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THE POWER OF ORIGINAL THINKING

THIRD AVENUE CAPITAL

t hird Ave nue Value Fund
t hird Ave nue sm all- c ap Value Fund
t hird Ave nue re al Estate Value Fund
t hird Ave nue inte r national Value Fund
t hird Ave nue Hig h yie ld c re dit Fund

F irst QUArt Er p o rt Fo lio m A nAg Er co m mEntA ry
31 January 2014

letter from the Founder
(Unaudited)
Dear Fellow Shareholders:
Much emphasis is placed on general “debt levels” in the
belief that the amounts borrowed by u.S. Federal, State
and Local governments are excessive. Indeed, 74% of
recent poll1 respondents stated that a high priority ought
to be given to debt reduction by governments.



How productive are the use of Proceeds received
from the borrowings; and



How liquid is the borrower.

There seems to be a common belief that a government’s
use of proceeds is always non-productive. Insofar as this
is true, it seems to be valid to concentrate attention on
the debt level because large debt levels coupled with a
It is obvious that this almost universal emphasis on
lack of productive use of proceeds means that the
general debt levels is misplaced. rather the emphasis
government entity will not be, or remain, credit-worthy.
should be on the credit-worthiness of borrowers,
However, there seems to be no evidence that all
specifically what are the borrower’s abilities to access
government expenditures are non-productive. Indeed, in
capital markets, if needed.
at least three historic areas, the federal government’s use
There are two things about
of borrowed moneys was
borrowing that any rational
unbelievably productive, probably
“it
is
obvious
that
this
almost
analyst ought to keep in mind.
returning to society and the
First, while individual debt universal emphasis on general country benefits with a present
instruments mature, aggregate debt levels is misplaced. rather value hundreds of times greater
debt for most borrowers almost
the amounts spent. These
the emphasis should be on than
never gets repaid from the
three areas which come to mind
borrower’s perspective. rather,
the credit-worthiness of
are as follows:
for most borrowing entities, debt
borrowers,
specifically
what
1) The Homestead act of 1862
is refinanced and expanded as
which enabled and accelerated
are
the
borrower’s
abilities
the borrower becomes increasingly
the rapid settlement of the u.S.
credit-worthy. Second, if a
to access capital markets,
West.
borrower is not credit-worthy
if needed.”
and can’t be made credit worthy,
2) The Serviceman’s readjustment
then sooner or later that
act of 1944 (the GI Bill of rights)
borrower has to reorganize or liquidate. reorganization
which resulted in the u.S. obtaining a highly
can encompass capital infusions, major asset sales or a
educated population and the world’s best university
recapitalization designed to reduce or extend cash service
system.
that the borrower has to pay out for interest, principal
3) research and Development expenditures by the u.S.
retirements and premiums.
military after World War II which gave the u.S. and
Credit-worthiness is a function of four factors for feasible
the world, among other things, the Internet and a
borrowing entities – whether corporate or governmental:
highly efficient aviation industry.
• Debt level;
The u.S. Government, and its agencies, are credit-worthy
and seem likely to remain credit-worthy for the
• Terms of the Debt;
1

In the nBC news/Wall Street Journal Survey Study #14039 conducted by Hart research associates/Public Opinion Strategies,
22 January -25 January 2014, 74% of the 800 respondents indicated that reducing the federal budget should be an absolute
priority for this year.

1

letter from the Founder (continued)
(Unaudited)
available to a government or its agencies, individual
creditors can be forced to accept a POr which entails the
creditor giving up rights to contracted for money payments
upon the affirmative vote for the POr by two-thirds in
amount and 50% in number, of the votes cast by each
impaired class. alternatively, the reorganization can take
place in Chapter 9 after a cram-down ordered by a court
of competent jurisdiction, usually a Bankruptcy Court.

foreseeable future. In contrast, many states and local
governments, including Puerto rico, a territory, are not
credit worthy. Sooner or later many of these entities will
have to reorganize, i.e., restructure their debts to reduce
or eliminate periodic cash burdens.
reorganizing governments seems to be many times
tougher than reorganizing corporations. The Third
avenue Funds are unlikely to become involved with much
troubled municipal debt unless prices are manifestly
lower than they are for troubled corporate debt. For this
there are three general reasons:

unlike corporate reorganizations, for sovereigns such as
municipalities, the period of exclusivity lasts forever
(Corporations have exclusivity for 210 days after a
Chapter 11 filing). Elected government officials most
probably can’t be removed from office as a result of
bankruptcy proceedings.

1) Chapter 9 may not be available to the defaulting
debtor.
2) It may be impossible to get rid of incompetent
elected officials.

The ultimate goal of a reorganization is to make the
debtor feasible (i.e., credit-worthy) within the context of
maximizing present values for creditors up to the amount
of the creditors’ claims in accordance with a rule of
absolute priority where no creditors of a class are given
preference over other members of the same class
(forgetting certain priorities written into the Bankruptcy
Code).

3) It may be hard to issue equity to impaired prepetition creditors to satisfy part, or all, of their
claims.
Many governments including all 50 states and Puerto rico
are not eligible to reorganize under Chapter 9 of Title 11
(the Bankruptcy Code). access to courts through Chapter
9 provides a structured setting in which the rules for
reorganizations are spelled out for local governments and
their agencies. also, post-petition borrowings can be very
attractive to lenders if the borrower has been granted
Chapter 9 relief.

In corporate reorganizations, it is relatively common to
issue ownership interests to impaired pre-petition
creditors in satisfaction of the present value of their
claims. Such equity interests might satisfy some or all of
a creditor class’s claims. In issuing cash, or new debt
which requires cash payments sooner or later, as part of
a POr, the debtor has a harder time becoming feasible
than if ownership interests were issued in, say, common
stock which does not pay a dividend. In the vast majority
of governmental reorganizations, it seems not possible
to satisfy any portion of creditors’ claims by issuing
ownership interests either in the form of equity interests
or the direct distribution of assets.

no municipality can seek Chapter 9 relief without the
affirmative consent of the state in which the municipality
is located. It seems as if in the vast majority of instances
outside Title 11, no creditor in this country can ever be
forced to give up his, her or its, rights to money payments
without his, her or its consent. In a court proceeding (such
as Chapter 11, 7 and 9 of Title 11) this right can be
abrogated. Without the ability to coerce creditors to give
up their rights to cash payments, huge hold-out problems
exist, markedly reducing the probabilities of achieving a
successful Plan of reorganization (“POr”). If Chapter 9 is

2

letter from the Founder (continued)
(Unaudited)
the role of net Asset Values for
certain tAm portfolio companies

reporting publically, while u.S. companies rely on GaaP.
Insofar as portfolio companies own income producing
real estate (as many TaM portfolio companies do), the
real estate accounted for under IFrS is carried at an
appraised value based on appraisals by independent
appraisal firms; under GaaP income producing real estate
is carried at depreciated historic cost less impairments.

Many common stocks in various Third avenue Portfolios
are selling at discounts from readily ascertainable net asset
Values (“naV”) of anywhere from 25% to 75%: e.g.,
Dundee Corp., Henderson Land, Lai Sun Garment,
Wheelock & Company and a goodly proportion of the
issues held by Third avenue real Estate Value Fund. These
are the common stocks of companies which are well
financed and which have had good to excellent records of
growth. In contrast to these discounts, the Dow Jones
Industrial average (“DJIa”) at January 31, 2014 was selling
at 2.76 times book value. In other words, certain TaM
Portfolio companies can be acquired at, say, uS$0.25 to
uS$0.75 for each uS$1.00 of corporate net assets most of
which are accounted for under International Financial
reporting Standard (“IFrS”),while comparable DJIa assets
cost uS$2.76 for each uS$1.00 of corporate net assets
most of which are accounted for under Generally accepted
accounting Principles (“GaaP”). This discrepancy makes no
economic sense except that the discounts have always
existed for the securities named at the start of this
paragraph and no catalysts such as changes in control or
going private, appear to exist for those companies.

The assets of TaM portfolio companies are probably more
liquid and probably more easily measurable than is the
case for the DJIa portfolio companies. a large portion of
the TaM portfolio companies’ assets consist of income
producing real estate, performing loans, assets under
management (“auM”), and marketable securities; assets,
that by and large, are measurable, separable and salable.
In contrast, most DJIa assets have almost all their value
tied-up as an integral, and inseparable, part of going
concern operations.
The Price Earnings ratios (“PE”) for the TaM portfolio
companies are manifestly lower than is the case for the DJIa
portfolio companies. Indeed several of the TaM portfolio
companies’ which report under IFrS standards, sport PE
ratios of two to three times reported earnings. PE ratios are
integrally related to naVs and are a function of return on
Equity (“rOE”). The TaM portfolios, of course, have much
higher equity values per dollar of market value than do the
DJIa portfolio issues. The rOEs for the TaM portfolio
companies appear to be comparable to the rOEs for the
DJIa portfolio companies. Thus, the TaM portfolio common
stocks are characterized by relatively modest PE ratios.

The quality of net assets of the TaM portfolio companies
appears to be significantly better than the quality of the
net assets of the DJIa portfolio companies. also naV, or
book values, seem to be significantly more important in
analyzing the TaM portfolio companies and their
securities than is the case for the DJIa portfolio
companies. There are a number of reasons for this
superior quality factor.

Of course, while Third avenue believes in our investment
philosophy, we must acknowledge that there can be
problems with an naV emphasis, in general, and with the
Third avenue portfolios, in particular.

First, the TaM portfolio companies appear to be more
strongly financed than the DJIa portfolio companies.
Moreover, the reported naVs in accounting statements
for TaM portfolio companies which are domiciled outside
the united States are mostly more realistically stated than
are the naVs for DJIa portfolio companies. non-u.S.
companies which are publically traded use IFrS in

Discounts from naV, and naV itself, are pretty much
ignored by most market participants, including even
disciples of Graham & Dodd (“G&D”). G&D were believers
in the primacy of the income account, even though they
did not ignore naV completely.

3

letter from the Founder (continued)
(Unaudited)
was in the prior period. Historically this has been the case,
at least since the end of World War II. While this fact alone
does not guaranty good market performance for a Third
avenue portfolio, it at least seems to have promise of
putting the odds in our favor where the common stock was
acquired at a meaningful discount from naV.

There is a tendency for the managements of well-financed
companies, such as those in the Third avenue Funds, to
be relatively oblivious to the needs and desires of outside
minority shareholders. In a way this is understandable
since managements, which often own little or no common
stock, run companies that need little or no access to
capital markets. Historically, this has been a special
problem for many well financed Japanese companies
whose common stocks were selling at material discounts
from naV. Third avenue tries to avoid investing where
these types of managements exist. We strive to ensure
that managements and/or insiders are substantial
shareholders for all of our equity portfolio holdings.

