Like a Hedge Fund, But Without Hedge-Fund Fees

The following is our latest Fund Analyst Report for FPA Crescent Fund FPACX. Morningstar Premium Members have access to full analyst reports such as this for more than 1,000 of the largest and best mutual funds. Not a Premium Member? Gain full access to our analyst reports and advanced tools immediately when you try Morningstar Premium free for 14 days.

FPA Crescent can clear the hurdles between it and its goals and still deserves a Morningstar Analyst Rating of Gold. Expenses are the biggest and most obvious hurdle. The fund has never been cheap and likely never will be; the managers argue they offer a hedge fund-like philosophy and approach for less than hedge fund fees. Precious few alternative or traditional strategies, however, have been able to overcome higher-than-average fees over the long term, but so far this fund has been the exception. It has delivered excellent results after fees for 24 years, and for most of that time fees were much higher than they are now. Expenses here have dropped 43% since 2009, and, while they're still above average, they are lower now than they have ever been. Asset size is another potential hurdle. With more than $20 billion under management here and in similar strategies, its management team's ability to invest in the small- and mid-cap stocks that helped it years ago is limited. Flows into the fund, however, have turned negative in recent years, which actually alleviates some asset bloat concerns. There also are more people involved: Manager Steve Romick now has two comanagers and eight analysts contributing. Romick and his team also apply the same eclectic, contrarian style that shoots for equitylike returns with less than equitylike risk by watching and waiting for the right price and place to deploy cash across the capital structure. Patience and strict value standards remain the fund's edge. Romick remains pessimistic about valuations in general but hasn't gone on strike. The fund still had a lot of cash on hand at the end of 2017's first quarter--38% of assets--but he still thought financials stocks were relatively inexpensive after their post-U.S. election rally. The team also had been snooping around the healthcare sector after its weak 2016. The fund's helping of high-yield bonds remained small, less than 6% of assets, after taking profits on some energy and basic materials sector issues it had picked up earlier in 2016. This approach has helped the fund achieve its goals over time.

Process Pillar: Positive | Dan Culloton 05/19/2017

This fund ranges across asset classes, market caps, sectors, geographies, and public and private markets in pursuit of equitylike returns with less risk. The managers, who can also short securities, are absolute value investors who view risk as the possibility of suffering permanent loss, not of underperforming a benchmark or peer group. They seek securities trading at substantial discounts to their estimated worth and stockpile cash when they can't find them. This flexible approach earns a Positive Process Pillar rating.

The fund's asset allocation varies based on where value resides. In the late 1990s and early 2000s, it favored small caps that had lagged in the 1990s' bull market. In 2008, it turned to high-yield and distressed debt, believing they were cheaper than stocks. In 2009, the fund shifted to moderately priced blue chips.

Macroeconomics influence but don't drive the process. The fund raised cash in the mid-2000s, when the credit boom neared its peak. Concerns that loose monetary policy has inflated asset prices have guided the fund into cash again in recent years.

The fund's size makes it harder to invest in small- and mid-cap stocks and limits the impact of its illiquid investments. But the team also is deeper, and the fund has expanded its tool kit by lifting its limits on overseas investments and individual short positions.

This fund found itself preparing for the opportunity to pounce in early 2017. The managers found the stock and bond markets dearly priced for the most part and trimmed some of the positions they entered in the latter half of 2015 and early 2016, primarily among energy high-yield bonds and some financials stocks.

The portfolio, however, maintained significant positions in financials companies. Veteran manager Steve Romick said they still looked relatively inexpensive even after their post-election rally. The Trump administration's trade, tax, and financial regulation agenda looked more uncertain at the start of 2017's second quarter, but stocks like

The fund's high-yield stake in early 2017 remained below 6% of assets as its managers trimmed some bonds and found little else to get excited about. The fund has, however, stayed creative and opportunistic on the margins, making a private loan to the troubled Sears Canada alongside private equity firms such as KKR and TPG. The managers expect an internal rate of return of nearly 12% on the loan.

