Inside this Issue - First Eagle Funds

Is it harder – or even ill-advised – to be
patient when an ever increasing amount
of automated trading is pushing share
prices around?
MM: The compression of time horizons
and the increased trading done by algorithm
creates more liquidity for us to take
long-term positions. That lowers the cost,
at the margin, of our entering or exiting a
long-term position. More generally, the
more compressed the time horizon of the
market is, the less the market is willing to
pay for a business’ “muddle-through”
value, which we base on looking at peak
and trough margins and normal business
cycles. We look at earnings power three,
four and five years out – the less we have
to pay for that, the more our patience
pays off.
Where the prevalence of short-term
trading can be hurtful is when there’s a
feedback loop between intrinsic value and
the perception of value, which happens
particularly in highly leveraged situations.
When a company is in trouble and
there’s a lot of negative momentum trading
as a result, that can feed on itself as
the company has to recapitalize at progressively
lower prices, diluting value.
That’s a key reason we avoid highly leveraged
situations as a rule.
Marty Whitman, in an interview for this
issue, says those types of negative feedback
loops have led him to completely
avoid companies reliant on continuous
access to capital markets.
MM: People tend to lose sight of the fact
that what you own in an equity is only a
residual claim on a business. At the heart
of value investing is the notion of mean
reversion, that by paying a low multiple
on a conservative margin you can win
with the passage of time as the valuation
of the business and the margins normalize.
What can break that and cause mean
aversion, though, are things like fading
business models, expeditionary management
deploying capital in a dilutive way
and – what Marty Whitman is talking
about – adverse capital-structure contingencies.
We make every effort to invest
only in the universe of companies where
those risks of breakage are as limited as
possible.
Describe what you mean by a business’
muddle-through value?
AD: Intrinsic value to us means the price
that a knowledgeable buyer would pay
for a business in its entirety in cash today.
Any knowledgeable buyer will recognize
and take into consideration whether current
earnings are too high or too low,
ON UPSIDE:
If we pay a low multiple and
perhaps get a discount to
asset replacement value, we
kind of get the future for free.
based on the cyclicality of the business
and where it is in the cycle. Similarly, we
don’t want to capitalize earnings streams
that are too high or too low, but focus in
valuation on what the cash flow of the
business is somewhere between the
extremes. Because the future is uncertain,
we don’t exaggerate the precision of the
values we come up with. That said, over
time our intrinsic value estimates – based
on actual transactions – have proven to
be quite accurate. We tend if anything to
be too pessimistic, which is fine.
MM: If we can pay a low multiple at an
enterprise level on muddle-through cash
flows, and perhaps also get a discount to
the asset replacement value of the business,
we in a way get the future for free.
We start out trying not to lose money, but
if we’re disciplined in the way we go
about that, we get a shot at a decent
amount of upside over time.
How has the composition of your portfolio
changed in the past year, reflecting
where you’re seeing opportunity and risk?
MM: The biggest change is that we’re
more fully invested, with our cash posi-
June 30, 2009 www.valueinvestorinsight.com
INVESTOR INSIGHT: First Eagle
tion in the First Eagle Global Fund down
from about 20% to less than 10% today.
We always like to retain deferred purchasing
power, so the sum of our cash,
short-dated government bonds and our
gold positions is still about 20% of the
portfolio. That’s lower than it has been
historically, which is a reflection of the
fact that we’re finding a higher proportion
of decent businesses at decent valuations
today.
Reflecting some of the balance-sheet
concerns we continue to have in many
parts of the world, we’ve also seen the
portfolio gravitate somewhat more
toward Japan. It’s where the excesses
were not in the last cycle, and most of the
companies we own there have resilient,
global franchises and no debt. The capital
markets could close for a decade and
they’d still be fine.
Has your exposure to gold gone up or
down?
AD: It has gone up, not because we’ve
added to the position, but because the
values of bullion and gold stocks have
held up much better than our typical
equity holding. We've always considered
gold to be a valuable potential hedge
against all the bad things that could hurt
our equity holdings, and that certainly
remains true today. It may be some time
off, but we worry a lot about the potential
for inflation and for currency debasement
– currencies declining in value relative
to real assets – as a result of unprecedented
fiscal and monetary stimulus.
Were the more negative scenarios to play
out, real assets like gold should prove
quite valuable.
Are other commodities interesting to you
as well?
AD: We have some long-held positions in
timber companies, including Rayonier
[RYN], Plum Creek [PCL] and Deltic
[DEL], which have proven to be an effective
hedge against dollar devaluation
over time. We think they will prove to be
an effective hedge against currency
debasement as well.
Value Investor Insight 3