First Pacific Advisors Reveals Its Major Winners and Losers, Views on Shareholder Activism in Q1 Letter

Robert Rodriguez and Steven Romick’s First Pacific Advisors LLC recently published its first quarter commentary for investors of the FPA Crescent Fund, revealing its current views on the market and its thoughts on shareholder activism. The FPA Crescent Fund is the flagship fund of First Pacific Advisors LLC, accounting for almost 59% of the $29 billion in assets that the firm currently manages. Though the Crescent Fund underperformed the S&P 500 during the first quarter, being down by 0.19% compared to the S&P 500’s return of 1.35%, it has managed to beat the index by 128 basis points on an annual basis since its inception in 1993. First Pacific Advisors has engaged in several activist campaigns over the last few years and defended shareholder activism carried out by long-term shareholders in the letter, which was penned by Mr. Romick.

“Stereotypical activist tactics like delivering poison pen letters to boards and management and short-term financial engineering often produce ephemeral benefits. Real engagement by meaningful owners seeking to maximize long-term intrinsic business and per-share value tends to have longer-lasting effects. We are only interested in the latter approach, as we believe that dovetails with our desire to have an ownership culture in the boardrooms of companies in which we invest.”

In the letter, Mr. Romick, the firm’s portfolio manager, revealed that the fund increased its exposure to the financial sector to 20.5% of its portfolio by the end of the first quarter, deeming the sector as a whole to be undervalued. He also disclosed that though there were no major winners or losers in the fund’s portfolio during the first quarter, First Pacific Advisors used the market volatility during the quarter to increase its holdings in each of its top five losers. In the remainder of this article, we will discuss five major holdings of the fund at the end of 2015, three of which were among its top winners during the first quarter, while the other two were among its top losers.

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Top Losers

#2 American International Group Inc (NYSE:AIG)

 – Shares held by First Pacific Advisors LLC (as of December 31): 9.27 million

 – Value of Holding (as of December 31): $574.40 million

American International Group Inc (NYSE:AIG) became a part of First Pacific Advisors LLC’s portfolio during the second quarter of 2011. Though the stock tumbled for the next six months, it steadily rose between 2012 and 2015, gaining about 250%. It’s been a different story this year however, with shares of the insurance giant being down by 11%, with the dismal quarterly numbers reported by the company on May 2 proving to be the latest downward catalyst. While the Street was already expecting AIG to report poor quarterly numbers due to the losses that it incurred on its investments during the first quarter, it wasn’t expecting the company to declare EPS of just $0.65, missing the consensus estimate by $0.35. Along with its earnings, AIG also revealed that it returned $4.00 billion of capital to shareholders during the first quarter and as of May 2 had bought back $870 million worth of stock during the second quarter. While First Pacific Advisors inched up its stake in American International Group Inc (NYSE:AIG) by 3% during the fourth quarter, billionaire John Paulson‘s Paulson & Co. reduced its holding in the company by 21% to 11.60 million shares during the same time.

#1 Citigroup Inc (NYSE:C)

 – Shares held by First Pacific Advisors LLC (as of December 31): 11.12 million

 – Value of Holding (as of December 31): $575.55 million

With its shares tumbling by almost 20% during the first quarter, Citigroup Inc (NYSE:C) ended up becoming the top loser in First Pacific Advisors’ equity portfolio during the period. Interestingly, Citigroup Inc (NYSE:C) was the only stock that Mr. Romick discussed in his first quarter letter. He highlighted how Citigroup at one point during the first quarter was trading down by almost 60% to its tangible equity. Furthermore, he also explained how the stock is extremely cheap right now, even after accounting for all of the downside risks:

“On the eve of the global financial crisis, Citi had just 3% tangible equity propping up its tangible assets whereas today, it has 10.5%, higher by a factor of more than three. Some of Citi’s loans will default and it won’t get full recovery in all cases. When we stress test its balance sheet and assume an unusually bad outcome for its loan book, its capital ratios remain solid. If half of its China, energy and metals & mining loans were to default this year and Citi recovered just 40 cents on the dollar, and if consensus earnings are correct, then Citi would still earn money this year and end 2016 with more than $60 per share of tangible book value and tangible equity to tangible assets of more than 10%. That would mean book value would actually increase despite the write-offs. We, therefore, thought Citi at a 40% discount to its minimum worth was a great risk/reward.”

On April 19, analysts at Goldman Sachs reiterated their ‘Buy’ rating on the stock and upped their price target on it to $53 from $52. A hedge fund that increased its stake in Citigroup during the first quarter was Brian Gaines‘ Springhouse Capital Management, which lifted its holding by 10% to 626,000 shares.

We’ll share the fund’s top winners during the first quarter on the next page.