Q3 2014 TAM Shareholder Letters

3Q 2014 T h i r d A v e n u e F u n d s Po r t f o l i o Mana g e r Commen t a r y

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Third Avenue Value FundPage 4

Third Avenue Small‐Cap Value Fund2

Third Avenue Real Estate Value FundPage 16

Third Avenue International Value FundPage 21

Third Avenue Focused Credit Fund Page 27

THIRD AVENUE FUNDSPortfolio Manager Commentary

July 31, 2014

Letter from the Chairman

InsidePortfolio Manager Commentary from

Dear Fellow Shareholders,

Most businesses (and governments) which are successful achieve success by creating

wealth while consuming cash. In most cases, consuming cash carries a fair amount of

investment risk because consuming cash requires the business to have access to capital

markets, sometimes continuously as is the case for commercial banks and broker‐dealers.

Capital markets are notoriously capricious, sometimes not available at all – see the 2008‐

2009 financial meltdown; and sometimes are a source of almost free money – see the

1999 – 2000 IPO bubble.

Other businesses, a minority I expect, are designed to create wealth by having positive

cash flows from operations; for example single income producing real estate projects,

investment companies and investment management companies. Other things being

equal, or close to equal, Third Avenue Management (TAM) analysts and portfolio

managers prefer to invest in the common stocks of companies with positive cash flows

from operations, but not to the exclusion of the common stocks of companies creating

wealth while consuming cash. As a practical matter, TAM is very price conscious and gives

price, especially as related to estimated Net Asset Value (NAV), great weight in making

buy, hold, or sell decisions whether the business creates wealth by consuming cash or is a

cash generator.

In analyzing cash flows, it is super important that the analyst distinguish between project

finance and corporate finance. Project finance looks at periodic net cash flows with a

defined termination date. For any project to make sense it has to be based on forecasts of

a positive Net Present Value (NPV), i.e., the present worth of the cash flows to be received

over the life of the project plus cash to be received at the termination of the project, if

any, has to be greater than the present worth of the cash costs involved with the project.

In contrast, in corporate finance, one looks at the wealth creation to be realized by a

business entity with a perpetual life. Wealth creation is a result not only of successful

operations but also judicious investing and having attractive access to capital markets.

While individual projects have to have a positive NPV to make sense, corporations with a

perpetual life don’t. CIT and GE Capital provide good examples of the interplay between

project finance and corporate finance. Each receivable issued by CIT or GE Capital (i.e.,

loans to customers) is designed to have a positive NPV. This is project finance. But as the

CIT or GE Capital receivables portfolio expands as net new loans are written, the

companies become cash negative. This is corporate finance. The cash

Martin J. WhitmanChairman of the Board


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shortfalls are met by CIT or GE Capital by accessing capital markets – issuing new debt, commercial

paper, bank loans and sometimes equity.

The TAM investment formula for many common stocks is to buy into the common stocks of

companies with super strong financial positions priced at meaningful discounts from readily

ascertainable NAV, where analysis indicates strong probabilities that the NAV will grow over the long

term by not less than 10% per annum compounded after adding back dividends. Advantages of

strong financial positions include the facts that competent managements can be opportunistic and

also tend to avoid becoming supplicants to having to access capital markets under conditions where

managements have little, or no control of the timing of such access.

An investment in the common stocks of companies meeting the TAM investment criteria does not,

of course, guarantee good investment performance but it certainly seems to put the odds in favor of

good investment performance over the longer term, say at least three years. I believe, based on

several studies that for at least 80% of the companies at least 80% of the time, NAV’s will be larger in

the next reporting period than in the prior reporting period. If those increases in NAV continue to

be created, the only way to lose money is to have the discounts from NAV at which price the

security was acquired, widen and stay widened.

TAM analysts recently ran a statistical analysis,1 i.e., a screen, for a broad universe of global stocks,2

based on the following three criteria:

1) Ten year book value per share increased by at least 10% per annum

2) The common stock was selling at 1 times tangible book value, or less

3) Market cap > $1 billion

For the top 100 most well capitalized companies on this list based on total debt to capitalization

(which ranged from 0% to 30%),the results were very interesting:

o For the ten year period, all but ten of the common stocks in the screen had a positive total

return

o Of the ten common stocks without positive price appreciation, the largest annualized loss

was only 6.7%3

o 55% of the companies in the screen enjoyed, at least, double digit annualized returns.

Thirteen of the issues in the screen enjoyed ten year annualized returns in excess of 20%

Using TAM analytic talent, the Third Avenue Funds seek to identify securities that have these and

similar characteristics, which we believe will increase the odds that our Funds will have improved

long term performance.

Is NAV, or book value, a good indicator of wealth in conservatively financed companies? The answer

is yes and no. TAM focuses very much on the common stocks of companies where the NAV is

readily ascertainable. Frequently it is not readily ascertainable. There are two widely used

accounting standards used in the investment world: Generally Accepted Accounting Principles

1 Bloomberg; data as of 7/22/2014.2 Companies listed on the following countries’ exchanges: Australia, Austria, Belgium, Bermuda, Brazil, Canada, Chile, Denmark, Finland,France, Germany, Greece, Hong Kong, Iceland, Ireland, India, Indonesia, Israel, Italy, Japan, Mexico, Netherlands, New Zealand, Norway,Philippines, Poland, Portugal, Russia, Singapore, South Korea, Spain, Sweden, Switzerland, Taiwan, Thailand, Turkey, UAE, UK, US, Vietnam.3 Price appreciation including reinvested dividends.


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(GAAP) used in the U.S.A. and International Financial Reporting System (IFRS) used in the rest of

the world.

Does GAAP give good approximation of NAV for financial institutions? Mostly yes. The assets of

financial institutions are mostly paper which can be readily valued. The problem with many

financial institutions is not valuing assets, but that it may be hard to ascertain what the real

liabilities are. For example, in the case of many non‐life insurance companies, especially casualty

underwriters, the bulk of the liabilities will be determined by future events (e.g., hurricanes) which

tend to be unpredictable.

Does IFRS give good approximations of NAV for companies whose assets consist largely of income

producing real estate? The answer is yes. Under IFRS income producing real estate is carried on

the balance sheet at appraised value with the appraisals conducted by recognized independent

appraisal firms.

Do GAAP or IFRS give good approximations of NAV for going concerns engaged in manufacturing,

distribution, or transportation where individual assets are not separable and saleable without

jeopardizing going concern operations? The answer seems to be definitely no in most cases.

Do GAAP and IFRS, for companies that are not well financed, or do not have easy access to capital

markets, give good approximations of NAV? The answer is no in most cases. Indeed when a

company is not well‐financed, a large book value may be a negative factor. Frequently large book

values tied up in, say, plant or equipment or inventories, may reflect very large overheads more

than anything else.

In one sense large NAV’s for income producing real estate as ascertained by independent

appraisers, may be one predictor of future cash flows. Independent appraisers typically use three

approaches in an appraisal – the income approach, the market approach and the replacement cost

approach. Insofar as the income approach is weighted it consists of the capitalization of estimated

future cash flows. Wheelock common stock at this writing is selling around HK $40; NAV at

December 31, 2013 was around HK $82. Insofar as the HK $82 was based on the income

approach, the appraiser is stating implicitly that Wheelock Common is selling at a very low price

relative to forecasted future cash flows. If there are investment problems with Wheelock, it does

not seem to involve the long term profit outlook based on estimates of periodic cash flows. Rather

the problems for outside, passive investors seem centered on the observation that for Wheelock it

is extremely unlikely that there will ever be a change of control or a going‐private transaction.

I shall write to you again when TAM reports for the fiscal year to end October 31, 2014.

Martin J. Whitman

Chairman of the Board


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Value FundPortfo l io Manager Commentary

TH I RD AVENUE

JU L Y 3 1 , 2 0 1 4

From the Portfolio ManagerChip Rewey

Lead Portfolio Manager of the Third Avenue Value Fund


I am honored to be taking the lead position on the Third Avenue’s Value Fund (Fund), Third

Avenue’s flagship strategy and a hallmark in the industry. The Third Avenue Management

(TAM) Value team, my co‐Portfolio Managers and I will continue to pursue the concentrated

approach to value investing that has been the pledge of the firm since its founding. The

Fund has been and in my view will always remain eclectic and opportunistic in its mandate.

While I am new to TAM, I am not new to Marty Whitman’s investment philosophy. In fact, a

great deal of my own investment philosophy and process has been built on the teachings in

his books and investor letters. I embrace Marty Whitman’s and the Fund’s disciplined and

systematic approach. As value investors we scour the investment universe seeking

companies with strong creditworthiness, a meaningful discount to net asset value (NAV) and

the ability to consistently compound NAV growth. In our relentless search for value, we

pursue opportunities across geography, industry, asset class and market cap. Additionally,

reflective of Third Avenue’s culture, the Fund has a history of successful distressed credit

investments alongside well‐capitalized equity holdings as we search for value up and down

the capital structure. In Marty Whitman’s words, “guided by an adherence to price

consciousness and a deep understanding of underlying business fundamentals and asset

values, Third Avenue rarely, if ever, invests alongside the galloping herds”. This approach

has shown time tested success for over twenty‐four years and across different market

cycles.

A “price conscious” buy is the critical lynchpin for our strategy, as it not only sets the basis

for future return potential, but as importantly provides downside protection to avoid a

return‐sapping capital loss. It is said that patience is a virtue, and indeed for our strategy,

patience for an appropriate discount is essential for our purchase decisions. As we scour

our broad and eclectic investment universe, we analyze many more companies than we will

ever own. It is this continuing due diligence of management discussions, supplier, vendor

and competitor interviews and financial statement analysis that helps us build our industry

knowledge and form our unique view on what an enterprise and its assets are worth. We

analyze many ‘good’ companies, but it is critical that we are patient and buy

opportunistically when the discount to asset value provides an acceptable return and a

mitigation of risk.

