How First Eagle Mixes Moats with Cigar Butts

John Coumarianos: Hi. This is John Coumarianos, senior mutual fund analyst at Morningstar. And I am delighted today to have Abhay Deshpande with us. Abhay is a co-manager of three mutual funds, First Eagle Overseas, First Eagle U.S. Value, and First Eagle Global. These three funds have had extraordinary performance. Overseas and Global have done about 12% annualized for the past 10 years, and U.S. Value doesn't have a history that long, but it has done about 5% annualized for the past five years. All three funds have smashed their peers and their indexes.

Abhay, thanks so much for joining us today.

Abhay Deshpande: Thanks. Nice to be here.

Coumarianos: Abhay, you became the manager of these funds, I believe, in 2007, but you were an analyst at the shop for longer than that. So you are responsible for a lot of the good performance these funds have enjoyed. Tell us a little bit about what it was like going from an analyst to a portfolio manager on the funds and how your responsibilities have changed a little bit?

Deshpande: Well, the performance track record, I mean, I can't take credit for 10 years. It's truly a team effort, and obviously, the track record goes back to Jean-Marie Eveillard's own involvement with the funds. I had been an analyst since 2000, and my responsibilities there as a senior analyst included sourcing the companies that we looked at, eventually bought, doing all the ground-up research, all the fun part basically, visiting the companies, getting to know their management teams.

As time went on and as we added analysts, the responsibilities sort of migrated more into hiring and training function as well. And then more recently in the portfolio management role since 2000 as co-Manager with Matt McLennan on various fund since 2008, we've progressed and instituted a portfolio management style that is very similar in terms of the interaction with analysts, very similar to how it was when I was an analyst myself.

So back then and now, we depended quite heavily on the in-house analyst team. We depend on them to track down management, to keep track of the changes in the businesses and most importantly, to establish intrinsic values of the companies that we own. So the interaction is very similar to how interaction used to be with the Jean-Marie himself.

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Coumarianos: Great. Tell us a little bit about the portfolio. In our discussions, in our meetings that we had earlier today, we used the phrase where we described the portfolio as containing partly moats or stocks with moats, as Warren Buffett would say. And then some stocks that we might classify as cigar butts, where they don't have as long a duration, is one way we might put it. Give us a few examples of stocks, the portfolio that fall into both of those categories.

Deshpande: Sure. As you mentioned, I mean, we're value investors, but value investing can mean a lot of different things. On the one hand, you have the old styled Benjamin Graham-type stocks, and these are basically companies that you can analyze on a statistical basis that was very quantitatively driven. Maybe it's a low price to book value or approach to net asset value.

On the other hand, you have these Buffett-type companies, where the value is in the franchise and the duration of the franchise. Intrinsic value in that case actually grows over time, and it's a much more of a qualitative analysis as well. There is more judgment required. And so the portfolio itself, we invest across that spectrum, so the portfolio itself includes these cigar butt names and as we mentioned in the franchise type, Buffett-type companies themselves.

On one hand, we have a company like Chofu Seisakusho, which is a Japanese boiler company that literally sells boilers to the Japanese retail market, and as you would imagine, it's not a growth business. But at the same time, it trades for less than that cash.

On the other end, we have company like Cintas or Sodexo, which are businesses where we feel that the duration is pretty long in nature. In other words, it's one of those proto-typical Buffett-type businesses, where he says can you go to sleep and wake up 10 years later, it's basically the same business.

Coumarianos: Right.

Deshpande: In all cases, we establish an intrinsic value and we purchase them for below intrinsic value. In the case of the statistically-oriented Graham-type stocks, we sell at intrinsic value roughly because the value is not growing.

Coumarianos: Right.

Deshpande: On the Buffett side, though, those businesses can grow over time and consequently intrinsic values can grow over time, so we're less anxious to sell them at intrinsic value.

Coumarianos: Buffett also says time is the friend of the moat business, but the enemy in a way of the cigar butt.

Deshpande: That's true. It's a very good point, a good way to put it.