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FPA's Romick: 'Cushion Bonds' Long Gone

Steve Romick, manager of FPA Crescent, on dodging the worst of downturn and capitalizing on recent opportunities.

Mike Breen: Greetings, this is Mike Breen from Morningstar coming to you from the 2009 Morningstar Investment Conference. We've gathered some of the best money managers in the world here, and we're fortunate to have one of them with us now. Steve Romick from FPA Capital. How are you today?

Steve Romick: FPA Crescent.

Breen: FPA Crescent, sorry.

Romick: But I do work on the FPA Capital.

Breen: OK, we were just discussing that. You folks had been, sort of, I guess I would call it bearish, long before anyone else. One of the few shops, funds, that actually was talking about the subprime meltdown and some of those issues before they occurred. So you dodged that bullet, did relatively well, held a lot of cash. Just looking at the fund, you seem to still be in a good bit of cash. So I take it you don't think the storm has passed? I was just going to get your thoughts on the macro environment and what opportunities you see out there.

Romick: You know, I don't--I mean, it's very generous for you to say a number of the things you just said in that introduction. I don't believe that we actually dodged the bullet. We just didn't catch it in the heart.


Breen: OK. You weren't mortally wounded. That's the new outperformance, minus 20 instead of minus 40.

Romick: Great. It feels so good, you know. No, we actually would like to be a lot more invested than we are now. We would like to have been. We shifted the portfolio, the FPA Crescent portfolio, a lot more to debt. And we went from about 5% to over 30%. But we should have been at least 10 points higher than that. As we pulled liquidity down to as low as 23%. We would liked it to have been in the low teens, but we just didn't get all the debt that we wanted. We had orders on our trading desk at 10% above the current offers on some bonds. So as these bonds we're trying to buy at say 68, we had orders in this up to 74, and we weren't getting them executed just because of the liquidity. And since these bonds don't trade on an exchange, if you're at the right market maker, it's a little bit luck of the draw.

Breen: And was that mostly corporate debts, or a mix?

Romick: All corporate, all high-yield and distressed. All higher--I mean we're not talking high yield... some of this will become equity. There will be bankruptcies in our portfolio. We expect it to be a way for us to either end up with equity or get paid out at a level that's well above our purchase price.

Breen: OK. Were you seeing any special opportunities? Because when I looked at the portfolio, a lot of it wasn't high-yield. There were some pretty decent names. I cover value equity funds, and there were a lot of names that folks, some famous managers, were buying equity in. It seemed like there was maybe a one-time deal there last fall where spreads got really out of whack. Did you see some of those types of things--where you could get high-yield returns on something that's better credit quality?

Romick: I call those cushion bonds, and we were able to put some of those in the portfolio, but that wasn't the lion's share of the portfolio. I guess you would be making reference to something like Home Depot debt, where we bought the paper. We had 14 at yield, and 14 month paper at our purchase at 12%, a little over 12%.

Breen: OK.

Romick: Which is very attractive. Although the 12 was tied to Libor, and Libor's since dropped,  so our effective yield will end up being north of 10, some place between 10 and 11.

Breen: Is that opportunity gone in the market?

Romick: Oh, it's gone.

Breen: Cushion bond long gone?

Romick: Long gone.

Breen: You snooze, you lose.

Romick: Those bonds are back to par at the bottom of the low 90s.

Breen: All right, great.

Michael Breen does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.