Having served on an audit committee, as a Director of an
nySE company audited by a member firm of the Big Four,
I think a comment about how reliable and protective of
minority stockholders I find u.S. audit statements to be
appropriate. This is important when investing in
companies where financial statements are important for
an analysis, something that is always the case in credit
analysis and also is the case both for TaM portfolio
companies and DJIa portfolio companies. (Financial
statements are less important when analyzing the
common stocks of high-tech start-ups or natural resource
companies seeking or exploiting new discoveries).
auditors tend to be ultra-strict and conservative when
certifying audited financial statements. The auditors will
insist that material matters be disclosed by management
and that disclosures be complete and comprehensive
within the modifying convention of conservatism. audits
can be relied on by market participants to be
comprehensive, reliable and essential tools for most
analyses. It seems remote, to me at any rate, that the u.S.
companies in which Third avenue invests, will be subject
to the kinds of problems that existed in connection with,
say, the Enron financial statements. The last thing a Big
Four audit firm seems to want is accountant’s liability
arising out of stockholder class actions or Securities and
Exchange Commission proceedings. The last thing Third
avenue portfolio managers and analysts want to do is
invest in the common stocks of companies whose
financial statements are incomprehensible, or almost so.

In this era of ultra-low interest rates, companies with
strong financial positions are sacrificing rOE for the safety
and opportunism inherent in having a strong financial
position. Third avenue is very prejudiced in favor of
opportunistic managements, such as those heading
Brookfield asset Management and Wheelock &
Company, both of which subsequent to the 2008
economic crisis were able to acquire companies or assets
on highly attractive bases.
There is little or no attraction in focusing on naV for going
concerns lacking catalysts if the market participant has a
short run goal; i.e., where short-term market
performance is the most important consideration. I
believe that a vast majority of market participants are
short–run oriented.
One major problem with many of our portfolios is that
there appears to be little possibility that there will be
changes of control or going-private transactions, two
courses of action that could result in immediate, and
substantial, market price appreciation for a common stock.
rather, for many of our holdings, one has to rely on the
continued growth of naVs in an environment where
discounts don’t widen materially over a longer-term period.
However, for many Third avenue portfolio companies, naV
seems likely to be larger in each reporting period than it

4

letter from the Founder (continued)
(Unaudited)
I will write you again when the quarterly report for the
period to end april 30, 2014 is issued.
Sincerely yours,

Martin J. Whitman
Chairman of the Board
Founder, Third avenue Management, llc

5

third Avenue Value Fund
(Unaudited)
Dear Fellow Shareholders:

which are based primarily on proved reserves of oil and
natural gas. Stock performance for the Fund’s E&P holdings
has been relatively weak recently despite a significant
improvement in natural gas pricing and fundamentals. as
of 31 January 2014, the Henry Hub natural gas price was
uS$4.94 per million British Thermal units (mmBtu), up 38%
compared to October 31, 2013 and 48% compared to a
year ago. natural gas storage was down 29.5% compared
to a year ago and 21% compared to the five-year average
storage level, as the combination of reduced dry gas drilling
and a cold winter has significantly improved the supply /
demand outlook for producers.

We initiated a position in the common stock of Kurita
Water Industries Ltd. (“Kurita”), a Japan-based provider
of water treatment chemicals, facilities and maintenance.
Kurita’s business is currently depressed, as many of its
Japanese electronics customers have been struggling and
the company has experienced cost over-runs as part of
its recent international expansion efforts. nevertheless,
Kurita has remained profitable and generated positive
free cash flow despite the challenging industry
environment. The company is well positioned, with a debt
free and cash rich balance sheet. This financial flexibility
will allow for the continued international expansion
efforts. The management team has a good long-term
track record, having operated the business profitably in
each of the last ten years. additionally management is
much more shareholder friendly than most Japanese
companies, as evidenced by a history of share
repurchases (7% of the outstanding shares since 2011)
and a dividend increase in each of the last ten years.
Kurita common was purchased at a slight premium to
book value and about a 7.5% free cash flow yield. Cash
and marketable short-term investments account for
about one third of the company’s market cap.

During the quarter, we trimmed several positions that
had appreciated, particularly in financial services, and
eliminated the Fund’s position in nintendo Common.
During the year and a half in which we owned nintendo
Common, the business performance was poor while the
stock performance was strong. Therefore, we elected to
sell and lock-in our 30% return, rather than wait for a
turnaround which, while possible, will be challenging. The
Fund’s Tellabs Common position was also eliminated as
the sale to Marlin Equity Partners, which was discussed
in last quarter’s letter, was completed. at quarter end,
cash accounted for about 14% of the Fund’s net assets.

DiscUssion oF QUArtErly ActiVity

Our work on portfolio positioning has stressed, as always,
companies with strong financial positions and a history
of building business value over time. We are able to
acquire shares in these companies because short-term
circumstances and events can lead to divergences
between the price that the market assigns to the
company now and its long-term value. If we are correct
that the businesses, as they are now, can have their
values compounded by competent management teams,
we will see that divergence narrow over time. This is what
history has taught us and it is why we spend our time
trying to understand how businesses work to create value
rather than studying price movements of securities.

recently initiated European Blue Chip common stock
positions include Total, Pargesa and Vodafone. Each of
these companies has a very strong financial position,
capable management team, healthy growth prospects
and a common stock selling at a meaningful discount to
our estimate of net asset value with a mid-single digit
dividend yield.
We continued to add to our positions in oil and gas
exploration and production (“E&P”) companies during the
quarter. as described in previous letters, our approach to
E&P investing is to invest in strongly financed and well
managed companies whose common stocks sell at
significant discounts to our estimates of net asset value,

6

third Avenue Value Fund (continued)
(Unaudited)
WHy opErAting
pErFormAncE mAttErs

Value Fund versus the MSCI World Index. We note that the
spread widened in 2013 (see below).

In a recent issue of the Financial Analysts Journal, Clifford
asness wrote an enlightening and entertaining article
titled, “My Top 10 Peeves”. asness has his own particular
way of looking at the world and although it is not the
same as ours, we were intrigued by his definition of
“risk” as the chance that an investor’s analysis is wrong
and the worst consequences of being wrong. We looked
at the portfolio through this lens and found that even
though this is not the definition of risk that we employ
during our portfolio construction, that the Fund looks
quite promising when viewed in this light.

price-to-Book comparison:
third Avenue Value Fund Ucits* versus msci World index
(30 June 2009 – 31 December 2013)
TAVFXU P/B

2.50

MSCI World P/B

P/B Value (x)

2.00

1.50

1.00

0.50

0.00
Jun-09

Dec-09

Jun-10

Dec-10

Jun-11

Dec-11

Jun-12

Dec-12

Jun-13

Dec-13

Being long-term oriented value investors, we often invest
* 30 June 2009 through 31 March 2014.
in situations where the near-term outlook is cloudy at best.
Over the past year, index prices have grown much faster
When the near-term outlook is cloudy, how can we tell if
than book value compared to the Third avenue Value
we are wrong and how do we limit downside if we are?
Fund
holdings. Given our high active Share, it is not
Two ways. First, we buy strongly capitalized companies to
surprising
our holdings would diverge from the indices.
limit downside; and, second, we
active Share is a term that has
grade our companies based on
“given
our
differentiated
gained prominence in the
their ability to grow book value or
approach to investing and our investor community over the past
net asset Value (“naV”). We feel
that grading based on book value focus on balance sheet strength, few years. It measures the
percentage of the portfolio that
growth is superior to earnings
the Fund’s Active share is quite deviates from the exposures in
based metrics because it gives a
the Index. If one of our positions
high, at 98%. the benefit of
better reflection of growth in
business value. If we are buying having high Active share is that isn’t in the Index or the
companies that are growing our Fund provides an alternative weightings are different, it
contributes to our active share.
business value, it will help limit our
Given our differentiated approach
to
passive
products
and
to
other
downside if we are wrong on our
initial analysis. Below we provide
actively managed funds that to investing and our focus on
balance sheet strength, the
an analysis of how our companies
more closely adhere to
Fund’s active Share is quite high,
are performing according to those
benchmark
weightings.
We
at 98%. The benefit of having high
metrics and why think they are
active Share is that our Fund
aren’t index huggers so our
important. Based on the analysis,
provides
an alternative to passive
we feel quite comfortable with the returns will often vary from the
products
and to other actively
risk/return profile of our portfolio.
indices, as they have over the managed funds that more closely
The chart below illustrates the price
adhere to benchmark weightings.
past three years.”
to book value of the Third avenue

7

third Avenue Value Fund (continued)
(Unaudited)
We aren’t index huggers so our returns will often vary
from the indices, as they have over the past three years.

three-year basis, according to these metrics, roughly 65%
of the portfolio is potentially undervalued.

We are vigilant about allocating capital to companies
that are well financed, well managed and have the
ability to grow net asset value (“naV”). We use the term
naV often. It represents our estimate of intrinsic value.
although in some cases book value is a close estimate
of naV, in many cases, it is not. One thing we know,
based on the data, is that total returns over time tend
to converge to a combination of book value growth plus
dividends paid. This leads us to believe that companies
consistently growing book value (or, in our parlance,
companies that are naV compounders) will eventually
deliver total returns in line with fundamental growth
and performance.

three-year Annualized Book Value per share growth versus
Annualized return (as of 31 December 2013)
BVPS
Ann.
Growth

50%

40%

Lai Sun Garment

30%

Wheelock

20%

Intel

Hang Lung
Apache

10%
MSCI
World

POSCO

Ann. Return
-30%

Devon Energy
0%
-20%

-10%

0%

Pargesa

10%

KeyCorp
20%

Daiwa

30%

SEACOR

-10%
10%

year-to-year book value changes give a reasonable proxy
for the growth in intrinsic value. Our process demands
that we focus on those changes. The genius of assessing
companies this way is we not only “grade” based on
changes in earnings power, but also on management’s
ability to allocate capital prudently. Many of our peers’
primarily focus on income statement metrics, such as
earnings per share growth. We think that approach
overlooks capital allocation. It is worth noting that other
esteemed investors, such as Warren Buffett of Berkshire
Hathaway, James Tisch of Loews and Tom Gayner of
Markel grade not only investments in this manner but
themselves. In Buffett’s most recent letter to Berkshire
Hathaway shareholders he reiterates that his goal is to
grow Berkshire’s book value in excess of the S&P 500’s
book value. This is something he feels he can control.
We agree.