Many investors have asked me what will change as I take on the role of Lead Portfolio

Manager. While I look forward to fostering the investment philosophy of the firm, I believe

that there is always room for continuous improvement in the process of how we can

execute this strategy. There are many tools and best practices along the lines of idea

Third Avenue Value Team

Chip Rewey, CFALead Portfolio Manager

Vic Cunningham, CFAPortfolio Manager

Michael LehmannPortfolio Manager

Yang LiePortfolio Manager

Andrea Sharkey, CFAResearch Analyst

Portfolio holdings are subject to change without notice. The following is a list of Third Avenue Value Fund’s 10 largest issuers, and the percentage of the total net assets each represented, as of July 31, 2014:

Covanta Holding Corp., 5.12%; Bank Of New York Mellon Corp., 4.98%; POSCO, 4.87%; Cavco Industries Inc., 4.78%; Wheelock & Co., Ltd., 4.53%; Apache Corp., 4.28%; Devon Energy Corp., 3.96%; Hang Lung Group Ltd., 3.64%; Total S.A., 3.53%; Daiwa Securities Group Inc., 3.49%


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Value Fund

generation techniques, risk correlation matrices, investor expectation studies and sell discipline

that I have found to be useful in the portfolio construction process. All of these tools or best

practices are helpful in determining the most appropriate position size for any given investment.

Over my twenty‐three years in the industry I have learned that determining which securities

should opportunistically be top weightings and at what price from both a buy and sell perspective,

is critical in harvesting top investment performance. The conviction to purchase discounted

securities must be paired with an effective process to execute the decision. Likewise, the decision

to sell a security to harvest a gain, or recognize a significant change in the investment case relies

on effective research and valuation, but also a process to identify and review these securities on a

timely basis. In my role as lead of the value strategy, I will pursue continuous improvement in our

processes so as to harvest the investment outperformance that our philosophy can deliver.

I believe that a highly collaborative team based process builds higher levels of conviction and

superior investment results. My co‐Portfolio Managers on the Value Fund are not only deep in

their years of experience, but also tenured in their careers at TAM.

In addition to the immediate team, the strategy is supported by the breadth and depth of the

entire TAM research staff of over twenty five analysts, spanning Small Cap, International, Real

Estate and Credit mandates in the U.S. and globally. The Fund will retain the spirit of the flagship

TAM strategy, and continue to draw on and contribute to the firm’s vast resources and analyst

team.

Sincerely,

Chip Rewey, Lead Portfolio Manager

Third Avenue Value Fund


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One of the common questions our fellow shareholders have asked recently is whether we are able

to find good value investments given the strength of the markets, especially in the U.S. where the

broad market indexes are near all‐time highs. The short answer is absolutely. While current

earnings and price trends are important, our investment process extends well beyond them. Our

process is rooted in evaluating the entire enterprise, as opposed to focusing on more idiosyncratic

quarterly earnings reports. In our analysis we are essentially counting up the assets and

ascertaining a fair NAV for a company as if we were purchasing the entire business. From there we

assess the company's balance sheet and credit profile, to ensure that it has the financial capacity

to meet obligations and investment opportunities, as well as the ability to survive market storms.

Our focus on the ability to compound NAV provides a distinction between higher quality

companies, and those that could be in secular decline or other ‘value traps’ and reveals a lot more

opportunities that may appear obscured by a standardized and generic approach to valuation. We

ask ourselves what we would do to grow the business and create shareholder value if we were the

CEO. We focus our company and industry research and our assessment of the company’s

management team against our answer to this question. Thus, by focusing on a longer term

horizon, we see longer‐term opportunities that investors absorbed by the shorter term overlook

and/ or ignore.

As the U.S. Federal Reserve’s quantitative easing program winds down, we have seen a decline in

correlations within equity markets. Investors are now forced to evaluate the risk and return

metrics of individual securities. This is significantly different from the broader ‘risk‐on versus risk‐

off’ macro mindset that has dominated markets over the last few years. In addition, the coupling

of cash availability with an improvement in confidence of corporate decision makers, CEO’s and

CFO’s, has led to a resurgence in M&A and other resource conversion opportunities. These actions

are a positive for our conception of value investing, as they illuminate the undervalued

opportunities we have identified through our research. In market environments such as the

current one, it is not surprising resource conversion is a common theme for many of the Fund’s

top performers during the quarter.

In the remainder of the letter we will discuss a number of investments, all among the top

contributors to returns, which highlight how our disciplined investment process has enabled us to

unveil opportunities in the U.S. Bank and Technology sectors; and in resource conversion

opportunities, with examples in the Energy and Real Estate sectors.

Bank Investing and Downside ProtectionTAM has a long history of investing in companies in the Financial sector. After the most recent

global financial crisis our analysis found regional banks more attractive than money center banks.

The focus on regional banks is driven by three main dimensions:

1. Attractive price to tangible book basis with better return profile

2. Well capitalized

3. Provide downside protection when you need it most

Value Fund


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The Fund’s strategy of investing in regional banks has been a frequent topic of conversation with

shareholders as money center banks have lower price to book ratios. In our view, a simple price to

book analysis obscures some of the most compelling differences across banks.

The chart below shows fundamental information for the Fund’s two regional bank holdings, Key

Bank (KEY) and Comerica (CMA), displayed side by side with the same information for three widely

held money center banks (Bank of America (BAC), JP Morgan Chase (JPM) and Citigroup (C). Note

that from a price‐to‐book (P/B) standpoint, the differences among these banks, ranging between

0.7 and 1.2, favors the money center banks.

Value Fund

Fundamental Information on Selected Banks

CompanyPrice (P)

Book Value (BV)

Tangible BV (TBV)

P/B P/TBV ROATier 1

Common

Level III Asset % S/E

Stressed Capital Ratio*

Key Bank 14.3 11.6 10.4 1.2 1.4 1.1% 11.3% 5.6% 8.0%

Comerica 50.2 40.7 37.1 1.2 1.4 0.9% 10.5% 2.0% 7.8%

Bank of America 15.4 21.2 14.0 0.7 1.1 0.4% 12.0% 11.7% 5.0%

JP Morgan Chase 57.6 55.2 42.2 1.0 1.4 0.7% 9.8% 27.8% 5.5%

Citigroup 47.1 66.8 56.9 0.7 0.8 0.5% 10.6% 20.7% 6.5%

Data as of 6/30/2014. ROA data is trailing 12 months.

Source: Capital IQ and Comprehensive Capital Analysis and Review 2014 (*).

We have preferred regional banks for three reasons. First, at TAM we focus on price to tangible

book value (P/TBV) as opposed to simple P/B. Tangible book value is a better measure of intrinsic

value as it excludes intangible assets which wouldn’t carry much value in liquidation. As discussed

earlier, one of the dimensions we focus on as we evaluate companies is the assets. The valuations

of KEY and CMA are much closer to peers listed above on a P/TBV basis. Evaluating just a single

statistic may provide misleading conclusions when evaluating an investment. Thus, we also

consider how well a company can compound its book value over time. As seen in the table above,

both KEY and CMA are generating higher returns on assets (ROA) than peers. This is important as

companies that generate higher returns deserve premium valuations. Again, we distinguish among

the many metrics. We focus on ROA as the measure of ROA does not favor companies that carry

higher leverage and perhaps higher risk.

Second, the Tier 1 Common Equity ratios for KEY and CMA compare favorably against the money

center peers. This metric indicates that the Fund’s regional banks are as well, if not better,

capitalized than money center banks. As discussed in the opening paragraphs of the letter, the

integrity of the balance sheet is a key dimension to our analysis.

Third, the chart above also shows the Level III assets for each company. Level III assets are not

traded in liquid markets so prices are determined using a company’s internal models. Those prices

could be entirely accurate, but as seen during the financial crisis, when liquidity dries up, asset

prices of illiquid securities can get distorted quickly. We aren’t willing to take that risk. By focusing

on KEY and CMA’s TBV and lower exposure to Level III assets, we gain additional comfort with their

balance sheets. The regulators agree with our view. The table above shows “severely stressed

capital ratios” from the Federal Reserve test earlier this year. The stress test assumptions are

extreme (deep recession, high unemployment, 50% decline in equity prices and 2001 house

prices), but the results do provide insight into the strength of the asset portfolios.


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KEY and CMA’s above average results on the stress tests are another indication of the high

transparency and durability of their balance sheets.

This analysis has important implications over how we manage the Fund because we have a high

level of conviction on the securities we select and we scrutinize companies along several

dimensions and focus on the appropriate statistics,. One of the key questions we ask ourselves

when making an investment is would we buy more if the stock price declined? We mentioned

earlier in the letter that we ‘count the assets’ when determining NAVs. We need to be sure those

assets will be there when we need them most, such as in times of market turmoil. We would be

reluctant to add to our positions if we lost confidence in the values of the assets. This is

particularly important when investing in financial companies where the assets values are harder to

judge.

In sum, a discount to book value isn’t good enough for us at TAM to invest in a stock. We also

need conviction in adequate downside protection. Investing in companies with low leverage and

high quality assets helps us develop that conviction. CMA and KEY fit our strict criteria and have

provided solid returns to investors thus far and as both grow book value plus dividends in the

future, we are confident those returns will continue.

The Fund invested in the common stocks in KEY and CMA at discounts to tangible book and with

the expectation that they could grow book value at double digit rates over time. Given the

satisfactory ROAs and BV compounding (trailing twelve month BV growth including dividends:

CMA: 12%, KEY: 9.8%), we are happy with how our companies are executing, despite persistently

low interest rates and sluggish loan growth. What’s more impressive is that our companies are

able to generate higher ROAs despite carrying more excess capital which weighs on returns. Both

companies are positive contributors to the Fund’s performance year to date.

