For many years I advocated Third Avenue Value Fund (TAVFX), because it had an excellent and very long track record, and had the experience to invest in both stocks and distressed debt.

This month I am withdrawing that advocacy. The reason is that TAVFX, with over $5 billion under management, now has over half its assets in just 5 stocks, all in east Asia. Still more alarming, over a third of assets are in just 4 stocks, all Hong Kong real estate investment trusts.

The fund manager’s explanation for this concentration is essentially “China is a growth story.” Ominous. China is a well-managed command economy that grew by exports — exports that will not grow for the foreseeable future. China may instead be the Mother of All Black Swans.

Those four Hong Kong REITs still have all the features that made TAVFX great: strong balance sheet, shares trading well below adjusted book value. They are incredibly good companies, selling incredibly cheap — hence the concentration. And this will probably do well. Probably. But it is too much risk concentration. There are easier ways to make a buck — mainly by going to smaller cap investments.

Barron’s reports quarterly on exchange-traded mutual funds. Most of the report is pointless: short-term performance is essentially random, so looking at what a fund did last quarter is misleading. But the article includes one useful table, shown below.
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At a restaurant in Palo Alto in 1999, I overheard a woman say she hoped her stock options would keep converting profitably, because “I need them to pay my rent.” She was the Silicon Valley equivalent of today’s house-flipper.

She depended upon constantly rising asset prices to cover her negative cash flow.

Today the buzz in Orange County cafes is strikingly similar, along the lines of, “sure hope I can sell my house in Lake Perris — I need the money to pay my variable-rate mortgage in Irvine.”
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If you believe my recent articles, you don’t want to hold broad index funds, nor growth stocks, nor bonds of duration greater than 1 year. You want to limit dollar assets, yet it’s too expensive to invest in foreign assets on your own. Good grief, what’s left? Finally, some answers.

In effect, the only thing left, by process of elimination, is to hold a diversified portfolio of old-fashioned value stocks and short term bonds, denominated in various currencies, including the dollar. There are three inexpensive ways I can think of to do that.
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Common wisdom is that index funds outperform managed investments over the long term, because market efficiency gives no advantage to judgment. Right? Well… generally. But here’s an illustration of how one simple, basic judgment can provide superior returns.

Below is a 125-year history of the S&P500 index (or, prior to 1926, its large-cap equivalent), rendered as a set of monthly 20-year periods. Each point in the graph shows a 20-year compound return versus the PE10 ratio of the index (price divided by the 10-year trailing average of earnings plus dividends) at the beginning of that period.
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Publicly registered, thinly traded real estate limited partnerships (RELPs) can provide attractive income with safety to the small investor. These are perhaps less risky than buying interests in new limited partnerships.

Generally formed during the 1975-90 real estate boom, RELPs are not corporations, but limited partnerships managed by a general partner. They own income property, such as apartment buildings or storage units, collect rent on them, and pay out some of the profits to their unit-holders (analogous to shareholders). Limited partner unit interests can be purchased, just like shares of common stock, from specialized brokers. Many partnerships pay periodic distributions — analogous to dividends — and the yields can be very attractive, given that the partnerships often sell at substantial discounts to the market value of their assets.
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A partner at a well-known law firm asked me yesterday if he should refinance his mortgage to a 7/1 interest-only ARM, and use the extra cash flow to buy stocks. Does this strategy survive a risk-reward examination?

My opinion is no. But his question threw me off guard, because it’s more complex than it looks. Here are the issues at hand.
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Nearly all proven investors agree most assets are now moderately overpriced. Now what? Like most people (including some famous ones), you can’t stand to sit on the sidelines — even though you probably should. Here are some alternatives for the action-oriented.

First, you could buy extremely short-term paper, either directly or in the form of money markets. This is debt, issued by governments or corporations, that is paid off in a matter of a few months, limiting your exposure to sudden shifts in interest rates.
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In these heady times, with average PE ratios at over 20, it becomes easy to forget the basics of sound investing. Remember the words of Buffett’s own sage, Ben Graham, and return to earth before the market does.

In 1934, Graham intoned, “An investment operation is one which, upon thorough analysis, promises safety of principal and a satisfactory return. Operations not meeting these requirements are speculative.”
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“All assets are too expensive.” Everyone knows this, or claims to. Yet no one is selling. What can you do? Find the few securities that are reasonable on a value basis, and forget about chasing double-digit returns for now.

This week, I read the phrase “all assets are too expensive” in no less than four major publications: the Los Angeles Times, the Wall Street Journal, Forbes and Barron’s.
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