-20%
Encana
-30%

Source: Factset
note: Bubbles represent all positions in the Value Fund.
Bubble sizes are adjusted to reflect position sizes as of
31 December 2013

We wanted to examine these same numbers on a five
year basis which we believe is even more relevant. as the
Value Fund uCITS portfolio will not reach the five-year
mark until 31 March 2014, we took a look the domestic
40 act Value Fund portfolio for comparative purposes. In
looking at this same chart for the five-year period ended
31 December 2013 for the 40 act Value Fund, roughly
60% of the portfolio is potentially undervalued when
looked at in this way (of course, we have reasons to
believe that each and every investment is worth more
than its current price). Discrepancies between book value
growth and annualized return narrowed compared to the
three-year numbers, giving us conviction that stock
performance does gravitate to book value growth over
longer periods of time. Lastly and most importantly, most
of the holdings in the 40 act Value Fund portfolio are

at year-end, we took a close look at our holdings and
compared stock price performance to growth in book
value over three and five-year periods. The results were
encouraging. The best way to interpret the chart below
is to consider any position to the left of the solid line as
potentially undervalued, as the book value per share
growth has exceeded share price performance. On a

8

third Avenue Value Fund (continued)
(Unaudited)
Maybe these discrepancies will persist. There is good
evidence indicating that’s unlikely. The charts above
include the total return of the MSCI World Index
compared to book value growth over three and five-year
periods, as well. note that over those time frames the
book value and total return performances tend to
converge. Given that MSCI World Index has 1,610
positions, that’s a robust data set to reinforce our belief
that book value growth is a strong predictor of stock price
performance. There is no reason why it should not work
for our holdings. another data point that also caught our
attention was the book value growth of our holdings
exceeded the growth of the MSCI World Index over both
the three and five-year periods highlighted. That means
not only are our holdings potentially undervalued, but
also are higher quality based on book value per share
metrics.

above our near our 10% annualized naV growth target.
We do not want to give the impression that our process
is formulaic in any way, but we do look at historical book
value patterns as a means to judge businesses and
management quality. If they have not hit our hurdles, we
need to know why and have a strong conviction that the
historical return patterns will improve in the future.
Why do these discrepancies exist? although these are our
theories, we thought they were worth sharing. We
gravitate to holding companies and companies with heavy
insider holdings. as we say, we like investing alongside
management. This makes rational sense, but has not
proven additive to returns lately. Many companies with
heavy insider ownership are not as liquid. Being long-term
investors, this does not bother us. yet, it does not make
those companies attractive candidates for passive
instruments, such as ETFs. Those products need liquidity.
With assets shifting to passive products over the past few
years, this might explain the recent under-performance as
less liquid names are not attracting investments. ultimately
operating performance will dictate stock performance, but
sometimes the relationship can get distorted. now might
be one of those times.

We shall write to you again after the second quarter of
fiscal 2014. Thank you for your continued interest in the
Fund.
Third avenue Value Fund Team
Ian Lapey
Michael Lehmann
yang Lie
Victor Cunningham

you can’t pick up the newspaper without reading about
Federal reserve tapering. as the Federal reserve has
begun the process of reducing liquidity in the economy, it
has spooked many investors. We have a contrarian view at
Third avenue. Due to post-crisis remedies, liquidity has
been bountiful over the past few years. Given our balance
sheet approach, with a heavy emphasis on strong financial
position, we tend to own companies that are better
capitalized than most. That is a distinct advantage when
companies need capital, but given all the excess liquidity
being pumped into the economy, that advantage has been
neutralized. With the Federal reserve scaling back bond
purchases, credit should get tighter. In that scenario, it will
give our companies more opportunities to use their
balance sheets to profitably invest to grow naV.

9

third Avenue small-cap Value Fund
(Unaudited)
team took the reins book value per share has
compounded at nearly 19%1 annually, while pre-tax
earnings have compounded at comparable rates.
Importantly, management has kept a very conservative
balance sheet in achieving that growth with only modest
use of debt along the way. Indeed, a strong balance sheet
is sine qua non in a business that requires global scale,
local knowledge, as well as deep credit skills. Valuing
World Fuel Common is not straightforward inasmuch as
the company, while not requiring large or regular capital
expenditures, does not consistently generate free cash
flow, owing to the business’s varying working capital
needs. It might be the poster child for the business model
known as “the creation of wealth while consuming cash.2”
But based on the Fund’s cost basis, equating to 11x to 12x
2013 pre-tax earnings, we viewed the shares as
reasonably undervalued, particularly given the company’s
strong financial position and likely ability to grow at
attractive rates in the years ahead through both organic
means as well as acquisitions. Seen through another lens
and further underpinning our valuation, we believe the
company enjoys enormous intangible assets that protect
the business and include its sheer scale, hard-to-replicate
local networks of suppliers and contractors as well as
customer relationships spanning decades.

Dear Fellow Shareholders:
We are pleased to provide you with the Third avenue
Small-Cap Value Fund’s (the “Fund”) report for the
quarter ended 31 January 2014.
QUArtErly ActiVity

We initiated most of the Fund’s new positions at modest
size, except for World Fuel Common and SunCoke
Common, which attained more meaningful status and are
discussed in enough detail below, we hope, to provide
tangible examples of our investing approach at work. The
former may well be a “compounder”, while the latter may
be categorized as a “special situation.”
One aspect of our search process entails looking for
attractive businesses whose shares may have been
avoided by the larger investment community because
temporary problems mean “dead money” i.e., shorttermism. Such might be the case with World Fuel
Common. run by an entrepreneurial duo for more than
13 years, World Fuel Services (“WFS”) today is a global
powerhouse in the brokerage and trading of fuel and
related services, including logistics and credit support, to
the aviation, marine and land transportation markets.
Customers as diverse as FedEx, MaErSK Lines and Wawa
depend on WFS to help plan, manage and finance the
billions of gallons of fuel needed to support their
operations around the globe. The company largely acts as
a broker or agent in these transactions, utilizing third-party
storage and delivery infrastructure and contracts with
customers to avoid commodity price risk. One of the
issues facing WFS is the wind down of a large naTO
contract in afghanistan. We believe the company will
replace the lost volumes in time and that the setback
represents only a minor (and fixable) dent in an otherwise
formidable company. Management has done an
admirable job growing the business: since the current
1
2

Our search for new investments gives us not only the
portfolio but our “Work In Process” library of stocks that
we follow and learn about, sometimes for years before
initiating a position. SunCoke Common initially came onto
our radar screen when the company’s shares were spunoff from Sunoco in 2011. With a 22% market share, the
company is the largest independent producer of coke
used by the north american steel industry. additionally,
the company operates coke-making operations in Brazil
and in India via a joint-venture. We avoided the stock at
the original spin date because of lingering customer

retained earnings per share, a potentially better metric than book value per share because it reflects the results of operations as opposed to financing, has grown at similar rates.
This observational quote gets attributed to our Founder Marty Whitman.

10

third Avenue small-cap Value Fund (continued)
(Unaudited)
contract issues connected to operational challenges that
we wanted resolved before making any commitments.
With those items attended to and the recent occurrence
of a “resource Conversion”3 event, we revisited our
thinking on the company in the latter part of 2013.

Supporting management’s operational improvement
efforts is an asset base with an average age of 10 years in
an industry where 56% of the domestic capacity is more
than 30 years old and where more than 25% is more than
40 years old. Old capacity will likely wear out in coming
years and need to be retired or replaced. (Imports
represent about 8% of north american supply.)
Importantly, SunCoke’s processing technology appears to
lead the industry – the company is the only one to build
and operate a new greenfield coke operation in 20 years.
Thus, SunCoke’s assets might be viewed as having some
scarcity value.

We suspect the public market may ignore SunCoke
because it is a commodity producer and commodities
(broadly speaking) are in the doldrums4. Moreover, the
company’s economics and corporate structure make
reported GaaP earnings and the like virtually useless for
those depending on conventional value analysis
techniques. But we gravitate to “out-of-favor” or
misunderstood investments that possess multiple
avenues for “self-help” i.e., paths to business
improvement largely within management’s control. In
SunCoke’s case self-help entails a number of items,
including:

Capital allocation:


The listing of SunCoke Energy Partners LP (“SXCP”)
creates a currency for that company that enjoys a
richer valuation and lower cost of capital than that of
the parent; in the periods ahead SunCoke ought to
benefit from growing cash disbursements not only
via its limited partnership interest, but also from
distributions related to its general partner interest;



SunCoke equity may also benefit in the periods
ahead given credible probabilities for debt
reduction, initiation of a dividend or share
repurchases.

Operational:


Lowering costs at the company’s metallurgical coal
operations or, possibly, the disposition of a business
that is currently losing money;



Improved economics as the company overhauls its
Indiana Harbor operations, the full benefits of which
ought to emerge in 2015;



Further backward integration into coal handling and
processing assets that would broaden the
company’s customer base and benefit from longterm off-take agreements;



Iron ore processing and handling opportunities that
would expand upon the company’s tolling-business
model;



a new u.S. plant in the state of Kentucky, currently
in the permitting process, could start to add
significant cash flow as early as 2017.

3
4

While the company enjoys a solid financial position and
does not bear any life-threatening contingencies, one has
to be sober about the u.S. steel industry. Measured in
tons, the industry has been in slow decline for many years
and imports of crude steel always hang over domestic
producers. nor can one ignore the thicket of industry
regulations and a concentrated customer base with
tenuous finances (your business is only as healthy as your
end customer.)

In this case the resource Conversion occurred when SunCoke listed shares of its coke-making business, SunCoke Energy
Partners LP.
as one proxy, the DJ-uBS Commodity Index has dropped 8% compounded for the past three years.

11

third Avenue small-cap Value Fund (continued)
(Unaudited)
Our sum-of-the-parts valuation suggests a range of value
in the mid-to-high uS$20s, with the Fund’s cost basis at
a 25% to 30% discount. We are further comforted from a
downside perspective insofar as SunCoke operates with
multi-year, take-or-pay contracts characterized by healthy
pass-thru provisions, characteristics that lend a high
degree of stability in what is otherwise a cyclical market.

Fund’s approximately 8% average cash weighting
during 2013 obviously hurt relative performance in
such an unusually strong year and accounts for the
vast majority of the Fund’s underperformance. The
cash was a by-product of our research and portfolio
management process, not a market call, a process
that has greatly improved in 2013. The Fund’s
expanded and more productive team in 2013 was
able to deploy much of the Fund’s cash, prudently
we believe, as the seeds for future returns. notably
at year-end cash levels had been whittled down to
less than four percent.

Three of the Fund’s eliminated positions, Park Common,
Superior Common and Tellabs Common, shared two
common traits worth remembering: (i) in each case the
underlying businesses boasted cash rich balance sheets
but had little in the way of compelling, long-term
reinvestment opportunities, rendering the cash sterile
from a shareholder perspective (other than a small, onetime special dividend in the case of Park and Tellabs); (ii)
linked to business improvement is capital allocation.
Management’s capital allocation skills and its agenda,
particularly where cash rich balance sheets exist, deserve
extra analytical focus. Tellabs Common was sold in a
tender offer at a modest market premium (albeit at a loss
from the Fund’s cost basis), while modest positive returns
at Park offset modest losses in Superior Common. The
last vestige of the Fund’s long-time holding in Cross
Country Common was sold as the stock market finally
started to attribute brighter prospects to that company’s
healthcare-related staffing business. The rapid rise in the
share price during the last year, however, attached an
unduly optimistic outlook to Cross Country’s long-term
economic value, leading us to eliminate the position.