Value in Technology: IntelSome investments are NAV compounders, i.e., ones in which we would like to buy and effectively

own ‘forever’. Other investments are more opportunistic in nature. These are investments which

we hope to harvest from time to time. In both cases our investment approach remains the same.

Our longer term focus on the entire business and its assets can help us identify investments where

the short term mindset of the ‘galloping herd’ actually creates opportunities for patient and

thoughtful investors.

A case in point is Intel, a well‐financed leader in designing and manufacturing microprocessor

chips. We invested in Intel common stock early 2013 when the shares sold off meaningfully on

investor fears of a poor near term outlook due to weak PC end‐user demand and general macro

related weakness in IT spending. In our view, these shorter term, more macro related concerns

were ignoring Intel’s solid franchise in microprocessors for PCs and servers, which it has continued

to enhance through its technological and manufacturing leadership. While Intel faces challenges in

trying to capture share in faster growing mobile markets, we believe that there is substantial value

in its core businesses. There are reportedly some 600 million PCs that are four years old or older

vs. typical replacement cycle at around three years. Given the proliferation of new applications,

many of which require greater computing power, an upgrade of one's PC, particularly in the

workplace, eventually becomes a necessity. For anyone who has experienced the frustration of

Value Fund


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trying to work on an older PC, watching the hourglass or equivalent thereof, slowly spin as an

application is loading, you know what we mean! Further, we were being paid to wait, as the stock

paid a 4.3% dividend; the Fund was able to acquire shares at around 4.6 times EBITDA and 10

times earnings.

The strengths of Intel showed through in its second quarter 2014 earnings report which benefitted

from an improvement in PC demand, helped by upgrades driven by the expiration of support for

Windows XP and a realized 11% increase in pricing in its data center offerings, where Intel

continues to be the market leader. We did take advantage of a rise in the stock price to trim the

Fund’s position as shares rose approximately 30% year to date and moved closer to our NAV

target.

Resource Conversion: A Value Creation Theme

Management teams have many levers to pull from in order to generate value for shareholders. At

TAM, we often describe the different types of value creation generally, under the catch all phrase

‘resource conversion’, but it can essentially be defined as the many ways that a company has to

create value for the underlying shareholder. Mergers, acquisitions, spin‐offs, takeovers, asset

disposition, large dividends or share repurchases each can be a powerful mechanism to surface

value when it’s not fully recognized by the market. We have found that the optimal situation is

when a management team has many tools to choose from and is able to capture value from the

entire set of choices. This theme has emerged in full force in our energy holdings, which after

several years of participating in the industry‐wide ‘land grab’ now are positioned with diverse

portfolios of assets and essentially too many opportunities to efficiently develop within a rational

capital structure. Resource conversion was a key driver for the positive attribution from the Fund’s

energy holdings in the third‐quarter, and also provided us with the opportunity to initiate a

position in Weyerhaeuser.

Energy Holdings

Each one of the Fund’s Independent Energy and Production (E&P) company holdings, Apache,

Devon and Encana, moved forward with resource conversion activities in order to surface

shareholder value and better focus their drilling and production spending. We were able to build

each of these positions when the companies were deploying capital to acquire attractive assets,

looking through the markets’ skepticism on the transformation of these companies and focusing

on the value that could be created longer term by integrating these properties and optimizing the

overall asset base. What was clear to us was that the valuation disparity between pure play E&Ps

and more diversified ones allowed us to acquire many attractive assets within these companies

essentially ‘for free’ as the market failed to recognize the value of the under‐developed assets in

their portfolios. In each case, management’s ability to refocus on improving capital efficiency and

a bit of successful ‘self‐help’ has transformed the profile of these portfolio holdings. We note that

we welcome and have benefitted from the rise of activist investors’ positions in the sector as their

increased public scrutiny has accelerated the resource conversion process.

Value Fund


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Encana was a pure play natural gas company when fracking technology dramatically expanded the

supply of natural gas on the North American market. The company initially struggled to optimize

their capital allocation across a very broad portfolio of assets, concentrated on gas. Under the new

leadership of CEO Doug Suttles, the company unveiled a strategic shift to focus on its five core

liquids‐rich plays in North America. Suttles moved to monetize underutilized assets including the

sale of the Jonah, Big Horn and East Texas properties for over $4 billion and focus on the highest

return assets.

Devon has benefitted from the merger of Crosstex Energy with Devon’s midstream assets to form

the EnLink MLP which strategically unlocked billions of dollars of value that was hidden in these

assets. Devon now is focused on the development and optimization of its five premier asset plays,

including its prolific Eagle Ford assets and its Permian basin acreage. These actions have

transformed Devon from a primarily natural gas producer to a more balanced oil and gas company.

Apache is transforming its holdings from a diversified array of E&P assets to one that is more

focused on unconventional onshore liquids plays. We expect the company to live within its cash

flow, excluding the CAPEX required for its two liquid natural gas (LNG) projects, Wheatstone and

Kitimat. Longer term, we think Apache will at least partially monetize LNG projects, which are

operated by Chevron, to focus on higher return projects that support production and cash flow

growth. Although not expected nor central to our investment thesis, the recent involvement from

JANA Partners further validates our view that significant value remains under‐appreciated within

Apache’s still fairly diverse portfolio of E&P assets.

Weyerhaeuser

The Fund initiated a position in Weyerhaeuser as the company moved to finalize the distribution of

its WRECO homebuilding subsidiary in an exchange offer with Tri Pointe Homes Inc.

Weyerhaeuser is a Real Estate Investment Trust with wood products and wood fiber businesses,

and the second largest owner of timberlands in the U.S. It is worth noting that Weyerhaeuser was

sourced with TAM’s Real Estate team and is a solid example of the ability of the Fund to pull ideas

from across the entire TAM research team. The Reverse Morris Trust distribution of WRECO was

structured as an exchange offer, whereby shareholders could choose to accept shares in the new

Tri Pointe, or to retain their interest in Weyerhaeuser. We chose not to indicate for Tri Pointe

shares, and were pleased that the exchange offer was oversubscribed so that we retained our full

position in Weyerhaeuser. The net effect of the transaction from our perspective was a resource

conversion event in which WRECO was traded for a large repurchase transaction, representing

roughly 10% of Weyerhaeuser shares plus $700 million in cash.

We see the remaining businesses of Weyerhaeuser, led by CEO Doyle Simons, trading at a

substantial discount to our estimated NAV combined with a solid outlook of secular growth, self‐

help margin improvement initiatives and a good way to gain exposure to a recovery in the U.S.

housing market.

Value Fund


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Post the WRECO divestiture, the remaining operations are Timberlands (about 46% of operating

income), Wood Products (35%) and Cellulose Fibers (19%). The timber division owns forests in the

U.S., Canada and Uruguay, and recently added 645,000 acres of strategic Pacific Northwest forest

with the purchase of Longview Timber in July 2013. The Longview acquisition not only provides

operational scale and cost reduction opportunities, but increases Weyerhaeuser’s exposure to the

lucrative Asian export log markets, primarily China and Japan. Weyerhauser is able to accelerate

the harvest on its acquired Longview acreage, as the average age of the acquired trees was over

the optimal twenty five to forty year growth cycle the company targets. The Wood Products

operations produce Lumber, Oriented Strand Board (OSB) and Engineered Wood Products and

have clear upside cyclical leverage to the nascent recovery in the U.S. single family housing market.

The Cellulose Fiber division produces fluff pulp and specialty pulps used in a wide variety of

consumer end markets. Division management is focused on reducing costs and increasing

manufacturing efficiency to compete in this cyclical industry.

Looking forward, we remain pleased with the current portfolio and optimistic about prospects for

future growth. We look forward to writing you again after the fourth fiscal quarter of 2014. Thank

you for your continued interest and support of the Fund.

Sincerely,

The Third Avenue Value Team

Chip Rewey, Lead Portfolio Manager

Michael Lehmann, Portfolio Manager

Yang Lie, Portfolio Manager

Victor Cunningham, Portfolio Manager

Value Fund


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Small‐Cap Value FundPortfo l io Manager Commentary

TH I RD AVENUE

JU L Y 3 1 , 2 0 1 4


We are pleased to welcome Chip Rewey to Third Avenue’s Small Cap team as a fellow

shareholder and Co‐Lead Manager, working closely with Curtis Jensen. As outlined in

Third Avenue Value Fund’s letter, Chip has also joined that team as Lead Portfolio

Manager. These appointments not only speak to Chip’s decades of successful

experience at like‐minded investment firms, but also to his embracing of a collaborative,

team approach to investing, as well as to Marty Whitman’s time‐tested deep value

philosophy. Chip evidences all the characteristics we seek in our teammates: an

independent and curious mind; a high level of energy and a sense of urgency in a job

that we are privileged to do every day. Chip’s addition will help us to build on the

terrific momentum that this team has developed.

Portfolio Performance and ActivityThe Third Avenue Small‐Cap Value Fund (Fund) generated a 0.6% return over the last

fiscal quarter, and a ‐0.5% return year to date, significantly outperforming its

benchmark during both periods.1 The Russell 2000 Value Index returned ‐1.27% and

‐2.1% for the quarter and year to date, respectively.

Fund Management added four new positions during the quarter, the three most

significant of which are discussed below. We added opportunistically and selectively to

several existing Fund positions and exited eight holdings, the largest of which are also

detailed below.

The fully invested portfolio ended the period with seventy eight holdings. The largest

new positions included Patterson Companies Common Stock (Patterson), Standard

Motor Products Common Stock (SMP) and Cooper Tire and Rubber Common Stock

(Cooper).

