed companies really in 2005 in the portfolio, and since then, the NAVs have compounded across our holdings at rates between 10% and 20%--about 14% on average. So, it's been very, very impressive.
Now, the stock performance has been much weaker than that. So, therefore, the discounts have really widened, which is very attractive obviously from a long-term future capital appreciation standpoint. So, to your point, one of the points of the visit is to try to evaluate some of the investments that our companies are making, which will be drivers of future NAV growth.
The reason I picked Shenyang is that that is a city, one, that two of our companies have significant investments in, Henderson and Hang Lung, and also it's reported to be one where there is a really excess supply, so somewhat of a troubled, very, very competitive market.
So, I really wanted, to some degree, just to see how bad it was--to visit a shopping center that was in operation, make sure that it was actually of reasonable quality and had some level of traffic, which it did. So, I did come away somewhat relieved based on expectations in Shenyang that were for a pretty tough environment.
Hughes: So, there is another part of the world that is seeing its own headlines, and that's Europe. And we are seeing some more activity, especially among value investors, your colleague, Amit Wadhwaney included. How do you go about that exercise, when you see that there's some new opportunities perhaps in Europe, but you've also got a portfolio of some stocks that you consider to be trading cheaply as well. What is that balancing act?
Lapey: Well, at Third Avenue we have a 29-person investment team, and we meet all 29 of us once a week, and then we have separate meetings for the value team, the international team.
So, at these meetings, over the course of 2011, certainly there were a lot of very attractive potential European common stock investments. So, what Marty and I had to really determine was whether any of them were so attractive, and really the two biggest variables that we're thinking about are the size of the discount and then the potential NAV growth compounding, future compounding. At least in 2011 what we saw was that our holdings in Asia, which had really only peripheral exposure to some of the European sovereign debt issues, traded off in many cases much more significantly than many, say, blue chip European common stocks. So, ... although there were certainly attractive opportunities, we, in a nutshell, liked what we owned better.
Now, in the future, we'll just have to see. We've started to see so far in 2012 some narrowing of the discounts in our Hong Kong names, and if we get greater opportunities, we certainly have a big inventory of European common stock potential investments and certainly we're in position to act on those.
Hughes: Right. Then it wouldn’t seem right to not talk about or to touch on the U.S. for this fund, which really, many, many years ago, was much more heavily invested in the U.S., and now that’s sort of shifted overseas. What are you seeing in the U.S.?
Lapey: We're seeing opportunities. As you say, we only have about 22% of the portfolio [in the U.S.], which is very low for us. We're focused on a few different areas. One is in distressed, where we certainly very much like investing in bonds that are yielding at least 15% where we think we're investing in the fulcrum security. So far, we haven't really identified anything like that recently, but it is certainly an area where we'll look for future opportunities.
Oil and gas is one area. In 2011 we actually exited two significant holdings, Nabors Industries and Cimarex, so we entered the year really with very minimal exposure to that industry, and with natural gas at about $2.50 a share, we think there will be a lot of opportunities there.
We have, in 2012, initiated one new position in a U.S. oil and gas exploration and production company that trades at a significant discount to NAV, and there could be other opportunities in that sector both in terms of performing bonds or if the company is really well financed the common stock.
Then I guess another area where we're looking is certainly the insurance area, where again as value investors, unfortunately, we're sort of drawn to these industries where the near-term outlook is poor, and with high levels of insured losses and very low interest rates, hence low investment income, the current earnings for insurance companies are very depressed, but if we can find some opportunities, and there are several where we can buy in to companies with good underwriting track records that are trading at significant discounts from tangible book, that could be a potential opportunity for us.
Hughes: Well, thanks so much for your time and best of luck with the portfolio.
Lapey: Thank you, Bridget.