Our cautiously optimistic views on the general
economic landscape – flagged at various points in
our quarterly letters, including the July 2013
“Outlook” and January 2012 “Portfolio Positioning,
Investing Observations” – appear reasonable in
retrospect but our determination not to “pay up” for
stocks likely hurt us this past year. Some readers may
recall our discussion dating back to the Fund’s July
2012 letter in which we asked the question: “are you
a ’relative’ investor or an ’absolute’ investor?” We
were generally unwilling to lower our return hurdles
i.e., our discount rates, in order to get invested. nor
were we willing to bend on our financial strength
and other quality criteria. The bulk of 2013’s market
performance is largely attributed to multiple
expansion. Investors proved willing to pay more for a
given level of earnings or cash flow and the
outperformance of smaller, lower quality issues –
precisely the kind of investments that the Fund tries
to avoid. The team’s focus on quality and stringent
valuation techniques undoubtedly held us back in
the recent environment, but we believe the decision
to stick to our discipline will be ultimately vindicated.



a few names in the portfolio negatively impacted
the results. We have discussed one of those names,
JaKKS Pacific, in recent letters. It has been
eliminated from the Fund. Our investment in Weight
Watchers Common has been a disappointment both

pErFormAncE rEViEW – 2013

Viewed in the single dimension of relative performance
the Fund’s results in 2013 might be seen as mediocre,
though it is hard to imagine a 26.1% return in any year as
disappointing! But in a year where the median returns of
our peer funds and the Fund’s benchmark return were
nearly 35%, the Fund’s results could plausibly raise a
question mark. a few items worth considering:


unlike most of our peers and the Index, the Fund
was not 100% invested for most of the year; the

12

third Avenue small-cap Value Fund (continued)
(Unaudited)
industrial batteries, similarly made great strides in
2013. The company’s margins are on track to
improve – as they have for several years – while free
cash flow will expand massively.

from a fundamental, as well as stock price,
perspective. We downsized the position during the
year in reaction to negative fundamental
developments, but elected to keep a toehold
position as it appeared the stock was oversold. The
Fund’s investment in Cloud Peak Energy, a leading
producer of thermal coal in the u.S. Powder river
Basin, was similarly downsized during the year given
our team’s view that realizing full value will likely
take longer than originally anticipated. The
investment time horizon has lengthened so it made
sense to reduce our exposure. Shares of Cloud Peak
have rebounded nicely so far in 2014, as coal prices
have improved markedly.

In a very real sense, we performed within our own
expectations and vision for the Fund. One needed to be
nearly perfect, if not aggressive, to outperform in 2013.
We were not perfect but we were disciplined and that
will prove more important in the long run. Our team
made huge progress on many other dimensions, such as
portfolio quality and process improvements, factors that
ought to get the most weight from investors considering
where their prospective returns may lie, as opposed to
past returns.



normally any number of the
A look AHEAD
Fund’s holdings are subject
“most
of
the
Fund’s
stocks
to takeovers, often at
We have built a portfolio that will
significant premiums to
be resilient to unpredictable
performed admirably and
market prices. Significant
macro factors, ever-shifting
were paralleled, if not
takeovers, however, were
investor sentiments and the
matched, by underlying
relatively absent from the
inevitable business cycles. Over
scene in 2013 (unlike in
the full course of a market cycle,
business development.”
2012, when takeovers
we believe returns will be
undoubtedly
helped
competitive. Our process is
enhance the Fund’s performance). We view this as
sharper than ever and also more attuned to the dynamic
part of an unpredictable ebb and flow in the
business fundamentals attached to the Fund’s holdings.
portfolio. We do not generally count on takeovers to
The market tumult in January has jolted all investors, but
drive performance; such events are just one way
has also unearthed some nice opportunities for us. We
that value can be recognized in the portfolio.
remain pleased with the current portfolio in terms of
quality, valuation and potential for future growth.
• Most of the Fund’s stocks performed admirably and
were paralleled, if not matched, by underlying
We look forward to writing you again when we publish
business development. For example, the Fund’s top
our Second Quarter report dated 30 april 2014. Thank
performer, Oshkosh Corporation, is on track to
you for your continued support.
greatly improve margins, returns, earnings and cash
Sincerely,
flow per share this year and next while cash
continues to accumulate on the balance sheet. In
Third avenue Small-Cap Value Fund Team
addition to debt reduction, the company recently
Curtis r. Jensen
announced a large share repurchase program.
Tim Bui
EnerSys, the second top contributor to the Fund’s
Charlie Page
performance and the world’s largest producer of

13

third Avenue real Estate Value Fund
(Unaudited)
Westfield Group, Millennium & Copthorne, Post
Properties, City Developments, and Commonwealth rEIT
(uS). after taking into account this activity, the Fund
ended the quarter with the following allocations: north
america (40%), Europe (23%), asia ex-Japan (14%),
australia (5%), and Cash (18%). The Fund’s returns will
undoubtedly be impacted by the performance of real
estate securities in these regions in the short term.
However, as bottom-up fundamental investors it is our
belief that the Fund’s long-term returns will ultimately be
determined by the performance of the underlying
enterprises in which we are invested and the elimination
of the price-to-value discrepancy that currently exists in
the Fund’s holdings. Therefore, we thought it would be
worthwhile to provide our shareholders with a review of
the new positions and the Fund’s top five holdings which
collectively account for about 25% of the Fund’s assets.
Only two of the positions outlined below have been top
holdings in recent years. While the holdings in the
portfolio have evolved, the underlying theme for Fund’s
core holdings remains the same, as each security
currently trades at a discount to our conservative
estimate of net asset value and represents an ownership
interest in a real estate company that is well-financed, run
by a competent control group, and is positioned to
increase underlying value by 10%, or more, per year after
adding back dividends.

Dear Fellow Shareholders:
We are pleased to provide you with the Third avenue real
Estate Value Fund’s (the “Fund”) report for the quarter
ended 31 January 2014.
portFolio UpDAtE

During the quarter, the Fund actively recycled capital by
eliminating two common stock positions (Thomas
Properties and Parkway Properties), further reducing a
previous top-10 holding (Taylor Wimpey), and
reallocating the proceeds to three new common stocks
(rayonier, Colonial, and Starwood Waypoint). The new
positions are each unique real estate securities that
ended up on our radar as a result of our differentiated
screening process. as noted in previous letters, we have
enhanced our process over recent years. In addition to
tracking our existing holdings, we closely follow 30 to 40
securities (our “T-2” portfolio) that we would like to
own – just at lower prices. In addition, we run proprietary
quantitative and qualitative screens on the rest of our
real estate universe to generate additional ideas. The
Fund’s long-term holdings, or strategic positions, tend to
originate from our “T-2” list, whereas the Fund’s shorterterm, or special situation investments, tend to be a result
of our weekly screens. This quarter, all sources yielded
actionable investment ideas. rayonier Common was on
our “T-2” list when it became available at a more suitable
price; Colonial Common was picked up on a quantitative
screen after its stock price declined sharply following an
announcement that it would undertake a dilutive capital
raise; and Starwood Common was sourced from a
qualitative screen after Starwood Property Trust
announced that it would be spinning off the portfolio into
a separately traded company. Having the infrastructure
in place to capture potential investment opportunities
and the ability to underwrite investments in a judicious
manner is more than half the battle.

nEW positions:

inmobiliaria colonial (“Colonial”) is a Spanish real estate
operating company with three primary assets: (i) a whollyowned office portfolio in Spain, (ii) a 53% stake in Societe
Fonciere Lyonnaise – a separately listed French rEIT that
owns an office portfolio in Paris, and (iii) a homebuilding
business in Spain. We have followed the company for
several years but never invested in Colonial Common
because, notwithstanding its high-quality office portfolio
(Paris, Madrid and Barcelona), the company was saddled
with too much debt resulting from a leveraged buyout in
2006. The company recently announced that it planned

The Fund also increased its investment in six existing
holdings including the common stock of Songbird Estates,

14

third Avenue real Estate Value Fund (continued)
(Unaudited)
in October 2013, the company announced a slew of
warnings related to this business unit including cost
overruns at a large expansion project and an outlook for a
weak pricing environment given additional supply in the
global market. after the announcement, the stock price fell
by more than 25%, creating an opportunity for the Fund
to establish a position in rayonier Common at a discount
to our estimate of the private market value of its three
businesses. Shortly thereafter, rayonier announced it will
be splitting into two companies by spinning off its
performance fibers business into a separately traded entity.
The purpose of the transaction is to surface the value in
the underlying businesses, allow each company to
establish its own capital structure and growth plans, and
attract investors dedicated to each business as they have
very little overlap today. The market responded positively
to the announcement. unfortunately, the Fund had only
established a 1% position in rayonier Common prior to the
announcement. We will continue to monitor the existing
investment and reassess the opportunity to add to the
position as the company splits into two separate entities.

to raise £1.0 billion of capital through a highly-dilutive
rights offering to existing shareholders, use the proceeds
to pay down its credit facility and then re-focus on
stabilizing and enhancing its office portfolio. after our
initial assessment of the terms on the offering, we elected
to conduct more extensive due diligence which included
meetings with management, property tours in Madrid and
Barcelona, as well as meetings with a number of other
market participants. Following those efforts, the Fund
initiated a position in Colonial Common with plans to fully
participate in its pro-rata share of the rights offering. Our
initial stake in Colonial Common is small, but upon
completing our subscription in the 9-for-1 rights offering,
the total investment will represent a meaningful position
in the Fund and at a price substantially below our estimate
of net asset value. Post rights offering, the company will
be in a very sound financial condition and well-positioned
to invest capital to enhance the value of its properties. We
believe the company’s new management team is
competent and should be able to materially increase net
asset value considering that nearly 20% of its Spanish
office portfolio is vacant and the company has been capital
starved over the past five to six years. In addition, the
company has a substantial tax loss carry forward which
could shield taxes for up to 18 years – a hidden asset that
could ultimately prove quite valuable.