Patterson is the second largest distributor of dental, veterinary, and rehabilitation

supplies in the U.S. Together with its chief competitor, Henry Schein, Patterson enjoys

leading market shares across its served markets. By virtue of its scale, Patterson brings

value to its customers by providing turnkey office solutions and by delivering high levels

of service. The combination of an aging demographic, a growing pet population, more

Third Avenue Small‐Cap Team

Chip Rewey, CFACo‐Lead Portfolio Manager

Curtis R. Jensen,Co‐Lead Portfolio Manager

Tim Bui, CFAPortfolio Manager

Charlie Page, CFAPortfolio Manager

Evan Strain, CFAResearch Analyst

Portfolio holdings are subject to change without notice. The following is a list of Third Avenue Small‐Cap Value Fund’s 10 largest issuers, and the percentage of the total net assets each represented, as of July 31, 2014:

HCC Insurance Holdings, Inc., 2.80%; JZ Capital Partners Ltd., 2.59%; Axiall Corp., 2.50%; Progress Software Corp., 2.28%; Syntel, Inc., 2.22%; Semgroup Corp., 2.11%; Unifirst Corp., 2.08%; Genpact, Ltd., 1.99%; World Fuel Services Corp., 1.95%; EmcorGroup, Inc., 1.94%

1 The Fund’s one, five and 10 year performance was 17.20%, 13.71% and 7.35%, respectively.Third Avenue Small‐Cap Value Fund is offered by prospectus only. The prospectus contains more complete informationon advisory fees, distribution charges, and other expenses and should be read carefully before investing or sendingmoney. Past performance is no guarantee of future results. Investment return and principal value will fluctuate so thatan investor’s shares, when redeemed, may be worth more or less than original cost. The Fund’s returns should be viewedin light of its investment policy and objectives and quality of its portfolio securities and the periods selected. M.J. Whitman LLC Distributor. If you should have any questions, or for updated information (including performance data current to the most recent month‐end) or a copy of our prospectus, please call 1‐800‐443‐1021 or go to our web site at www.thirdave.com. Current performance may be lower or higher than performance quoted. The Russell 2000 Index measures the performance of small companies. The Russell 2000 Value Index measures the performance of those Russell 2000 companies with lower price‐to‐book ratios and lower forecasted growth values.


13

Small‐Cap Value Fund

physical and occupational therapies, with international expansion provides a stable growth

backdrop for the company. We also believe there is room for operational improvements that can

enhance the return on the company’s assets. Management has, steadily returned capital to

shareholders, both through significant share repurchases as well as a growing dividend. With the

shares yielding 5% to 6% based on free cash flow, the current share price reflects an estimated

20% upside to our conservative estimate of Net Asset Value (NAV).

Founded nearly one hundred years ago by a Lithuanian immigrant whose grandson is the current

CEO, SMP today is an aftermarket auto parts manufacturer and distributor specializing in engine

management and temperature control products. Longer term, we believe that the increasing

number of older model cars on the road with ever more complex electronic and digital systems

create a defensive and growing revenue base for the company. Management augments SMP’s

growth by acquiring smaller competitors to expand its product portfolio and has steadily improved

the company’s margins and returns through various cost initiatives. Like Patterson, SMP has

returned capital to shareholders via share repurchases and growing dividends – without sacrificing

the balance sheet. The Fund’s entry point approximated a free cash flow yield of 8%, reflecting a

potential upside to our estimated NAV of at least 20%.

Cooper, the fourth largest light vehicle tire maker in the United States, had been the subject of a

failed takeover bid by India’s Apollo Tyre, a deal that unraveled late last year owing to the parties’

inability to resolve a dispute related to Cooper’s Chinese joint‐venture. Cooper appears to be well

managed; in the past 10 years operating margins have more than doubled, returns on capital have

spiked and the balance sheet has been steadily de‐levered. The business should benefit from

improving tire replacement trends, a growing business in China and a supportive raw material price

environment. Recently Cooper announced its first Original Equipment deal to supply certain Ford

Motor models.

Based on the Fund’s initial purchases, equating to about five times EBITDA, we estimate that the

public market had discounted the company’s shares by as much as 25% or more from our

conservative estimate of fair value. As another point of reference, our analysis suggests a

replacement cost for the company’s capacity ($75 to $100 per tire) that is more than twice that

value implied by the company’s current market price, enhancing the downside protection of the

investment.

Notably, a resolution to the dispute in its Chinese joint venture is likely value‐enhancing and is

expected before year‐end. Several parties expressed interest in buying Cooper last year, opening

up the possibility that the company becomes an attractive partner for a global tire company

looking to gain scale either in the United States or China.

The Fund realized a number of favorable outcomes among its major dispositions during the period.

These include Big Lots, Compass Minerals, Sensient Technologies and Susser Holdings, each of

which were among the best contributors to performance in recent periods. The outperformance

led us to harvest gains in these positions where valuations got either in line with or ahead of our

fair value NAV estimates.


14


Big Lots, one of the nation’s largest closeout retailers and operating more than one thousand and

five hundred stores in the U.S. and Canada, respectively, initially gained our attention as a

turnaround story. Despite weak top line results during the last couple of years, we were attracted

to the company’s relatively stable margins, even during recessionary periods, and highly cash

generative operations. We believed the “problems” in the business, such as merchandising and

sourcing, were likely temporary and fixable, that the company had not lost its core customer and a

new CEO had a decent chance of success in the turnaround. Management’s restructuring does

appear to be gaining traction this year and the share price has responded accordingly. Skeptical of

a persistently difficult retail environment and mindful of what we viewed as a full valuation,

however, Fund Management sold its shares, realizing an IRR of 42%.

Fund Management exited its position in Compass Minerals, one of North America’s largest and

lowest cost salt producers, following vastly improved business conditions from the investment’s

inception in late 2011, at a valuation that approximated the high end of our estimate of Net Asset

Value. The investment produced an annualized IRR of 17%.

Sensient Technologies, a manufacturer of colors, additives, flavors and fragrances to a wide variety

of industries, benefited from steady, albeit uninspiring, operational results that eventually came

under question from an activist shareholder. Sensient’s share price responded positively to the

presence of the dissident shareholder and when the share price reached the high end of our NAV,

we exited our position, resulting in an IRR of 23%.

As noted in last quarter’s letter, Fund Management elected to sell its position in Susser Holdings

when that company became the subject of a takeover by Energy Transfer Partners. The

investment thesis in Susser, a growing convenience store chain in Texas, was based on its unique

Laredo Taco food‐service operation, exceptional management team, and ownership in a valuable,

publicly‐listed fuel distribution franchise. Sale of the investment, one with an unusually short

tenure, was completed this quarter and resulted in an IRR of 81%.

OutlookOne of the common questions our fellow shareholders have asked recently is whether we are still

able to find good value investments given the outperformance by small capitalization stocks

relative to other assets and especially in view of their relatively rich valuations. The short answer is

absolutely. While current earnings trends are important, they are not our starting point. Our

process is rooted in evaluating the entire business enterprise, essentially counting up the assets

and ascertaining a fair value NAV. From there we assess the balance sheet and credit profile of a

company, to ensure the company has the financial ability to meet its obligations and investment

opportunities, and the ability to survive market storms.

Stocks get mispriced by the public markets for various reasons, including, for example, investor

short‐termism, a perceived lack of ‘catalysts’ or an ignorance of inherent asset values that may not

be fully exploited. Our in‐depth, fundamental research helps to separate this ‘noise’ from longer‐

term fundamental value while our focus on the ability to compound NAV provides a distinction

between higher quality companies, and those that could be in secular decline or other ‘value

traps’.


15

As the U.S. Federal Reserve’s quantitative easing program winds down, we have seen a decline in

correlation within equity markets. Correlations across stocks are declining as dispersion in the

performance across stocks is increasing. Equity markets appear to be less driven by the broad ‘risk

on’/ ‘risk off’ investor mindset that has been dominant since the onset of the global financial crisis.

Instead, over the last few months, fundamental characteristics of companies are having more

influence on stock returns. The renewed interest of investors in fundamentals bodes well for the

Fund, as our investment process thrives in these environments.

The current global economic and geopolitical situation remains fraught with uncertainty. We

recognize this and in doing so focus our efforts on those variables that we can ‘control’, namely

the value proposition and quality of the businesses in which the Fund invests. In this vein, we seek

companies that are well managed, have a sustainable competitive advantage, sensible balance

sheets and a wide gap between stock price and our conservative estimates of NAV.

While we acknowledge that future equity market returns may be more subdued than those of the

past five years, we view equities favorably and our differentiated portfolio in particular, where the

results we believe will be much more tied to individual company results than to the results of the

general market.

We look to the future with confidence, knowing that:

o We have the tightest process and highest quality portfolio ever in the strategy. Chip’s

addition brings even more experience, more depth on companies and industries and

potential for new ‘best practices’ from a like‐minded firm we have known for decades.

o Our process transcends any one individual; our system of checks and balances makes sure

all voices are heard and questions answered while maintaining efficiency in processing

ideas.

o The evidence of our improvements during the past year in our process and portfolio is

delivering attractive returns this year, particularly when viewed in the context of the

investment risks assumed and the resultant ‘return per unit of risk’ that we believe – and

the data supports – is well in excess of the index.

We thank you for your support of the Fund and look forward to writing to you again next quarter.

In the meantime please let us know should you have any questions or comments.

Sincerely,

The Third Avenue Small‐Cap Value Team

Chip Rewey, Co‐Lead Portfolio Manager

Curtis Jensen, Co‐Lead Portfolio Manager

Tim Bui, Portfolio Manager

Charlie Page, Portfolio Manager



16

Real Estate Value FundPortfo l io Manager Commentary

TH I RD AVENUE

JU L Y 3 1 , 2 0 1 4


We are pleased to provide you with the Third Avenue Real Estate Value Fund’s (Fund)

report for the quarter ended July 31, 2014.

