Third Avenue Management, an investment management firm, published its “Real Estate Value Fund” second quarter 2021 investor letter – a copy of which can be downloaded here. A portfolio return of +17.71% was recorded by the fund for the second half of 2021, below the FTSE EPRA NAREIT Developed Index that delivered a 16.11% gains for the same period. You can view the fund’s top 5 holdings to have an idea about their top bets for 2021.
In the Q2 2021 investor letter of Third Avenue Management, the fund mentioned Federal National Mortgage Association (NYSE: FNMA), and discussed its stance on the firm. Federal National Mortgage Association is a Washington, D.C.-based mortgage loan company, that currently has a $1.5 billion market capitalization. FNMA delivered a -45.61% return since the beginning of the year, while its 12-month returns are down by -35.00%. The stock closed at $1.30 per share on July 22, 2021.
Here is what Third Avenue Management has to say about Federal National Mortgage Association in its Q2 2021 investor letter:
“The Fund also adjusted its holding in the Federal National Mortgage Association (“Fannie Mae”) during the period. As noted in previous shareholder letters, the Fund established a position in the preferred equity and common stock of Fannie Mae in 2020. It was Fund Management’s view that this enterprise (along with the Federal Home Loan Mortgage Corporation or “Freddie Mac” and collectively the government-sponsored entities or “GSEs”) was (i) a critical source of financing for sustainable homeownership and affordable rental housing in the U.S., (ii) among the most profitable real estate firms globally when measured by operating profits, and (iii) had securities trading at fractions of their underlying value due to the GSEs having operated under conservatorship since 2008.
Further, it was Fund Management’s opinion that the GSEs would ultimately exit this framework while further rebuilding capital as outlined in the Federal Housing Finance Agency’s (“FHFA”) Strategic Plan—a process that could be expedited once legal rulings addressed controversial changes to its
Senior Preferred Stock Purchase Agreement (i.e., the “NetWorth Sweep”). However, given the significant “process risk” associated with such a substantial repositioning, the Fund would limit the amount of capital invested in the entities despite an unrivaled price-to-value proposition.During the quarter, the Supreme Court of the United States (“SCOTUS”) issued orders relating to two of the legal challenges outstanding. In Collins v. Yellen, SCOTUS upheld the plaintiffs’ claims that the conservatorship was unconstitutionally structured, remanded the case to the Fifth Circuit of Appeals for potential “retroactive relief”, but declined to deem the entire Net-Worth Sweep void through this particular constitutional claim. While this order fell short of providing outright relief, other challenges relating to “The Implied Covenant of Good Faith and Fair Dealing” and a “Takings, Illegal-Exaction, and Breach-of-Implied Contract Claim” remain ongoing in District Court and Federal Claims Court, respectively. These cases have yielded important discovery and will progress through the remainder of 2021.
Notwithstanding a more extended timeline, Fund Management continues to hold the view that administrative action would be the most prudent path forward. Put otherwise, recapitalizing the entities and releasing them as quasi-utilities with enhanced capital ratios accomplishes key objectives. This
primarily includes (i) moving the U.S. taxpayer out of the “first loss position” for the $6.5 trillion of mortgages the entities guarantee, (ii) providing more stability and capital for the enterprises to pursue their mission of promoting affordable housing, and (iii) respecting property rights while also preserving value for GSE stakeholders (including the U.S. Treasury).Such a plan has recently been populated in the Brookings Institute Report: Government Sponsored Enterprises at the Crossroads. It is also one that has been carefully assessed by the Congressional Budget Office (CBO) in its Effects of Recapitalizing Fannie Mae and Freddie Mac Through Administrative Actions. As noted within this analysis, “CBO’s model incorporates the judgment that in scenarios in which the GSEs’ common-stock sale did not raise enough funds to redeem the full face value of both the senior preferred and junior preferred shares, the Treasury would take a reduction in the value of its senior preferred stake before requiring junior preferred shareholders to do so.”
When factoring in all of these items, as well as the pricing anomalies throughout the capital structures, the Fund’s remaining investment in the GSEs is now exclusively focused on the preferred equity. At the end of the quarter, these holdings accounted for approximately 2.0% of the Fund’s capital and the securities traded at prices that represent less than 10% of their Liquidation Preference (e.g., “par value”). Meanwhile, the entities remain quite profitable and are rebuilding significant capital while the matters are addressed.”
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Based on our calculations, Federal National Mortgage Association (NYSE: FNMA) was not able to clinch a spot in our list of the 30 Most Popular Stocks Among Hedge Funds. FNMA was in 4 hedge fund portfolios at the end of the first quarter of 2021. Federal National Mortgage Association (NYSE: FNMA) delivered a -46.50% return in the past 3 months.
Hedge funds’ reputation as shrewd investors has been tarnished in the last decade as their hedged returns couldn’t keep up with the unhedged returns of the market indices. Our research has shown that hedge funds’ small-cap stock picks managed to beat the market by double digits annually between 1999 and 2016, but the margin of outperformance has been declining in recent years. Nevertheless, we were still able to identify in advance a select group of hedge fund holdings that outperformed the S&P 500 ETFs by 115 percentage points since March 2017 (see the details here). We were also able to identify in advance a select group of hedge fund holdings that underperformed the market by 10 percentage points annually between 2006 and 2017. Interestingly the margin of underperformance of these stocks has been increasing in recent years. Investors who are long the market and short these stocks would have returned more than 27% annually between 2015 and 2017. We have been tracking and sharing the list of these stocks since February 2017 in our quarterly newsletter.
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Disclosure: None. This article is originally published at Insider Monkey.