We initiated a small position in starwood Waypoint
residential trust (“SWay”), a u.S. rEIT focused on owning
and operating single family rentals. SWay was recently
spun off from Starwood Property Trust, a mortgage rEIT.
SWay currently owns a portfolio of approximately 5,049
homes and 1,736 non-performing mortgage loans
(“nPLs”), concentrated in markets with strong housing
recovery potential such as Florida (approximately 40% of
the portfolio). We have monitored the single family rental
industry since its inception and concluded that a successful
strategy requires stand-out property management and
proprietary sourcing. Starwood acquired Waypoint, the
oldest single family management platform in 2013.
Waypoint, founded in 2009, is arguably one of the best
operators in the industry – its legacy managed portfolios
have enjoyed operational metrics comparable with the
best multi-family operators (approximately 95% occupancy
with approximately 65% nOI margin). From the sourcing
perspective, what separates Starwood Waypoint from

rayonier is a real estate investment trust (“rEIT”) based
in the united States that has been on our watch list for
several years as the company owns high-quality timberland
assets, most of which are located in the Southeast, some
well-located land on the I-95 corridor in Florida and
Georgia that seems likely to benefit from higher-and-better
use potential over time, as well as a cellulose fibers
business that has become a market leader in specialty
fibers and a “cash-cow” for the company. The company has
also historically been conservatively financed and wellmanaged. until recently, rayonier Common traded at a
premium to our estimate of net asset value as market
participants have typically “paid up” to gain exposure to
the company’s rapidly growing fibers business. However,

15

third Avenue real Estate Value Fund (continued)
(Unaudited)
others is its nPL strategy that allows it to acquire properties
at more attractive values through its joint venture with
PrimeStar. The joint venture analyzes nPL pools,
determines bid values and the best workout strategy for
each nPL. Taking nPLs through foreclosure allows SWay to
acquire single family houses at a significant discount to
what competitors must pay when acquiring portfolios of
already-foreclosed houses. SWay currently has a net-cash
position with no debt on its balance sheet. Starwood
Common trades at a discount to replacement cost of its
existing homes and the market value of its non-performing
mortgage loans. We believe SWay will be able to continue
to grow naV at 10% a year via continued home price
appreciation as well as future acquisitions and workout of
nPLs. We believe SWay may also offer a unique hedge
against a stall in the u.S. housing recovery. Higher default
rates would result in more nPLs and foreclosures resulting
in higher demand for rental houses. Similar dynamics
created higher cash flows and valuations for apartment
owners since the financial crisis.

to net asset value and after the capital raise the company
would be well capitalized and positioned to increase the
underlying value of the enterprise. nearly five years later,
the thesis largely remains the same; Songbird Common
has increased by more than 40% since our initial
investment, but is still at more than a 15% discount to its
stated net assets per share (£2.21 as of 30 June 2013).
Furthermore, this value seems somewhat understated
since it places minimal value on the company’s
entitlements. In our view, these entitlements will
ultimately prove to be quite valuable as demand for
commercial and residential space at the Canary Wharf
Estate and surrounding area is poised to increase
considerably once the Crossrail project is completed in
2018. This high speed rail line is currently under
construction and will meaningfully enhance the ease of
transport from East London to West London. For
instance, it will take less than 40 minutes to get from
Canary Wharf to Heathrow, less than 15 minutes to Bond
Street, and altogether is estimated to bring an additional
1.5 million people within a 45 minute commute of
London. This should not only accelerate the development
on the Estate but could also lead to the rents on existing
properties to converge with rents in the City, which are
more than 50% above rental rates on the Estate.

top FiVE HolDings:
songbird Estates (5% of net Assets)

Songbird Estates is a u.K.-based company that is the 70%
controlling shareholder of the Canary Wharf Group
(“Canary Wharf”). Canary Wharf is a u.K.-based real
estate operating company that owns more than 7 million
square feet of class-a office and retail space on the
Canary Wharf Estate in East London. In addition to its
income producing portfolio, which is essentially fully let,
the company has entitlements for an additional 11 million
square feet of development on the Estate, an adjacent
Estate (Wood Wharf) and in Central London (Shell Centre
redevelopment). The Fund has owned Songbird Common
since 2009. at the time of the initial investment, the Fund
purchased shares and participated in a highly dilutive
rights offering which raised uS$1.4 billion of proceeds for
the company in order to repay debt. Similar to our thesis
on Colonial, it was our view that the Fund was
establishing a position in the common stock at a discount

Forest city Enterprises, inc. (5% of net Assets)

Forest City is a u.S.-based real estate company that owns
a high quality portfolio of commercial properties
concentrated in some of the best markets in north
america including new york City, Boston, Washington,
D.C., and San Francisco. In addition, the company controls
one of the most strategic development pipelines in the
country with major mixed-use projects in Brooklyn
(atlantic yards), Washington, D.C. (yards), and Denver
(Stapleton). Forest City has been a long-time holding in
the Fund. Historically the company created a great deal
of shareholder value by retaining the vast majority of its
cash flow and reinvesting in development and urban
regeneration projects at a profit. However, the company

16

third Avenue real Estate Value Fund (continued)
(Unaudited)
entered the financial crisis with an excessive amount of
development exposure and debt levels that were
unsustainably high. Forest City has spent the past five
years focused on completing its development projects
and right-sizing its balance sheet. In our view, the
company has completed about 85-90% of the steps
necessary get the company back into a position of
strength. However, Forest City Common still trades at a
price as if it were in the early stages of a repositioning. In
fact, at current prices Forest City Common is trading at
more than a 20% discount to a conservative estimate of
liquidation value (uS$23-24 per share) and more than a
35% discount to net asset value based upon public and
private market comps (uS$30-31 per share). This
discount seems extreme and will likely dissipate as there
is additional visibility on items that have created some
uncertainty (i.e., stabilization of ridge Hill development
project, profitability of Barclays Center, long-term plans
of its stake in the Brooklyn nets, etc.) and the company
possibly implements some other shareholder friendly
initiatives (e.g., reinstating the dividend, repurchasing
stock at discounted prices, collapsing the dual-class share
structure, etc.). In addition, Forest City is one of the few
real estate companies positioned to capitalize on demand
for new commercial building activity with entitlements in
some of the most supply constrained markets in the
united States. as market conditions allow Forest City to
reactivate these projects on a profitable basis, the
company should once again generate industry leading
returns through the development and urban
regeneration process, albeit at a more measured pace.

Weyerhaeuser is involved with wood products (i.e.,
lumber, OSB, and engineered wood products),
homebuilding, and cellulose fibers. The Fund originally
established a position in Weyerhaeuser Common in
2010. It was our thesis then that (i) the Fund was buying
into an incredibly well-financed company that owned
some irreplaceable assets at a material discount to the
private market value of the various businesses and (ii)
that the discount would close as conditions within the
uS residential markets (which impact three of the four
businesses) improved from depressed levels and the
company undertook some additional resource
conversion activities (e.g, sales, spin-offs, mergers, etc.).
Since making the investment, fundamentals in the uS
residential markets have improved, the company has
sold some non-core assets and recently announced its
intention to divest its homebuilding business. The stock
price has responded favorably to recent events.
However, we believe Weyerhaeuser is still far from
realizing its full potential. The process of unlocking value
seems to have recently accelerated. The company
recently appointed a new CEO (Doyle Simons) who has
a track record of cutting costs, divesting businesses to
realize value, and returning capital to shareholders. It
seems reasonable to expect over the next few years that
Weyerhaeuser will (i) complete the divestiture of its
homebuilding business, (ii) repurchase shares or pay a
special dividend with the proceeds, (iii) relentlessly cut
costs in the remaining businesses, particularly in Wood
Products so that the company can achieve full levels of
profitability when the u.S. residential markets return to
more normalized levels of housing starts (1.5-1.6 million
units annually), and (iv) ultimately divest its non-timber
businesses so that Weyerhaeuser is a more focused
company with an unmatched portfolio of timber assets.
Should that chain of events unfold, the value of the
various pieces should easily exceed uS$40 per share.
Our estimates of value may prove conservative if other
factors play out in the company’s favor, like the end of
the Mountain Pine Beetle epidemic in British Columbia

Weyerhaeuser co. (4% of net Assets)

Weyerhaeuser is a u.S.-based rEIT that owns one of the
most valuable and productive timberland portfolios
globally with 7 million acres of timberlands including 2.6
million acres in the Pacific northwest that are
particularly well suited for growing Douglas fir and
exporting to asia to capitalize on premium pricing in
those markets. In addition to its timberland business,

17

third Avenue real Estate Value Fund (continued)
(Unaudited)
reasonable over the next few years that Cheung Kong’s
discount could close as investors recognize the (i) stability
of profits from its large launch schedule in their Hong
Kong and China residential property portfolio focused on
mid-scale price points, (ii) continued earnings and
dividend growth from Hutchison Whampoa, and (iii)
potential for share buybacks and dividend growth given
its fortress-like balance sheet and cash generation. If that
is not enough, Cheung Kong management has a history
of well-timed resource conversions that could involve
selling stabilized assets outright or spinning off property
into publicly-listed vehicles to highlight and crystalize the
latent value for investors.

leading to higher prices for logs in the Pacific northwest
(where the company is the dominant log provider) and
more converting activity in the Southeastern u.S.
(where Weyerhaeuser has a great deal of excess
capacity within Wood Products).
cheung kong (4% of net Assets)

Cheung Kong Holdings is a Hong Kong-based property
owner and developer of real estate in Hong Kong and
Mainland China and is the controlling shareholder
(49.97%) of Hutchison Whampoa, a Hong Kong listed
conglomerate. The Fund established its position in
Cheung Kong during the course of 2011, taking advantage
of the sell-off in Hong Kong property shares. The
company exhibits all of the qualities that we find
attractive in an equity security: owner/operator model
with a deep corporate bench that has a solid operating
and capital allocation track record, possesses extremely
high quality assets, a strong financial position, and shares
that trade at a significant discount to conservatively
estimated net asset value with long-long term naV
growth potential. Since 2011, the Hong Kong and China
property market has been under a cloud of governmentled policy uncertainty which has dampened investor
sentiment for most Hong Kong property shares. Despite
the cloud of uncertainty, Cheung Kong’s operating results
have been respectable, with book value per share
compounding at slightly more than 9% over the three
year period. unfortunately, the fundamental progress has
not been recognized by investors, resulting in the shares
trading at a wider discount to book value (20%) and an
even larger discount to our estimate of net asset value
despite a strengthening financial position and exceptional
performance at its largest asset, Hutchison Whampoa
Limited, that accounts for 60% of its gross asset
value. This has led to the double discount often applied
to holding company structures reaching an extreme level.
The “stub” valuation of Cheung Kong is near a 65%
discount to our estimated net asset value, close to the
historical high in 2003 during the SarS epidemic. It seems

lowe’s companies (4% of net Assets)

Lowe’s is a u.S.-based retailer that shares a duopoly
position in the home improvement market alongside
Home Depot with more than 1,800 stores throughout
north america. The company sells a wide array of home
improvement products and services, such as appliances,
building materials, paint, lumber, and tools. The Fund first
initiated a position in Lowe’s Common in 2011. Our logic
at the time was that we were buying into a well-capitalized
retailer that was mostly insulated from the threat of ecommerce and purchasing the stock at prices that
represented a 10% free cash flow yield on what we
deemed to be depressed cash flows given the pullback in
home improvement spending. In our view, it seemed
likely that the cash flows would ultimately rebound,
expansionary cap-ex would be curtailed, and the impact
for longer-term shareholders would be magnified since
the company was actively buying back stock at discount
to reasonable estimates of value with all of its cash flow.
Our hope was that we were witnessing the early stages
of another autonation or autozone—two other nondiscretionary retailers that have aggressively repurchased
shares to turn what would otherwise be a stable business
into a “growth” engine. So far, we have not been
disappointed. Since initiating a position, Lowe’s earnings
have improved (by approximately 25%) and the number