Portfolio ActivityDuring the quarter the Fund added to some of its core holdings (Weyerhaeuser,

Westfield, and Cheung Kong), funded its pro‐rata share of Colonial’s rights offering, and

provided exit financing for IVG Immobilien as it moved closer to emerging from

bankruptcy. The Fund also eliminated three Real Estate Investment Trusts (REITs),

(Derwent London, Federation Centres, and Scentre Group) and one real estate related

company (Rayonier Advanced Materials) for valuation purposes, as well as another

position (Consolidated Tomoka) for portfolio management reasons. The proceeds from

these sales were primarily reallocated to companies with strong ties to the U.S.

residential markets, including some existing holdings (PNC TARP Warrants and Starwood

Waypoint Common) and two new positions (Realogy Common and Zions Common).

Weyerhaeuser Common was increased prior to the company separating its homebuilding

business via a split‐off transaction in late July. In that transaction, the Fund elected to

forego receiving shares in the homebuilding entity (now listed separately as Tri‐Pointe

Homes), essentially increasing its investment in the company’s timberland portfolio and

other remaining assets (wood products and cellulose fibers). Both Weyerhaeuser and Tri‐

Pointe Homes seem well positioned as stand‐alone companies that should continue to

benefit from a recovery in U.S. housing (more below). However, at the time of the

transaction Weyerhaeuser Common traded at a larger discount to our estimate of private

market value, while offering superior growth prospects and resource conversion potential

relative to Tri‐Pointe common stock. Following the additional investment, Weyerhaeuser

Common is the largest single position in the Fund.

The Fund’s position in Westfield Common was increased during the quarter ahead of a

corporate restructuring. The company previously owned a world‐class portfolio of malls

in Australia, the U.S., and the U.K. and also controlled some of the premier retail‐led

development projects in several gateway cities globally. During the quarter, Westfield

received the necessary approvals to spin‐off its Australian portfolio into Scentre Group, a

newly formed Australian REIT. After the spin, the Fund elected to sell its new position in

Scentre Common as it traded at a premium to net asset value (NAV). The Fund retained

its investment in Westfield Common. The renamed company (Westfield Corp.) owns the

U.S. and U.K. mall portfolios and has an opportunity to meaningfully increase its NAV over

the next three to five years as it delivers its major development and expansion projects,

including: the retail mall at the World Trade Center site in New York City, the expansion of

the Westfield London mall in West London, a brownfield development in Milan, and the

continued redevelopment of the Century City sub‐market of Los Angeles.

Third Avenue Real Estate Team

Michael WinerCo‐Lead Portfolio Manager

Jason Wolf, CFACo‐Lead Portfolio Manager

Ryan Dobratz, CFAPortfolio Manager

Larry Hedden, CFAResearch Analyst

Mohammad Tabibian Research Analyst

Kon‐Yao KwekResearch Associate

Portfolio holdings are subject to change without notice. The following is a list of Third Avenue Real Estate Value Fund’s 10 largest issuers, and the percentage of the total net assets each represented, as of July 31, 2014:

Weyerhaeuser Co., 4.74%; Cheung Kong Holdings, Ltd., 4.57%; Newhall Holding Co. LLC, Class A, 4.38%; Forest City Enterprises, Inc., Class A, 3.78%; Songbird Estates PLC, 3.45%; Westfield Corp., 2.76%; HammersonPLC, 2.71%; Lowe's Cos, Inc., 2.71%; First Industrial Realty Trust, Inc., 2.55%; Wereldhave NV, 2.40%


17

Real Estate Value Fund

The Fund took advantage of market volatility to increase its investment in Cheung Kong Common.

Cheung Kong is a Hong Kong based holding company with substantial investments in real estate,

infrastructure, power, and other private‐equity like investments through its 50% ownership stake

in separately‐listed Hutchison Whampoa. Similar to Weyerhaeuser and Westfield, Cheung Kong

has radically transformed its business model over recent years. In Cheung Kong’s case it has

actively managed its portfolio of investments by selling down exposure to yield‐oriented assets in

Asia (ports, commercial real estate, etc.) and reinvested the proceeds into “real assets” in Europe

on an opportunistic basis. These investments will ultimately be streamlined into more efficient

and productive platforms over the next few years. It is our view that as the management teams of

all three businesses execute on their forward thinking business plans, the earnings power of each

company will meaningfully exceed expectations and result in industry leading growth in NAV when

viewed on a per share basis.

The Fund also increased its position in Colonial Common during the quarter. As highlighted in

previous quarterly letters, Colonial is a real estate operating company (REOC) based in Spain that

owns a high‐quality office portfolio in Europe, with holdings in Madrid, Barcelona, and Paris.

Previously, Colonial had been saddled with unsustainable levels of debt. To pay down those

liabilities and right size its capital structure, the company completed a €1.3 billion rights offering

during the quarter in which the Fund participated by exercising the Colonial Rights it had received

after purchasing Colonial Common earlier in the year. Furthermore, the Fund also purchased

additional Colonial Rights as they became freely tradable and ultimately oversubscribed to the

offering. Colonial Common is now a top position in the Fund and we believe it offers significant

embedded growth potential as (i) the portfolio is currently more than 20% vacant; with its recently

strengthened financial position and improving market conditions, the company should be able to

increase occupancy, cash flows and underlying value; and (ii) the company could accelerate the

monetization of its deferred tax asset as it boosts profits of its own portfolio and through

additional acquisitions as a consolidator in the Spanish office markets.

IVG is another portfolio position that offers significant growth potential. As outlined in previous

letters, IVG is a REOC based in Germany that owns one of the largest office portfolios in the

country. It also has a large asset management platform and the rights to develop oil and gas

storage facilities in Northern Germany. Like Colonial, IVG owned valuable assets, but they were

encumbered by too much debt. IVG announced in early 2013 that it was going to be unable to

refinance an upcoming maturity. This led to a dramatic sell‐off of all securities across IVG’s capital

structure (debt and equity). After conducting extensive analysis of the company’s assets and

capital structure, we determined that the IVG Convertible Notes should be the fulcrum security

(i.e., the most senior issue in the capital structure to participate in a reorganization). The Fund

ultimately purchased a large stake in IVG Convertible Notes and participated with other

Convertible Note holders in an ad hoc committee to negotiate with the company and other

stakeholders to reach an out‐of‐court restructuring. A consensual deal with all stakeholders could

not be reached, forcing the company to file insolvency proceedings in Germany. In court, the

company proposed a debt‐for‐equity restructuring plan that granted 80% of the equity to

syndicated lenders and 20% of the equity to convertible bondholders. The preferred equity and

common equity received nothing pursuant to the plan and were effectively wiped out. The plan


18

was approved by the necessary stakeholders as well as by the Insolvency Court in late July.

Consequently the Fund’s position in the IVG Convertible Notes will be converted to common

equity in September. After the debt‐for‐equity swap, IVG will be a well‐capitalized REOC with an

opportunity to meaningfully increase the cash flows as it leases up its portfolio, which is only 80%

leased today. The company could also seek strategic alternatives for its remaining assets to realize

the highest and best use of these legacy investments.

The Fund initiated two new positions: Realogy Common and Zions Common. Realogy is the

preeminent and most integrated provider of residential real estate services in the U.S. As the

nation’s largest owner and franchiser of residential real‐estate brokerages, it has more than 13,500

offices and 247,000 sales associates. To put the scale of the company’s platform in perspective,

the company was involved in approximately 26% of brokered domestic existing home sale

transaction volumes in 2013, representing a market share two times larger than that of Re/Max

Holdings, its nearest competitor. During the quarter, the company’s stock declined by more than

20% following reduced expectations for existing home sales growth in 2014, allowing the Fund to

establish the position at an attractive price. While the short‐term outlook might be uncertain, the

prospects of Realogy continuing to increase its profitability over the long‐term seem promising.

For instance, existing home sales in the U.S. were only 5.1 million in 2013, well below a cycle high

of 6.5 million in 2005 and 15% below post‐crisis peak set in mid‐2013. Existing home sales as a

percentage of total inventory are also at all‐time lows and there exists significant potential upside

to the housing recovery, considering ten years of population growth, immigration, and household

formation. As home sales improve from such depressed levels, the business should become much

more profitable. And the embedded earnings power is quite substantial when considering

Realogy’s cash flow is more than 30% below peak levels. The company also has substantial

deferred tax assets in the form of a $2.1 billion net operating loss carry forward that will minimize

future cash tax payments. Upon achieving its target leverage levels (three times debt to EBITDA),

the company is likely to explore various ways of returning that capital to shareholders by either

instituting a dividend or share buyback program.

Zions is a bank holding company that conducts banking operations through its eight subsidiary

banks that control more than $45 billion of deposits in the Western region of the United States.

The Company has more than 50% of its assets in residential loans, commercial loans, or loans

secured by real property. Zions is known to have one of the premier footprints in the banking

space with about 80% of its business being derived from Utah, Texas, and coastal California. Zions

also controls one of the top small‐business lending franchises in the country. Zions Common has

been trading at a discount to its peers and book value as the bank has had a meaningful share of

its capital invested in collateralized debt obligations (CDO), which recently led to Zions failing the

Fed’s ‘stress test’. Additionally, Zions is a very asset‐sensitive bank, so its earnings have been

disproportionately impacted in this low‐interest‐rate environment relative to some of its peers

who generate a greater share of earnings from fee income versus interest income (as net interest

margins have been squeezed). The Fund purchased Zions Common after the company disclosed

positive developments including (i) the CDO portfolio has been further reduced during the second

quarter, (ii) the company completed a $550 million follow‐on equity offering, and (iii) the company

has passed the ‘stress test’ and the Fed has approved the company’s revised capital plan. After

these developments settle in, it is our view that Zions will once again be considered a well‐



19

capitalized bank with outsized growth prospects given its geographic footprint. As management

takes steps to generate additional fee income, realize other efficiencies, and boost profitability, the

discount to peers and book value should close. If not, it is not inconceivable that Zions would be a

highly desirable acquisition candidate for a larger bank or financial institution that could increase

the productivity of the Company’s deposit base while also gaining exposure to some of the most

highly sought after banking markets in the United States.