The portfolio remains an interesting mix of the opportunistic and cautious with such positions balanced by a large, nearly 40% cash stake.

Performance Pillar: Positive | Dan Culloton 05/19/2017

The fund's stated mission is to deliver equitylike returns with less risk than the stock market-- a hurdle it has far exceeded since inception--and earns a Positive Performance Pillar rating. Its 10.4% annualized gain from its June 1993 launch through April 30, 2017, beats the S&P 500 by 1 percentage point per year, while its standard deviation, a measure of volatility, was 31% lower than the index's.

FPA Crescent has won by not losing. With an oft-heavy cash stake, it will lag in some rallies. From its 1993 inception through the end of April 2017, it captured 69% of the S&P 500's gains in upturns. However, it was able to preserve those gains in rough environments, suffering just 46% of the index's losses in downturns. Over longer stretches, performance has been consistent. In 167 rolling 10-year periods from its birth through the end of April 2017, the fund has beaten the allocation--50% to 70% Morningstar Category average 100% of the time and the S&P 500 89% of the time.

It fares well on both an absolute and risk-adjusted basis against rivals and benchmarks with 60%/40% stock/bond mixes. Its Morningstar Risk-Adjusted Return of 6.5% annualized from inception through April 2016 beats the 4.5% of

People Pillar: Positive | Dan Culloton 05/19/2017

Steve Romick has led FPA Crescent since its 1993 inception, compiling a stellar record along the way. The fund isn't a one-man show, though. Analysts and investment committee members Brian Selmo and Mark Landecker have been comanagers since June 2013. Selmo is also research director for the Crescent team, overseeing about eight analysts with an average FPA tenure of more than three years. In total, 11 investment professionals works on this fund, which earns a Positive People Pillar rating.

FPA targets experienced analysts, but it takes pains to ensure its hires share the firm's distinctive investment style. Selmo, for example, had founded his own asset-management firm and was an analyst at value shop Third Avenue before joining in 2008. Landecker worked at Kinney Asset Management and Arrow Investments before joining in 2009.

Romick collaborates with other managers at the firm. In total, FPA has nearly 30 investment professionals with an average tenure with the firm of seven years. Romick's role at FPA has grown as former partner Bob Rodriguez stepped back and then retired in 2016, though FPA Crescent remains the only mutual fund he manages. He, Landecker, and Selmo also run a hedge fund, separate accounts, and a piece of

Parent Pillar: Positive | Dan Culloton 04/13/2017

FPA has changed but still earns a Positive Parent Pillar rating.

This is no longer Bob Rodriguez's shop; the outspoken legend retired in 2016. Steve Romick, FPA Crescent manager and managing partner with CFO J. Richard Atwood, is now its public face. He's no less zealous a contrarian than Rodriguez, though he expresses himself less vehemently and is more apt to nurture investor expectations than leave them to form their own.

The same is true of FPA. It still would, as former

A core of committed capital and virtues remain, however. Investors still run FPA for investors. They eat their own cooking and charge reasonable fees. They're focused on the long term, disdain trendy fund launches, avoid regulatory snafus, and write smart and engaging shareholder letters. The firm’s focus on achieving good absolute long-term returns via high-conviction, bottom-up strategies also hasn’t wavered.

Price Pillar: Negative | Dan Culloton 05/19/2017

FPA Crescent is expensive relative to its category and gets a Negative Price Pillar rating. Its 1.07% annual price tag, according to its most recent prospectus, though lower than in the past, remains above the category average and median. Outsourcing accounting and administration has shaved some basis points off this fund's levy, but assets have grown to more than $17 billion from $1.3 billion in this fund in 10 years. Shareholders have benefited in the form of lower administrative costs, but the fund's flat 1% management fee limits the extent they will profit from improving economies of scale.