EQSF Advisers Inc., New York, the investment adviser to the $232 million Third Avenue Value Fund, is looking to the regional broker-dealers in which it invests to help distribute its fund.
The fund also wants to form alliances with these firms in an attempt to gain defined contribution plan business. And, EQSF wants to participate in wrap-fee programs offered by these firms.
Chief Investment Officer Martin J. Whitman said the fund is the single largest outside shareholder of Piper Jaffray Cos. Inc.; EQSF is close to signing on with the firm's wrap-fee program. Likewise, Third Avenue Value Fund is in the wrap-fee program of Raymond James Financial Inc., another stockholding, and is in the running for the wrap-fee program of Alex. Brown Inc., yet another major holding.
If that sounds like it might smack of conflicts of interests, Mr. Whitman, a well-known "vulture" investor, makes no apologies. "I haven't been involved in anything without a potential conflict."
"If we develop something with Piper (Jaffray) and it looks at all colorable, we'll give it up in 30 seconds," he said.
Of course, Mr. Whitman did not sever ties with a company called Danielson Holding Corp., when one press report raised questions about whether the fund's ownership of the company constituted a conflict of interest. Mr. Whitman is chairman, president and chief investment officer of Danielson. The Third Avenue Value fund owned 803,669 shares of the insurance and trust holding company, representing 2.81% of the fund's net assets, as of Jan. 31.
What's more, Danielson Trust Co., San Diego, of which he also is a director, has been the fund's custodian since 1993.
Another recent press report questioned the independence of some directors of the fund, one of whom is Mr. Whitman's sister.
Mr. Whitman said potential conflicts are part and parcel of the business of being an active investor that makes big bets in a few holdings.
"If you prefer an adviser who puts his money where his mouth is, you're always going to have the seeds of conflict - and we're that type of manager."
The fate of Third Avenue Value's investment in Danielson rides heavily on what action Mr. Whitman takes as its chairman. Formerly called Mission Insurance, the firm was renamed Danielson, after Mr. Whitman's eldest grandchild, Daniel.
Danielson has insurance and trust subsidiaries, no debt, a $15 million cash hoard and "the granddaddy of all tax loss" carryovers, Mr. Whitman told Pensions & Investments.
Speaking in his Danielson capacity, he said: "I spent the better part of last year looking to acquire Enhance Financial Services Corp.," the financial insurer.
Enhance is also in Third Avenue's portfolio. In fact, the fund recently increased its position in the company.
"There are very few securities in the portfolio that Danielson didn't look at as potential acquisitions," he said.
Mr. Whitman has been in the bankruptcy and distressed securities business since he founded the broker dealer M.J. Whitman Inc. in 1974. His portfolio strategy is to buy securities at substantially below what he considers their private market value. He invests in companies in depressed industries and buys high-yielding public, private and bank debt with strong covenant protection. He also buys mortgage-backed securities including derivatives. No more than 25% of the portfolio may be invested in high-yield bonds, but fixed-income holdings per se are not limited.
To Mr. Whitman, even an actively managed mutual fund is a passive investment because he believes most mutual fund managers are trying to beat the market in the short run with no conception of value.
By contrast, his background as a vulture investor makes him a proponent of "control" investing. By virtue of shareholdings by his various entities, Mr. Whitman has become a director of such firms as Herman's Sporting Goods Inc. and its holding company; Nabors Industries Inc. and, of course, Danielson.
In keeping with Mr. Whitman's decisive style, the Third Avenue Value fund, which is legally a non-diversified investment company, makes big bets on a small number of companies. Until recently Third Avenue Value held only about 40 stocks. In the past two years it has begun buying what Mr. Whitman calls "venture capital" stocks, with capitalizations below $200 million. The addition of those small-cap, often high-tech, stocks has upped the average number of stock holdings to about 60, still well below funds of a comparable size.
Even the "larger" cap stocks in Third Avenue's portfolio have an average market cap of only $800 million.
A substantial portion of the portfolio may be invested in relatively illiquid markets, and the portfolio may leverage up to 50% of its assets.
About 80% of the stocks are financials, including five of the nation's nine financial insurers including MBIA Inc. and Ambac Inc. Such firms, which provide credit enhancement for securities offerings, were battered by the falloff in municipal bond issuance last year. The fund also owns many regional broker-dealers, which were hurt by the Federal Reserve's 1994 interest rate hikes.
Third Avenue Value's contrarianism has paid off with the bond market's rally this year. The firm enjoyed stellar returns investing in inverse floaters, which it purchased in November, a time when derivatives were a dirty word.
Including the floaters, the fund has 15% in bonds, a low percentage because it may hold as much debt as Mr. Whitman wants. The bonds typically are high-yield, secured bank debt.
Third Avenue Value is rated five stars, Morningstar Inc.'s highest grade, by virtue of its above-average return and low risk. From its inception December 1, 1990 through April 28, the fund returned an annualized 22.42% vs. 14.49% for the Standard & Poor's 500 stock index. Its one- and three-year returns for the periods ended April 28 were: 14.34% and 15.17%, respectively, vs. 17.42% and 10.54% for the S&P.
The fund eliminated its sales charge Feb. 28.
Despite the fund's unusual strategy, Mr. Whitman thinks it and similar funds offered by Heine Securities Corp., First Manhattan Corp., Tweedy Browne Co. L.P. and Neuberger & Berman have a place in 401(k) plans.
He said of retirement plan sponsors: "I think they're crazy not doing Third Avenue and similar funds at least as alternative investments. They're doing a gross disservice to beneficiaries."