18

third Avenue real Estate Value Fund (continued)
(Unaudited)
retire stock before the market recognizes the embedded
of shares outstanding has been reduced (by nearly 20%),
earnings potential in its store base.
so the earnings per share has increased by more than
50%. However, the stock price has increased by more
oUtlook
than that because the free cash flow yield has contracted
from 10% to nearly 6% today. as a result, we have
as the strategy enters its sixteenth year, we continue to
reduced the size of the position in the Fund from more
believe that real estate is an essential allocation for any
than 5% to approximately 3.5%. While the return
long-term investor. Historically, property has been a
prospects for Lowe’s are more subdued than they were
terrific place to park capital and protect it from inflation
when the stock was trading below uS$20 per share, or
over time. Further, should that capital be invested
just the value of the company’s real estate and inventory,
alongside capable managers in high-barrier-to-entry
there is still a great deal of upside for those willing to look
markets, low-double digit returns (10-12%) are
out over the next two to three
oftentimes achievable without
years. This is especially the case
having to take outsized risks.
“We believe it now makes
when considering that Lowe’s
real estate securities have had
geographic footprint lends it to be sense to look for securities that an incredible “run” over the past
more leveraged (operationally) to are not as widely held and that five years, though much of that
a rebound in home starts versus
performance is attributable to
are more likely to exhibit
Home Depot so it is more
the large u.S. rEITs that have
inefficient pricing. there are been popular with income seeking
dependent upon big ticket
purchases versus repair and
investors. We believe it now
certain pockets of the real
remodeling items. Provided those
makes sense to look for
estate universe that are likely securities that are not as widely
big ticket purchases materialize in
the later stages of the residential to prosper in the years ahead, held and that are more likely to
recovery, Lowe’s will have an
exhibit inefficient pricing. There
even in a rising rate
opportunity to meaningfully
are certain pockets of the real
environment, but it will take estate universe that are likely to
increase its earnings as the
company is only generating about
patience and skill to identify prosper in the years ahead, even
uS$3.1 million of profits per store
a rising rate environment,
those specific opportunities.” in
or nearly 40% below peak levels
but it will take patience and
(+uS$5 million per store).
skill to identify those specific
Management believes peak levels are once again
opportunities.
attainable. We’ll consider that to be our high case. But
Some of those areas include (i) companies that have
even in a more subdued case where profits return to
strong
ties to the u.S. residential markets which are in
uS$4.5 million per store, the company would generate
the
middle
stages of a long-awaited recovery, (ii)
about uS$3.60 per share of earnings, which would
companies
that
have entitlements for new development
translate into a value of roughly uS$55 per share at a 15
in
highly
desirable
markets along with the balance sheets
times earnings multiple. This value is more than 20%
and
management
teams necessary to provide new
above current prices and doesn’t factor in the incremental
commercial
building
as demand for new product
value that should be created as the company continues to
returns, (iii) smaller and mid-sized real estate businesses
that are viewed as strategic platforms and likely to be

19

third Avenue real Estate Value Fund (continued)
(Unaudited)
acquired by larger competitors or private equity funds
as M&a activity continues to accelerate, and (iv) special
situation investments particularly in recently
recapitalized companies that now have the balance
sheets and management teams necessary to increase
corporate value. The vast majority of the holdings in the
Fund are exposed to one of these four areas, which
should drive improved fundamental performance in
2014, as well as in the years ahead.
We thank you for your continued support and look
forward to writing to you next quarter.
Sincerely,
Third avenue real Estate Value Fund Team
Michael Winer
Jason Wolf
ryan Dobratz

20

third Avenue international Value Fund
(Unaudited)
net asset value (“naV”), something we find very
attractive in light of the factors described above –
namely the company’s world-class assets, proven
management team, conservative balance sheet and
first-quartile cost position.

Dear Fellow Shareholders:
We are pleased to provide you with the Third avenue
International Value Fund’s (the “Fund”) report for the
quarter ended 31 January 2014.
rEViEW oF QUArtErly ActiVity

The Fund’s holding in common shares of Taylor Wimpey
plc was disposed of in its entirety during the quarter. We
first bought shares of Taylor Wimpey in april 2011, in
midst of a severe housing depression in the united
Kingdom. at the time, the company had just divested its
non-u.K. businesses, the proceeds of which significantly
deleveraged the company, allowing it to weather the
storm and acquire land for prospective development at
attractive prices. This well-timed purchase of a scarce
input, combined with the subsequent recovery in home
prices (helped by more than a nudge from government
policy to assist home buyers) has allowed the company
to post record profit margins in recent periods. With the
stock having more than tripled from our purchase prices,
valuation considerations favored its disposition.

antofagasta plc (“antofagasta”) is a Chilean-based copper
mining pure play whose crown-jewel asset is Los
Pelambres, the world’s fifth-largest producing copper mine.
not only is Los Pelambres one of the world’s largest
projects, it sits squarely in the first quartile of the global
cost curve. It is also quite long-lived, with a 23-year
estimated life of mine that could be extended considerably
if even part of the property’s massive resource base is
developed in future years. It is fair to describe Los
Pelambres as a trophy asset within the copper mining
industry. antofagasta’s other large-scale project is
Esperanza, another first quartile, long-lived asset.
Political risk appears to be relatively low; all of
antofagasta’s mines are located in Chile, which has
historically been a very friendly jurisdiction for mining
companies. additionally, the company is controlled by
Chile’s Luksic Family, which owns 65% of the outstanding
shares (the Luksics’ stake is worth some uS$8 billion at
current market prices). as one would expect of operators
that have significant skin in the game, the Luksics have
long been outstanding stewards of shareholder capital,
eschewing large-scale acquisitions and risky development
projects in favor of organic growth and brownfield
expansions. Management has also maintained what is
certainly one of the industry’s best balance sheets. The
company currently carries a uS$1.5 billion net cash
position; this combination of a strong balance sheet and
first-quartile cost position should provide antofagasta
with ample protection in the event of a cyclical downturn.

FinAnciAl prUDEncE in A timE oF tApEring

Throughout 2013, the word “tapering” has inspired
moments of panic in global financial markets. Tapering
refers to the u.S. Federal reserve’s gradual retreat from
the Quantitative Easing (“QE”) programs pursued by Fed
Governor Ben Bernanke in the immediate aftermath of
the Global Financial Crisis. reduced reliance on QE is at
the heart of the Fed’s “return to normalcy”, and, over
time, seems likely to result in higher interest rates, though
the timing and magnitude of increased rates are
impossible to predict with any certainty. This has serious
implications not only for the u.S. Treasury market, but for
virtually all asset classes globally.
If it seems as if this note is headed toward prognostication
about what the Fed will do, rest assured, you are still
reading one of our letters. We are ultimately agnostic
about the direction of future Fed policy, because predicting
macroeconomic events is notoriously difficult and nearly

Declining copper prices and fears of an emerging
markets slowdown have now given us the opportunity
to buy antofagasta shares at a substantial discount to

21

third Avenue international Value Fund (continued)
(Unaudited)
attractive investment opportunities that might become
impossible to get right on a consistent basis. One could
available as a result of any broad economic or industryreason, for example, that investors will sell equities in
specific turmoil. In short, they have the ability to be buyers
anticipation of rising interest rates and lower levels of
among forced sellers who fall into financial distress.
liquidity. Conversely, one could reason that investors will
be more than happy to see Fed tapering, taking it as a sign
Take White Mountains Insurance Group, for example, a
that the Central Bank believes the worst economic
company with ample liquidity. While rivals may be hurt
conditions are behind us. Both conclusions, indeed, seem
by rising rates, White Mountains will likely remain
entirely plausible; however, if the historical track record of
unscathed and, most importantly, able to use its cash and
market prognosticators is any guide, both of these
equity to invest in businesses and assets at bargain prices.
predictions should be taken with a grain of salt. To be clear,
Indeed, this is a strategy White Mountains’ management
our goal is not to forecast the timing and magnitude of any
team has successfully executed
macroeconomic developments
for over twenty-five years, as
that may result from recent events
“. . . well-capitalized
evidenced by its sterling longand policy decisions (nor should it
term track record of growth in
companies
like
those
found
in
be). rather, our goal is to
book value per share. White
comprehensively evaluate any and
the Fund’s portfolio have the Mountains,
as well as allianz and
all potential impacts to the Fund’s
ability
to
seize
any
unusually
Munich re, three Fund holdings
existing portfolio, as well as to its
with interests in non-life and lifeattractive investment
opportunity set (of potential
insurance, not only boast ample
future investments), in the event
opportunities that might
firepower for M&a in the event
that recent developments create
that opportunities become
meaningful disruptions in global become available as a result of
available, but in general should
any broad economic or
capital markets.
generate increased income from
industry-specific turmoil. in their investment portfolios as and
Our portfolio is comprised of
companies that exhibit financial
short, they have the ability to when interest rates increase.
strength and that were purchased
WHAt (or WHErE) nExt?
at meaningful discounts to our be buyers among forced sellers
conservative estimate of intrinsic who fall into financial distress.” as recent events around the
value. Purchasing companies with
globe
have
so
clearly
strong balance sheets and high
demonstrated, many of the
quality assets means that, in practical terms, we have
effects of the Fed’s tapering will be felt globally, just as
bought ourselves protection against rising interest rates.
QE was a global phenomenon, with impacts on both
Because of their strong balance sheets, our portfolio
developed and developing markets. So far, the weakest
companies are financially equipped to withstand
links appear to be in emerging markets, although we
economic adversity, in particular, and generally do not
suspect that we may only be in the early stages in the
need to access capital markets in order to run their
game, and the impact might be more widespread.
businesses, a key advantage over competitors that rely on
Emerging economies tend to be a somewhat disparate
debt financing to execute their business strategies.
group,
each with its own problems and opportunities
Specifically, well-capitalized companies like those found in
owing
to
their degree of development, government/
the Fund’s portfolio have the ability to seize any unusually

22

third Avenue international Value Fund (continued)
(Unaudited)
ones, much of it u.S. dollar-denominated. The scale of the
issuance was impressive, with emerging market corporate
debt proving to be one of the most rapidly growing fixedincome asset classes, with the result that the size of this
asset class has now exceeded that of the u.S. High yield
market! To this we must necessarily add the sovereign
debt issuance which had been growing apace, and the fate
of which is necessarily intertwined with that of the
corporate debt issues in the respective nations. This had
been facilitated and reinforced by the lowered risk
perceptions of emerging market issuers and of emerging
markets generally.

central bank policies, labor market practices, openness
to trade, foreign investment, capital flows, etc.
Generalizations, so common in the space, are hazardous.
That said, the growing trade and capital flows between
both developed and developing countries have exposed
this disparate group to some common factors that
historically might have mattered less than they do now.
The current episode of “synchronization” of these factors
originates in the response by a number of countries to
the Global Financial Crisis. Both developed and
developing countries engaged in considerable fiscal
stimulus that took various forms in different countries,
such as sizable boosts in infrastructure spending in China
or vast mobilization of resources by the national
Development Bank in Brazil, combined with monetary
stimulus in a number of these countries where interest
rates were lowered significantly to offset the impact of
the dysfunction in global capital market conditions.
needless to say, in countries where these measures were
employed, they served to mitigate somewhat and
shorten considerably the impact of the global slowdown,
with resultant, relatively swift recoveries in their levels of
economic activity and consequently, in local capital
markets. With this occurring in an environment where
developed nations in many parts of Europe, and initially
the united States, were in the grip of a downturn,
emerging markets appeared to have largely sidestepped
the difficulties and were perceived as lower-risk
destinations for investor capital.