Residential MarketsAfter adding to the investments in PNC TARP Warrants and Starwood Waypoint Common, as well

as initiating positions in Realogy Common and Zions Common, the Fund has approximately 26% of

its net assets invested in the common stocks of companies with strong ties to the US residential

markets. These consist of well‐capitalized companies involved in nearly every link in the residential

‘value chain’. Current investments include land development (Newhall Land), timber

(Weyerhaeuser, Rayonier), building materials (Lowe’s), brokerage (Realogy), mortgage financing

(Zions, PNC, Wells Fargo), mortgage origination and servicing (PHH), multi‐family rental (Post

Properties), single‐family rental (Starwood Waypoint), senior housing (Brookdale), and urban

development (Forest City).

We recognize that there has been some recent “choppiness” in the U.S. residential markets and

most of the aforementioned companies have been impacted as a result. One issue is that new

home purchases have fallen by approximately 12% year‐over‐year and mortgage applications have

also declined by about 30% during the first half of the year. Also of concern is that annualized

home starts in the U.S. remain below the 1.07 million level reached back in October 2013.

However, we view this pullback as a speed‐bump in what should otherwise be a multi‐year

recovery in U.S. housing with the primary upside from here stemming from a recovery in volumes

as opposed to pricing. This view is based on Fund Management’s belief that:

1) the implementation of Qualified Mortgage Standards (QMS) at the beginning of the year

led to weakness in mortgage activity and home sales but the uncertainty of QMS has

largely been removed as the new guidelines have been integrated into the process at

every major lender and

2) that the excess inventory that was built during the 2003‐2006 timeframe (more than two

million annually) has largely been absorbed now as occupancy rates for apartments have

climbed to all‐time highs (95%) and inventories of for‐sale homes have fallen to historically

low levels (four months’ supply) which has led to a sharp recovery in home prices on a

national basis (up by nearly 20% over the past two years). Therefore, as new households

are formed from this point forward there will need to be more new construction, whether

single‐family homes or multi‐family dwellings, to meet this new demand. Based upon

positive household formations, positive net migration, secondary homes, and natural

obsolescence there seems to be demand for roughly 1.5 to 1.6 million home starts

annually, which is well above current production levels. Therefore, as new construction

activity continues to work its way back from the multi‐decade low levels reached in 2009

(539,000) to this long‐term need of 1.5 to 1.6 million units annually, our portfolio of

companies, which are unique to most global real estate funds, stands to benefit at nearly

every stage in the process.



20

While the Fund has substantial capital invested in companies tied to U.S. housing, investments in U.S.

homebuilders are conspicuously missing from the portfolio. We evaluate each company on a case‐by‐

case basis, and, generally speaking, we believe that prices for U.S. homebuilder common stocks already

reflect a full recovery (1.5 to 1.6 million home starts). On the other hand, common stocks of

companies providing ‘inputs’ to the homebuilding process continue to be attractively valued and have

substantial room for improvement as conditions strengthen further. We are taking full advantage of

the Fund’s flexible mandate to invest in a broad universe of real estate securities that still offer

considerable value both on the residential and commercial side.

At the end of the quarter, the Fund had approximately 35% of net assets invested in commercial real

estate companies, most of which control very strategic development pipelines that should prove to be

quite valuable as demand for new building returns; approximately 26% of net assets is invested in U.S.

residential‐related companies as outlined above; nearly 20% of net assets is invested in ‘special

situation’ investments such as recapitalizations and M&A candidates; and the remaining 19% is in cash

and cash equivalents. The Fund’s cash balance is higher than historical averages, mostly due to recent

inflows as well as more mature investments being sold.

Higher than normal cash balances naturally lead to the question about the Fund’s capacity. While we

take this issue seriously, there currently are no plans to close the Fund to new investors. As noted in

previous quarterly letters, we have historically allowed cash balances to accumulate during periods

when securities valuations do not warrant new purchases. Holding ‘dry powder’ and patiently waiting

for more reasonable prices has worked for us in the past. Long‐term investors in the Fund may recall

when the Fund was closed to new investors in 2005. At that time, the Fund’s investable universe was a

fraction of what it is today, given the resurgence in the securitization of real estate and the Fund’s

flexible mandate which allows us to exploit opportunities in common stocks of traditional real estate

companies as well as real estate related companies and real estate debt securities. We estimate the

investable universe is now in excess of $3 trillion (excluding debt securities).

We are committed to continuing our efforts of scouring our expansive universe for suitable

investments. Our ‘T‐2’ portfolio continues to expand as we find interesting companies that we desire

to include in the portfolio, but at lower prices. We perform rigorous fundamental analysis on each

potential investment, which allows us to quickly deploy into new positions during market dislocations.

Previous shareholder letters have highlighted our advance preparation and ability to deploy significant

capital in a short period of time. Members of the Fund management team each have significant

portions of their investible personal assets in the Fund. We are not willing to compromise returns for

the sake of remaining ‘fully invested’ and trust that the vast majority of our fellow shareholders are

likeminded. While we pursue a mere handful of suitable investments (we don’t need dozens), we will

wait patiently, protect our downside, and then buy with conviction when opportunities appear.

We thank you for your continued support and look forward to writing to you again next quarter.

Sincerely,

The Third Avenue Real Estate Value Team

Michael Winer, Co‐Lead Portfolio Manager

Jason Wolf, Co‐Lead Portfolio Manager

Ryan Dobratz, Portfolio Manager



21

International ValuePortfo l io Manager Commentary

TH I RD AVENUE

JU L Y 3 1 , 2 0 1 4


In the most recent quarter, the Third Avenue International Value Fund (Fund) established

three new positions and eliminated two positions. Before reviewing quarterly activity I

would like to share some insights about how we use (and how we don’t use)

macroeconomic information in our investment process. As fundamental ‘bottom up’

value investors it is often clear to our investors that we do not produce macroeconomic

forecasts. What may be less clear is that this does not imply that we are oblivious to, or

purposefully ignore, macroeconomic developments. Macro has two primary roles in our

investment process. The first one is as a tool to determine the sensitivity of our

investment theses to a variety of macroeconomic environments. This allows us to reject

investment opportunities for which our thesis playing out would require a very specific set

of conditions. The second one is as a frequent source of investment opportunities. Dire

economic outlooks have indeed been one of our team’s most fruitful hunting grounds

over the years. Troubling macroeconomic situations can easily shake investors

(speculators) focused on the near‐term outlook and paralyze those who require a high

level of confidence in their ability to forecast the macroeconomic future. Truth be told,

our habit of seizing opportunity in the face of dire macroeconomic circumstances has

occasionally appeared foolhardy in the short‐term. Yet, the Fund has made many

profitable investments in this way in the past, and in fact the topic of macro dislocations

also factors in each of the three new investments we discuss in detail later on.

The modus operandi of the Third Avenue International Value Fund investment team is to

identify businesses that can increase and compound intrinsic business value through a

variety of means ‐ asset disposals, business combinations, industry attrition or other

forms of industry consolidation, re‐investments within the business at attractive rates of

return or simply through earnings, just to name a few. Marty Whitman parlance captures

all of these methods under the umbrella of ‘wealth creation’. As part of this task, we

intend to identify businesses and companies that can compound value in a wide range of

economic environments, primarily meaning they don’t need an enabling tailwind. With

this as our mission, it becomes critical for us to consider various forms of dire

developments and the impact they may have on the business in question. We typically

consider a wide band of investment outcomes and develop a thoughtful consideration of

business risk and return across a range of macroeconomic scenarios. The insights gained

from this effort have a significant impact on both our sense of business valuation and risk

and is completely distinct from engaging in any type of macroeconomic prediction.

Further, our sense of the macro is integral in our attempt to avoid a mechanical or

formulaic approach to estimating business value. Said differently, we believe it to be

insufficient to estimate the value of a business today without giving serious considering to

the environment in which we are viewing it – i.e., which circumstances have given

Third Avenue International Team

Matthew Fine, CFALead Portfolio Manager

James HounselResearch Analyst

Jane SpiegelResearch Analyst

Harrison VigerskyResearch Analyst

Portfolio holdings are subject to change without notice. The following is a list of Third Avenue International Value Fund’s 10 largest issuers, and the percentage of the total net assets each represented, as of July 31, 2014:

Straits Trading Co., Ltd., 8.94%; Weyerhaeuser Co., 4.48%; White Mountains Insurance Group Ltd., 4.30%; Hutchison Whampoa Ltd., 3.99%; Telefonica Deutschland Holding AG, 3.50%; Rubicon, Ltd., 3.49%; Munich Re, 3.37%; Capstone Mining Corp., 3.36%; Pargesa Holding S.A., 3.35%; Daimler AG 3.24%


22

International Value Fund

rise to the current valuation. For example, in ways specific to individual businesses, low interest

rates may cause perversions by providing a profound tailwind enabling poorly financed companies

to thrive and questionable assets to be coveted. Conversely, a variety of otherwise terrific

businesses may be witnessing depressed operating performance as a result of historically low

interest rates. One financial services investment we later discuss in detail fits this description quite

well, we believe. In this type of macro environment, one can easily be deceived by large apparent

discounts to net asset value to the extent they have not considered whether changes in a dynamic

macroeconomic environment will diminish or eliminate their perceived discount not through share

price appreciation but via declines in underlying asset value. We of course love to pay huge

discounts to our estimate of business value but would in principle prefer to pay relatively smaller

discount to cheap underlying asset values than pay a large nominal discount to inflated asset

prices. The idea is essentially to identify opportunities to buy businesses at prices that will allow us

to earn a satisfactory return even without an improvement in operating performance and

simultaneously have the odds of improved operating performance and appreciation of the

underlying asset values tilted significantly in our favor. This is essentially the mechanism by which

the macro influences ‘margin of safety’, simultaneously increasing safety of one’s capital and

prospective returns. In other examples it may be that macro or industry conditions have

depressed underlying asset values as a result of the near‐term outlook. Our container terminal

investment described in detail below is a prime example. The critical idea is to identify not just

assets that can be bought at a discount but rather assets that can be bought at a discount to

depressed asset values. Investors sometimes refer to a company’s singular net asset value as

though it is identifiable with pinpoint accuracy. We believe that the notion of a singular fixed net

asset value is incommensurate with the fluctuating nature of asset values over time and under a

variety of highly fluid circumstances.

