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Buy Now, Get Paid Later

Whitman Mines Short-Term Losers for Long-Term Winners

January 27, 1998|RUSS WILES | Russ Wiles is a Mutual Fund Columnist For The Times

Martin Whitman can be described as three investors in one: a contrarian with a long-term focus who strives for tax efficiency.

He has guided the Third Avenue Value Fund to a 142% total return over the last five years, compared with 121% for the typical small-company value portfolio tracked by Morningstar Inc. of Chicago. Morningstar recognized Whitman's talents early on, naming him fund manager of the year in 1990.

Whitman, a New York native who still lives in the city, entered the industry after college in 1950, and for the next two decades moved from research to investment banking to investing in bankrupt companies, all at different firms.

He entered the mutual fund business in 1984 and started Third Avenue Value in 1990. A successor fund, Third Avenue Small Cap Value, was unveiled last year, with Whitman as co-manager. With both funds, his hallmark is to buy stocks as if he were purchasing individual businesses.

Whitman, 73, also teaches a class in investing at Yale University's school of management. He recently spoke to Russ Wiles, a mutual fund columnist for The Times.


Times: What's your basic approach?

Whitman: All of our equity investments have three characteristics in common.

One, the companies we select have extremely strong financials, meaning a high-quality balance sheet and, in particular, an absence of liabilities.

Two, they are reasonably well-managed.

Three, they're in businesses I can understand. In short, I'm looking for very strong businesses.

Times: You also want businesses that you can invest in cheaply?

Whitman: Yes. We don't like to pay more than 50 cents for every dollar that we think a company is worth.

Times: Can you still find such screaming bargains after three years of abnormally large gains in the stock market?

Whitman: Oh, sure. The general market doesn't count much. It's really specific markets that matter. Over the last 20 years, during this fantastic bull market, virtually every industry has gone through its own bear market as severe as anything that was seen during the 1930s.

You people in California know what happened to real estate. We've also had problems in energy, autos, steel, banking and a lot more. Such industry declines are ongoing and they create opportunities. Almost all of the common stocks we buy are facing terrible near-term outlooks. But that's how we get attractive pricing.

When we buy bonds, we often face an interruption in debt service. Other bond investors do a credit analysis to gauge whether there might be a money default, meaning a company can't pay either interest or principal when due. With our type of analysis, we assume there will be a money default, and we want to see how we would come out in that situation. We buy senior securities [which would be entitled to a top claim on assets in the event of a bankruptcy]. I like to call them distressed bonds.

Times: How much do bonds account for in the Third Avenue fund?

Whitman: At the moment, almost nothing, but that could change if we found attractive opportunities.

Times: Let's focus on stocks, then. Your relative performance against other small-company value funds has been impressive--Morningstar ranks you in the top quarter or so in terms of performance over the last five years. But that said, you lagged a bit in 1997. How come?

Whitman: We spent 1997 with about 40% of the portfolio in cash [which dampens returns in a rising market]. Now the cash position is around 36% and it's heading south. Part of the problem is that so much money came into the fund from investors during the year.

Times: The fund nearly tripled in size during 1997. Given your value-oriented approach, it probably takes awhile for you to put new cash to work.

Whitman: We have ongoing orders to buy various stocks, but we have to buy them at the prices we want. During some recent, unsettling days in the market, I was able to invest $100 million pretty fast. In a matter of two or three weeks, cash dropped to 36% from 40%.

Times: Do you think your cash position will come down further?

Whitman: I think it will come down dramatically.

Times: Looking at your top holdings, it's safe to say you have a large stake in financial companies.

Whitman: Financial and semiconductor equipment manufacturers account for the bulk of our portfolio.

I should add that we're not a very diversified fund. Our 10 largest holdings account for maybe 45% of the equity portion of the portfolio. But your comment also is an unfair one. The reason I say that is there are various types of financial companies. Among our U.S. investments, our largest stake is in companies that have a large presence in money management.

We also own property/casualty companies whose results are driven by their expense ratio rather than their loss ratio. These are title insurers, mortgage insurers and surety companies. The third category we own are regional and community banks. All three groups are very distinct businesses.

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