Most of these countries from whence this debt originated
have been in need of a variety of structural reforms relating
to labor markets, domestic competition policy, capital
markets or governance, amongst other things. Historically,
there had existed a sort of quid pro quo with the demands
of the suppliers of capital nudging forward changes that
would be of long-term benefit both to the issuers and
providers of capital. The volume of capital cascading into
companies in these markets on undemanding terms made
this all but moot. If anything, it has helped validate or
entrench these bad habits, extending the poor practices
that would have been otherwise under pressure to change
were capital less freely available. Cheap access to financing
has allowed both companies and countries to put off much
needed reforms. The disciplinary force of the capital
markets waned and borrowers took advantage. We fear
that, as this issuance boom goes in reverse, these structural
shortcomings might be laid bare at an awkward time with
unpleasant consequences. The cessation of QE could
reveal which countries and companies did little to mitigate
their structural deficiencies.

This lower level of perceived risk came at a time when
interest rates in the developed world were unusually
depressed by the Fed’s successive bouts of QE. against
this backdrop, the feverish search by investors for higheryielding securities led to a boom in the issuance of debt
by emerging market issuers – both sovereign and
corporate – a number of whom had never before
encountered such low rates of interest. not ones to look
a gift horse in the mouth, the borrowers seized the
moment, and there was considerable issuance of
corporate debt securities, pure vanilla and higher-yielding

By way of example, India has historically been heavily
dependent upon portfolio flows, reflecting a relative
paucity of Foreign Direct Investment (“FDI”). The limited
amount of FDI has been a function of capricious tax policy
(sometimes applied in an ad hoc manner), and a
tortuously protracted review and approval process for

23

third Avenue international Value Fund (continued)
(Unaudited)
depreciation in the value of various currencies, most
notably those of a group that has been dubbed the
“Fragile Five” – Turkey, Brazil, India, South africa and
Indonesia – for their particular vulnerability to foreign
capital outflows.

new investments, which has been further compounded
by corruption. The logical outcome of such a regime has
been increasing reluctance by corporate entities to invest
there, notwithstanding the size and potential of the
market. But, money flows both ways; and, in 2013, flows
into India reversed, causing a decline in foreign exchange
reserves and a run on the rupee. This is bad news for
Indian borrowers with dollar- or euro-denominated debt.

That is not to say, however, that we have not seen
opportunity in even those countries that have thus far
been the most visibly exposed to vulnerabilities. For
example, two of the Fund’s newer investments – Piramal
Enterprises Ltd. (“Piramal”) and Oberoi Ltd. (“Oberoi”) –
come from India, whose macro issues we touched on
earlier. However, we believe that each of these
companies is uniquely positioned to weather any macro
uncertainties and even thrive as a result of them. In the
case of Piramal, a holding company with investments in
pharmaceuticals, healthcare information technology and
financial services, the company currently possesses an
extraordinarily strong, liquid balance sheet, primarily as
a result of the 2010 sale of its generic pharmaceuticals
business to abbott Laboratories at an incredible valuation
of about 30 times EBITDa. This pile of liquidity is in the
hands of Chairman ajay Piramal, whose investment
acumen has enabled the company to build a 25-year
track record of compounding book value per share at an
average annual rate of roughly 20%. This is a good
example of the type of opportunities that may become
increasingly available in a time of increased capital market
turmoil: a company which has a management team with
an exceptional track record of shareholder wealth
creation, the balance sheet liquidity to take advantage
of investment opportunities that arise, and a
counterintuitively attractive valuation, at a significant
discount to naV.

This has rendered the country more dependent upon
fickle portfolio inflows, rather than more stable longerterm FDI. until recently, that risk was easy for many to
overlook as the waves of portfolio flows rolled in.
Beginning in 2013, the diminution of these flows exposed
the vulnerability of the country’s capital position, with
short-term results including a decline in foreign exchange
reserves and the depreciation of the currency. While we
highlight India here as an example of a lost opportunity to
strengthen the country’s institutional framework, it is not
unique among a number of developing countries that did
not seize the opportunity to do so during a period of
abundant capital inflows – leaving them vulnerable in a
variety of ways (varying from country to country), were
these capital flows to reverse, or the terms to become less
favorable in a less conducive market environment.
What we are also seeing now hints at something that has
occurred periodically. argentina defaulted in 2001 after
depegging its peso from the u.S. dollar. The value of its
debt, denominated in dollars, quickly outran the worth
of its depreciating currency. We saw the similar impact
of asset-liability currency mismatches throughout the
asian Financial Crisis of the late 1990s. It affects private
and sovereign debtors equally. Borrowing in dollars allows
lower cost access to the capital markets; but, it has its
dark side if the dollar-denominated debt is not effectively
hedged.

Similarly for Oberoi, the Indian property developer whose
attractive investment case we outlined in last quarter’s
letter, short-term macroeconomic and capital market
turmoil in India may very well sow the seeds for
significant future value creation over the long term, shortterm volatility notwithstanding. Why? unlike many of its

We have begun to see this dark side in recent months, as
the beginning of the Fed’s tapering of QE signaled the
potential end of “easy money” for emerging market
corporates and sovereigns, leading to a significant

24

third Avenue international Value Fund (continued)
(Unaudited)
insulated from what might currently be perceived by
many as emerging market issues. On the contrary,
although investor capital may be fleeing “risky” emerging
markets for developed markets, such as the u.S., which
are currently perceived to be relative “safe havens,”
developed markets are linked more closely than they ever
have been to emerging economies, with major linkages
in trade flows in addition to capital flows. For many
american, European and Japanese businesses, emerging
markets represent one of their most attractive growth
opportunities, and in many cases they already make up
significant proportions of developed world businesses’
total revenue and profits.

heavily indebted peers in the Indian property sector,
Oberoi is debt-free and, in fact, has a meaningful cash
position. as a result, Oberoi has the ability to buy land at
low prices in weak environments when others can’t.
Moving on to a fellow “Fragile Five” member, the Fund is
invested in one of the premier private equity groups in
Brazil, GP Investments Ltd. (“GP”). GP has been operating
in the Brazilian private equity space for over twenty years,
and the company boasts a high quality, experienced
management team. Like Piramal and Oberoi, GP has a
strong, relatively liquid balance sheet, and in our opinion
the company is extremely well positioned to take
advantage of any investment opportunities, both private
and publicly listed, that might come out of any significant
disruptions in the global economy. Even in the absence
of new external investments, GP can create value by
continuing to repurchase shares, which are trading at a
substantial discount to naV.

Looking back to our Second Quarter 2011 Shareholder
Letter, we discussed the fact that at the time, the Fund
had been investing increasingly in European companies –
as defined by their country of listing – while asian
holdings had been declining as a percentage of Fund
assets. We noted that while the Fund’s increasing
proportion of European holdings might have provided
the appearance of a geographically centered “theme,”
it was more correctly the result of a clustering of
opportunistically selected, individual investments linked
by the uncertainty that had overhung their discounted
valuations, in great part simply because of their country
of listing. We noted that, in fact, many of the Fund’s
European investments were clear beneficiaries of
developments in other, more rapidly growing parts of the
world, such as emerging asia, Latin america, and
elsewhere, due to their expanding customer bases there.
Conversely, today, developed markets may be perceived
as less vulnerable to the recent turmoil affecting many
emerging markets; however, the increased global linkages
in trade and capital flows could prove that perception
erroneous over time, and developed markets could very
well experience flow-on impacts from what are today
perceived as emerging market issues. Indeed, already
some companies based in the developed world are
confronting a slowdown in orders for their products from
emerging markets. In conclusion, we have limited faith in

While some countries are battling particularly acute
problems such as those noted above, other emerging
economies continue to be relatively sound structurally.
Take Colombia, for example, which is enjoying inflation
rates that are near six-decade lows. While countries such
as South africa and Turkey have recently announced
aggressive measures aimed at halting a plunge in their
currencies, Colombia has continued to buy dollars,
accumulating rather than depleting their foreign reserves
and taking advantage of low inflation to allow the peso to
weaken, to the benefit of its exporters. But while many
emerging markets are in much better shape than those
that are making the headlines today, they nevertheless
tend to get bunched together in times of broader panic,
as skittish investors throw out the baby with the bath
water. This phenomenon may present opportunities for
the Fund to invest in solid, high-quality businesses that
become available at unusually attractive valuations due in
part to broader market sell-offs, even in those markets
which the economy is much less vulnerable to recent
developments. Developed markets are by no means

25

third Avenue international Value Fund (continued)
(Unaudited)
our ability to forecast macroeconomic developments, but
are sensitive to the circumstances in which our
companies operate and the valuations that they reflect.
The recounting of these various sources of potential risk
is meant less as a forecast than it is to note that the
potential sources of a major “shock” to the system are
rising. While the proneness to missteps and accidents in
the global economy may be rising, our goal is to assess
the potential impacts to our existing holdings, and to take
advantage of unique opportunities that become
available. We believe that the companies in the Fund’s
investment portfolio have what it takes to withstand
pending turmoil and even benefit from it over the long
term, as exemplified by the several holdings that we
discussed earlier. additionally, economic and capital
market shocks and dislocations have historically been the
source of investment opportunities that the Fund has
historically exploited, and we intend to continue to do so.