It should not then be surprising that while we refrain from making predictions about

macroeconomic outcomes, our experience has repeatedly reinforced the notion that adverse

macroeconomic factors can lead to terrific investment opportunities. The section that follows will

discuss our three new investments and the macro and industry factors that gave rise to these

opportunities though the meat of the discussion will remain weighted towards our primary

concern, fundamental bottom‐up investment considerations.

New Investments Initiated During the QuarterBinckBank NV

The Fund initiated a new position in BinckBank NV (BinckBank), a Dutch financial services firm, at

what we believe to be a very inexpensive price. BinckBank’s specialty is online brokerage. In its

home market of the Netherlands BinckBank is the dominant retail brokerage firm as measured by

volume of transactions. BinckBank is also the market leader in Belgium. Its market positions in

France and Italy are much less significant. Given the relatively lackluster state of the European

economy and the accompanying lack of retail investor activity, it is not surprising to observe an

unusually low level of retail equity trading volumes in most parts of Europe. This is certainly the

case in the Netherlands and Belgium. The effect on BinckBank has been a cyclically low level of

operating profitability within its core business.


23

Further, BinckBank obtained a banking license some time ago giving it the ability to offer on‐

demand and interest bearing deposit accounts to its brokerage clients who occasionally have idle

cash balances. While BinckBank has a meaningful deposit base, it has never taken the leap of

building a traditional lending operation, other than offering margin loans to its brokerage clients.

Here to, given the lack of equity market optimism, demand for margin loans is currently muted.

Therefore, the asset side of BinckBank’s balance sheet, where the average bank houses loans and

all types of unsavory things, is comprised almost exclusively of short‐duration triple‐A European

sovereign bonds. The company’s banking operation takes an atypically low level risk which offers

comfort but also low returns, particularly so at the moment. Thus it comes as no surprise that both

its brokerage and banking earnings are cyclically depressed.

However, in 2007 BinckBank purchased a fledgling asset management business with the idea of

furthering the suite of investment services it offers its clients. The purchase and subsequent

business development has been a terrific success. BinckBank’s assets under management are

growing very nicely turning the asset management business into an important and growing profit

center for the company, which serves to offset the cyclical lows of BinckBank’s brokerage and

banking offerings. BinckBank’s increasingly significant asset management unit also provides the

prospect of growing BinckBank’s aggregate business value, notwithstanding the difficult

environment in its traditional lines of business.

BinckBank, like all European banks, is faced with the virtual certainty of increasingly stringent

capital requirements. BinckBank has essentially self‐imposed capital levels materially more

stringent than what is likely to be imposed upon it. At these very conservative levels of leverage

and tier one capital, the company is ‘over‐capitalized’ and could be earning much more on its

equity were it to take a bit more risk. Yet, even while earnings are low due to cyclical factors and

high levels of risk aversion, the business is trading at roughly ten times earnings. Meanwhile,

because the company consciously set its capital at levels sufficiently robust to both protect it from

turmoil and simultaneously support future business initiatives, it has no need to retain future

earnings, which would only add to the over‐capitalization. As part of recently disclosed capital

policy, the company announced that it intends to distribute virtually all future earnings via

dividends and share buybacks. At today’s share price, these distributions should translate to

something in the neighborhood of a 10% ‘yield’, which has a reasonable probability of growth.

Vard Holdings Ltd

We also initiated a position in Vard Holdings Ltd (Vard), a Norway‐based builder of high‐end

support vessels used in the offshore oil and gas industry, whose share price has reached very

attractive price levels of late due to a complex recent corporate history, but more on that in a

minute. The company operates ten shipyards worldwide and focuses on the design and

construction of highly advanced vessels customized for service in some of the world’s most

challenging operating environments, such as the North Sea. While the name Vard will be

unfamiliar to most, some long‐time readers of our letters might recall our ownership of a number

of oil service companies in the past. In fact, the industry environment in which we purchased

several companies to great success roughly ten years ago has much in common with the

environment today. One such previous Fund holding was Aker Kvaerner, a position initiated in



24

2004. Vard was formerly part of a business called Aker Yards, which was a sister company of Aker

Kvaerner, both controlled by the same Norwegian conglomerate, Aker ASA.

In more recent years, the Aker Yards business has traded hands several times ‐ twice since 2007.

Having restructured Aker Yards in the early 2000s, Aker ASA sold Aker Yards to STX of Korea in

2007. STX was eager to purchase its way into some of the most sophisticated areas of shipbuilding.

STX subsequently fell on very hard times and chose to separate and list the healthiest part of this

business, the offshore service vessel building business. In the initial public offering STX named the

business STX OSV and listed it in Singapore. Life for STX did not get any easier and the company

finally crumbled under a mountain of debt. In the process of trying to extricate itself from the debt

load, it was forced to sell its remaining stake in STX OSV to Fincantieri, a two‐hundred year old

Italian shipbuilder who naturally preferred to move on from the STX moniker. Thus, the business

was again renamed in April of 2013, this time Vard. Notwithstanding the inordinate amount of

corporate activity, changes of control and name changes, Vard’s management team, who date

back to the Aker days and earlier, has been very stable and continues to manage the business

sensibly within the niche of high‐end offshore service vessels that the company has come to

dominate.

Today, we believe we are paying a very modest mid‐single digit multiple of normalized operating

cash flow for Vard and that the development of the company’s order book is both supportive of

our sense of the quality of the business and its ability to generate attractive shareholder returns.

The combination of the quality of the business and the inexpensive price make for quite an

appealing opportunity. During the last couple of years, more muted order flows and accounting

write‐downs resulting from the restructuring of its troubled Brazilian yard had served to mask a

very healthy business. We suspect that the long‐term value of Vard was recognized by Fincantieri

in its decision to purchase a controlling interest. We also suspect Fincantieri would like to own the

entirety of Vard. Fincantieri has already made one attempt to buyout the shares they do not

already own. We would not be surprised if they try again. Depressed accounting earnings

combined with two changes of control, two name changes and a Singapore listing ill‐suited for a

Norwegian shipbuilder have all cooperated to create an attractive opportunity.

Santos Brasil Participacoes SA

Our third newly initiated position during the quarter was Santos Brasil Participacoes SA (Santos

Brasil), which arose primarily from our research conducted in Brazil earlier this year. In addition to

a variety of business factors below, the opportunity also arises from a fairly bleak macroeconomic

picture in Brazil. Santos Brasil is the operator of three container terminals in Brazil. The company’s

primary asset, Tecon Santos, is the largest container terminal in the Port of Santos. The Port of

Santos is the largest container port in Brazil, which is intuitive given that it services the state of Sao

Paulo (including the city of Sao Paulo), which represents roughly half of Brazilian GDP. Tecon

Santos itself handles 21% of all Brazilian and 7% of all South American container volumes. We

believe it is safe to assume that Tecon Santos will be a critical piece of Brazilian infrastructure for

many years to come.

However, in addition to waning optimism about the state of the Brazilian economy, several issues

have plagued the company and its shares. First, voting control of the company lies in the hands of

two owners who have not seen eye to eye with regard to the optimal path to value creation.



25

Separately, beginning several years ago, in an effort to create competition in the Port of Santos,

the Brazilian government offered multiple new container terminal concessions to new entrants.

Given the attractiveness of the Port of Santos and equally the opportunity to enter the container

terminal business in a country which is deeply underserved by container handling capacity, it is not

surprising that willing investors materialized. The newly constructed capacity is now operational

and Santos Brasil’s operating results have indeed shown the effects of the predictably eroded

market share. And finally, Santos Brasil has been in a holding pattern with regard to a significant

investment project it wishes to undertake at Tecon Santos until it is granted an extension of its

concession by government agencies. Santos Brasil has a terrific balance sheet and is eager to

deploy the capital when granted approval. All of these issues have created clouds over the

company sufficient that one of the most attractive assets in the entire global container terminal

industry is trading at roughly six time operating cash flow, which is inexpensive in absolute terms

and a huge discount to its global peers, many of which operate less desirable assets.

Having visited Tecon Santos, its competing terminals, company management and management of

competing operators, the value of the asset was glaring to us but we remained concerned by the

imponderable of how the shareholder dispute would be resolved. In April of this year, the two

controlling shareholder groups publically agreed to set aside their differences and move towards

eliminating Santos Brasil’s multiple share class structure. A single class of shares is a prerequisite

for a listing on Novo Mercado, a Bovespa classification which requires the highest level of

corporate governance. The company has announced its intention to move to Novo Mercado.

Separately, we believe that the end of the shareholder dispute improves the probabilities of a

renewal of the Tecon Santos concession. Our sense that this is a high probability event is also

supported by our conversations with the regulatory bodies themselves.

While our investment in Santos Brasil is a somewhat complicated one, we believe that each of the

major issues surrounding the company is simultaneously moving in a desirable direction. As

certainty develops, we expect that the critical nature of the asset and its lowly valuation will then

become investors’ focus and it will become apparent that this highly attractive asset is trading at

cheap prices in absolute terms let alone relative to non‐Brazilian assets of this quality which are

valued at a massive premium to Santos Brasil.