manager of the Fund on 30 June 2014, following my
retirement from Third avenue. Matt was the first
member of my investment team, joining me shortly after
the launch of the Fund, and he has assumed increasing
portfolio management responsibilities since being named
a portfolio manager in 2012. I know that Matt, as my
chosen successor, will continue to serve our fellow
shareholders well and will continue to work with our
team to scour the globe in search of long-term value.
gEogrApHicAl DistriBUtion oF inVEstmEnts

at the end of January 2014, the geographical distribution
of securities held by the Fund was as follows:
country
_______
Germany
united States
Japan
France
Britain
Singapore
India
Poland
Switzerland
Canada
Hong Kong
Greece
austria
South Korea
Taiwan
new Zealand
Brazil
Italy
Belgium
Equities – total
Cash & Other
Total

as always, we remain on the lookout for attractive
investments wherever they might appear – in the
emerging markets which currently seem the most
vulnerable, in those emerging markets which are stronger
but are nevertheless judged “guilty by association” by
investors/traders, and in developed markets that are
perceived by some to be more insulated at the moment,
but which may suffer related negative impacts. We do not
know the geographic region or industry from which the
next clustering of new investments in the Fund will come.
But we do know that these new investments will
represent a collection of individual opportunities to invest
in what we believe are high-quality, well-financed
businesses or assets that are made available at
discounted prices for whatever reason, be it companyspecific or macroeconomic in nature.
A WorD ABoUt sUccEssion

as Lead Portfolio Manager of Third avenue International
Value Fund, it gives me great pleasure to announce that
Matthew Fine will join me as a Co-Lead Manager,
effective 28 February 2014, and will become sole

%
___________
14.94
11.64
10.26
8.96
6.14
4.81
3.13
3.02
2.84
2.82
2.79
2.71
2.66
2.41
2.38
1.90
1.46
0.87
0.78
_______
86.52
13.48
_______
______
__100.00%
______

note that the table above should be viewed as an ex-post
listing of where our investments reside, period. as we
have noted in prior letters, there is no attempt to allocate

26

third Avenue international Value Fund (continued)
(Unaudited)
the portfolio assets among countries (or sectors) based
upon an overarching macroeconomic view or indexrelated considerations.
Thank you for your continued trust and support. We look
forward to writing to you again when we publish our
Quarterly report for the period ended 30 april 2014.
Sincerely,
Third avenue International Value Fund Team
amit Wadhwaney
Matthew Fine

27

third Avenue High yield credit Fund
(Unaudited)
Tom Lapointe, was recently recognized by Institutional
Investor Magazine as one of 2014’s rising Stars of Mutual
Funds.

Dear Fellow Shareholders,
Last summer, Third avenue Capital launched the Third
avenue High yield Credit Fund (the “Fund”), our first
uCITS designed to give investors outside of the united
States access to our very successful credit strategy. While
there is no doubt that high yield became a destination for
income seeking investors in a zero interest rate world, our
Fund uses fundamental research and deep company
knowledge to find those issues that are underrepresented in the indexes and by other managed funds.
as such, we have found issues in the market that remain
undervalued because they have been missed by the
income-grazing herd.

pUErto rico

Puerto rico municipal bonds are one of the most
interesting distressed situations to arise over the past two
years. not that it is one of the best opportunities to make
money, just that it has several key elements that make it
interesting:
1. The price is right – you can pick your poison,
uS$0.06 to uS$0.08 for long dated zero coupons,
uS$0.60 to uS$0.70 for low coupon 20-30 year
bonds, and uS$0.80 to uS$0.90 for two-year to fouryear debt. These bonds do not trade on yield or
spread to anything

The Third avenue High yield Credit Fund is comprised of
stressed performing bonds purchased at a significant
discount to par due to short-term difficulties that we have
determined will not ultimately cause the companies to
default or miss payments. The portfolio is concentrated
in our team’s highest conviction ideas, allowing the Fund
to establish meaningful positions in compelling credit
opportunities. The Fund’s yield is well in excess of the
Barclays High yield u.S. Corporate Bond Index and of its
category average.

2. There is a ton of these bonds – approximately uS$70
billion, plus or minus. Making it larger than TXu and,
on a current market value, even larger than Lehman
Bros.
3. There are multiple layers. There are at least six
different entities that issued debt , ranging from
General Obligation bonds backed by the full faith
and credit of Puerto rico to other bonds secured by
tax receipts and sewage and water assets.

It may be true that in High yield Credit the easy money
has been made, but, we believe that our more thoughtful
and selective approach to investing in the sector deserves
consideration by investors looking to diversify into other
asset classes. It has also historically been the case that
speculative grade credit investments have been the best
performers when interest rates rise, which is a possible
consequence of the u.S. Federal reserve tapering off of
its Quantitative Easing programs.

4. There is universal uncertainty – no one knows how
this process would play out in the event of a default
on a payment.
5. Bonds are in “Weak Hands” – We never liked this
term, it tends to suggest that there are some
institutions that were born as “dumb money”. In this
case, there is truth to the fact that most everyone
purchased Puerto rico bonds for the higher than
average yields, investment grade ratings and the
triple tax free status, not the underlying value of the
assets or Puerto rico’s credit worthiness.

Since our 4 June 2013 inception, the Third avenue High
yield Credit Fund a1 class and a4 class are up 4.51% and
4.79% respectfully, versus 3.89% for the Barclays u.S.
Corporate High yield Fund over the same period. We are
pleased with the start we have had and thank our
shareholders for putting their faith in us. We are also
happy to report that the team’s Lead Portfolio Manager,

6. a new issuance is likely to come – the Puerto rico
Senate approved a bill authorizing the issuance of

28

third Avenue High yield credit Fund (continued)
(Unaudited)
up to uS$3.5 billion in General Obligation bonds.
This announcement comes a week after the
Commonwealth released estimates for a balanced
budget for 2015.

back to par. We are not in that trade, but thank the shorts
for offering us paper that we believe they will need to buy
back at some point. We think the low-priced Tide offering
will not impact Sun and other brands as much as it will
impact regular-priced Tide and, at the end of the day,
P&G will lose money on this strategy.

as Marty Whitman wrote in his Founder’s Letter, Third
avenue will not get involved in this debt without a higher
level of understanding combined with a lower price. We
have been following the situation for the last six months
and have not invested. Perhaps this is the time to be
buying, as the ratings were all cut to junk and there seems
to be near panic among some of the holders. We did not
buy Italy and Spain two years ago and missed very good
returns. We also passed on Detroit, Greece and argentina.

American gilsonite
During the quarter, we also initiated a position in american
Gilsonite secured notes. The company has been in
existence for over 100 years, and operates under the
Oxford’s English Dictionary definition of a monopoly: 1. a.
Exclusive possession of the trade in some article of
merchandise; the condition of having no competitor in the
sale of some commodity, or in the exercise of some trade
or business. The company is the world’s foremost miner of
naturally occurring uintaite (Gilsonite is the trademarked
name). The product is used in drilling fluid by multinational
oilfield services companies. Pricing for its main product
increased by over 20%, annually, since 2007. recently,
volume began dropping faster than price was rising,
putting into question the company’s monopolistic power.
Investors took note and began to sell bonds to us at over
10 points below the 11.5% coupon paper’s peak. Our
bond investment is the only debt in the utah-based
company’s capital structure (save a small undrawn
revolver) and is comfortably the fulcrum security. It is a
good diversifier for our portfolio, because it has very little
correlation with other mined commodities, and it is
correlated with part of the u.S. economy where we are
bullish – oil and gas production. We believe the asset
value from reserves comfortably covers the bonds. Plus,
as the complexity of drilling increases (including very long
horizontal wells), the importance of using top tier product
increases. We believe customers will return when they
realize that the actual cost to using Gilsonite, even at a
very elevated price, is outweighed by the risk of leaking
10 barrels an hour (10,000 barrels of oil a day) from using
inferior products. We expect the investment to return low
teens – at a minimum.

portFolio UpDAtE

sun products
We recently initiated a core position in Sun products. Sun
is a recent leveraged buyout by Vestar. They purchased
some brands from unilever and now own “all” fabric
cleaner and other fabric cleaner and softener brands,
including Snuggle, Surf, Wisk and Sun. We purchased the
bonds in the mid to high 80s, after concerns about a new
competitive product being offered by Proctor & Gamble’s
(“P&G”) Tide. The new product will be at a lower price
point and people are concerned it will impact sales of
"all" and other mid-priced products. This is a great
business. It is very stable and concentrated in the hands
of three players. Price wars are never fun, and they could
shift market shares. Sun also has bank debt outstanding
that trades around 95 and has a 4.5% coupon. With the
subordinate bonds trading between 88 and 90, many
hedge funds have jumped on a seemingly easy money
capital structure arbitrage trade. It has become very
popular to go long the bank debt at 95 and short the
bonds (we have likely amassed a position from the shorts)
at 90 using a 2 to 1 ratio. The trade is close to carry
neutral (does not cost money on a running basis) and
should do well in a down side scenario. It also seems to
be a fairly safe trade on the upside if both securities trade

29

Third Avenue High Yield Credit Fund (continued)
(Unaudited)
Radio One

away; but, we wanted to be proactive – as an anchor
investor, we could have a say in how the capital structure
headed. We expressed our thoughts and pledged our
bonds for refinancing and took an anchor position in the
new notes. We believe the company is headed in the
right direction and we wanted to retain our interest.
Furthermore, as one of the top equity holders, we will
benefit from the cut in interest expense, so we see a little
bit out of one pocket and into the other. We do view the
company as unique, including being the only radio
company we know that owns a stake in a casino – Radio
One will own a minority interest in the new MGM casino
near Washington DC. Combined with the existing radio
and TV businesses, we believe it is truly a unique
entertainment company.

Radio One is a relatively long-term core holding of the
Fund and, in 2013, we helped the company refinance its
notes. Radio One is the largest media companies,
primarily targeting the African-American and urban
audience. The company owns and operates 54 broadcast
radio stations in 16 urban U.S. markets. The company
owns a syndicated programming production business and
an online business, and in conjunction with Comcast,
owns a 51% interest in TV One. The Focused Credit Fund
initiated a position in the notes about two years ago in
the high 70s / low 80s context. The company’s 12.5%
notes were the result of a needed bond exchange that
the company completed in 2010, as consolidated cash
flows began to hit a trough. As you can see throughout
our portfolio, we are believers in radio assets, and
particularly in radio assets that target specific
communities, as we value listener loyalty and brand
awareness. Also, we believe that urban communities have
traditionally been under-represented in advertisement
dollars, but that this gap is narrowing. As such, we
believed that, once stabilized, the radio businesses would
be solid cash flow generators. Additionally, we saw great
promise to the TV One business, and believed that the
asset would generate material cash flows. The Internet
and programming businesses we viewed as options. We
felt that at the prices we were purchasing the bonds, we
were covered by the radio and TV businesses, and found
future upside in the equity.

Thank you, for your continued support and trust. We are
working every day to earn and keep it.
Sincerely,
Third Avenue High Yield Credit Fund Team
Thomas Lapointe
Edwin Tai
Joseph Zalewski
Nathaniel Kirk

As the radio business rebounded and the TV business
grew, we grew more and more comfortable with our
thesis. The position grew in our portfolio and the market
became more comfortable with the company’s
prospects. Management has targeted a refinancing of the
12.5% notes as a top priority, followed by the desire for
an eventual purchase of the rest of TV One. In late 2013,
we received a call that management wanted to meet
about a bond refinancing. We certainly were sad to see
such a high yielding and, we believed, safe investment go

30

THE POWER OF ORIGINAL THINKING

THIRD AVENUE CAPITAL


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