Positions Exited During the QuarterNetia SA

The larger of our two dispositions during the quarter was Netia S.A., a Polish telecommunications

company. This disposition closes the books on what has been one of the Fund’s largest positions

for some time. I will attempt to summarize an eight year investment as succinctly as possible. Our

initial investment thesis, dating back to 2006, was essentially two‐fold. First, it seemed apparent

then that the business could be run with a much more profit‐minded approach as opposed to its

singular fixation on growth. Second, any reasonable estimate of the replacement cost the

company’s underlying asset base, which is primarily comprised of a very valuable Polish fixed‐line

fiber network, was well in excess of the value at which the company was trading in public markets.

Because of the public market’s undervaluation of the assets and our belief that the assets could be

made to produce much higher financial returns, we believed the company would likely be

purchased by any number of industry or financial buyers.



26

Roughly two years into our Netia investment the financial crisis took hold and devastated the then

largest shareholder of Netia. He was heavily indebted to say the least. In a rapid effort to pay down

debt, this distressed seller sold his entire stake in Netia in the midst of the crisis at prices much

lower than we had initially paid. We added materially to our position which had multiple

implications. Our average cost was lowered considerably and virtually overnight we became one of

Netia’s largest shareholders. This put us in a position to participate in the reconstruction of Netia’s

board of directors and help facilitate the transition to a focus on profit. I would characterize this

effort as successful. Margins and free cash flow improved markedly as a result of the change in

strategy. With regard to the second leg of the thesis (i.e., the takeover of Netia), we were

frequently encouraged by a rapidly consolidating industry and were occasionally party to

conversations covering various transaction possibilities. The recurring deal discussions continued

to provide us with a level of confidence that a change of control was likely to eventuate. Today,

Netia continues to operate in a very difficult environment and maintaining its level of profit and

cash flow has increasingly become a challenge. Rather than continue to await a transaction with

imponderable timing while operating performance continues to deteriorate, we chose to avail

ourselves of an opportunity to sell our entire stake, representing 12.7% of the company, at a

decent price. The entire experience netted the fund an IRR of slightly more than 5%, which is a bit

better than the Fund’s performance during that time period.

LG Corp

We also exited our position in LG Corp, which was initiated in May 2007. At the outset, we were

excited by the valuations to which LG Corp’s underlying operating businesses had fallen (many of

them are publically traded), the additional discount to net asset value (NAV) offered through the

holding company, LG Corp, and by the significant simplification of the holding company structure

that was taking place. As I look back on our LG Corp investment, I would conclude that our analysis

on each of these fronts was quite good and that the value drivers of the investment generally

developed as expected. Further, LG Corp common stock has historically been fairly volatile, which

can provide long‐term focused investors like us with wonderful opportunities to buy and sell when

price becomes sufficiently disjointed from actual business value. In the case of LG Corp, we

initiated the position in 2007 but bought and sold it during our holding period more than is typical

for us, owing to these periodic large dislocations of price and value. Having reduced the position

size over time, we chose to exit completely as we have found a number of exciting new investment

opportunities. In conclusion, the combination of our focus on price, a good sense of the

developments that would transpire at the corporate level and an opportunistic approach to buying

and selling the position during the holding period combined to produce a pleasing IRR of roughly

11% over the holding period, materially better than the average Fund holding during that time

period.

I would like to thank you for your continued support of the Fund and look forward to writing to

you next quarter.

Sincerely,

Matthew Fine, Lead Portfolio Manager

Third Avenue International Value Fund



27

Focused Credit FundPortfo l io Manager Commentary

TH I RD AVENUE

JU L Y 3 1 , 2 0 1 4

Dear Fellow Shareholders:

Sailing on Shenandoah

Third Avenue Focused Credit Team

Tom Lapointe, CFALead Portfolio Manager

Joseph ZalewskiPortfolio Manager

Nathaniel KirkPortfolio Manager

Edwin Tai, CFAPortfolio Manager

Brian LennonRestructuring Attorney

Andrew PelisekResearch Analyst

Casey SavageResearch Analyst

Robert ShermanTrader

The Shenandoah, my uncle’s 158 foot topsail schooner, has been braving the waters off the coast of Martha’s Vineyard for the last fifty years. Her hull form and rig, anchors, and all materials of construction adhere closely to mid‐19th century practices… she even carries cannons.

A few weeks ago I boarded the Shenandoah with my uncle (the Captain), my kids, thirty

summer campers between eleven and thirteen years old, a crew of six college students and

the same sense of adventure that I had the first time I sailed this ship. And I’ve been sailing

on Shenandoah every summer for as long as I can remember. The plan for the week was

simple: sail off Martha’s Vineyard to Nantucket, Cape Cod, and surroundings. The onboard

experience is unique; the vessel has no auxiliary power, no running water and no wifi. By

the end of the week all the kids onboard learned how to handle the ropes of the boat; there

was no other option. They learned to lift the two ton canvas sails (together), to put coal on

the stove to cook, and many other tasks that are ultimately lessons in teamwork,

persistence, and other important skills. Hopefully they can translate some of these lessons

to their lives. A learning experience for all, and a lot of time to reflect…

Jumping in the Water Watching my kids and the thirty campers contemplate the seemingly small decision of

jumping off a boat and into the ocean is an interesting lesson in human psychology. The

time needed from standing on the edge to actually jumping in the water for the first time

can range between a few fleeting seconds to a full, tedious, half hour. Many thoughts are

going through their heads as they contemplate the decision, giving them pause. A ten foot

jump or dive or cannonball off the boat and into the dark green water, might bring up the

most terrifying images to mind; tiburones (sharks), jelly fish, freezing water temperatures

and other unknowns. All these fears are offset by the pleasures of cooling off in the 90

degree weather, laughing with friends, and avoiding the embarrassment of being the only

one left on the boat.

Portfolio holdings are subject to change without notice. The following is a list of Third Avenue Focused Credit Fund’s 10 largest issuers, and the percentage of the total net assets each represented, as of July 31, 2014:

Lehman Brothers Inc, 4.77%; Clear Channel Communications Inc, 4.67%; Affinion Group Inc, 4.14%; Altegrity Inc, 3.55%; The Sun Products Corp, 3.26%; Energy Future Intermediate Holding Co Llc, 3.24%; Reichhold Industries Inc, 2.29%; New Enterprise Stone & Lime Co Inc, 2.24%; Global Geophysical Services Inc, 2.23%; Western Express Inc, 2.05%


28

Focused Credit Fund

I’m convinced that our personality and how we deal with change and the uncertainty generated by

our fears and desires is, for the most part, fully developed by the time we exit high school. The

events and choices we all face through our lives will be different, but we have already crafted and

honed our skills in the playgrounds of our childhood.

No one wants to be the first one to jump into the water. They all wait. Then, when one tries it,

another one will go and then another one, until they are all in the water. Somehow they believe

there is safety in numbers, even though the risks, as big or as small as they might be, are still there.

Somehow they all get comfortable with the idea of a shark showing up as well as with the cold

water temperatures, as long as we are all in it together. In fact, the kids stay in the water until they

are forced to come out, not by the things they originally feared, but rather by the lunch bell or an

‘all hands on deck’ call to raise the sails. This story falls under the category of what we’d call ‘mini‘

formative experiences. We bring it up because it helps form our belief of where we are in the

present market cycle.

Today investors are mostly all in the water. Investors have now been ’swimming around‘ for a few

years; enjoying rewards in the form of double digit returns in equity, high yield, and even bond

markets. Investors across the globe have grown accustomed to the low interest rate environment.

They seem quite comfortable with the elevated multiples in equity markets. However, the list of

things that kept them on the sidelines in 2008 and continued to scare them over the past few

years is long. High debt levels in the U.S., unemployment, a double dip recession, Chinese

economic growth (or lack thereof), rising interest rates, are just a few… You all know the list. The

list is much longer than the one that kept the kids out of the water! Yet again, we see that

somehow there is safety in numbers.

Fear is still in the back of investors’ minds and continues to be a ubiquitous topic of discussion…

And on the margin, investors do things they think might protect them and their portfolios should

any of these fears materialize. Many investors have bought short duration funds or floating rate

funds. They have also bought go anywhere funds that promise to ‘go where you can make money

and avoid the obvious losers.’ They have invested in hedge funds or long/ short funds and may

even be sitting on extra cash. But for all the attempts to hedge the downside, investors are mostly

all in.

It hasn’t been such a bad ride, after all we are entering the fifth year of a bull market. Thus, the

one question on everyone's mind: when should I get out of the water? Or, at least, when should I

be heading towards the shallow end so I can get out before others? Everyone is worried about

liquidity, and rightly so, not just in the summer doldrums months.

Shifting Tide. We have started to see a turn in the flows into high yield and floating rate funds, the

hottest asset classes in the past three years.1 High valuations, low liquidity and shifting investor

sentiment as a result of a seemingly inevitable rise in rates can be a powerful combination. We’ve

heard broad overarching statements about the performance and liquidity of fixed income in this

environment. In our view these statements that treat all fixed income segments equally obscure

what may ultimately be the most relevant information for investors. In this letter we focus on

some of these fundamental distinctions. Different segments of the fixed income market react1 Net outflows from High Yield ETFs in July 2014 were $3.1 billion, while the annual net inflows over the last three years (2011, 2012 and 2013) have been $6.8, $9.5 and $3.3 billion, respectively. Net outflows from Bank Loan ETFs in July was $134 million; while annual net inflows over the last three years for available data (since March 2011) has been $152 million, $1.3 billion and $5.7 billion. All data from Morningstar.


29

Focused Credit Fund

differently to a rise in interest rates. Low duration and high yield fixed income securities (such as

our Fund) can better absorb a rise in rates. In fact, two thirds of our Fund should be relatively

uncorrelated to interest rates. Likewise, high yield and distressed investing are not a synonym

for illiquidity. Many link the two terms together but they are not necessarily related. Liquidity

hinges (among other things) on the size of the issue and we are very mindful of the Fund’s

liquidity as we choose investments for the Fund.

Rates Will Rise The U.S. economy is growing. GDP numbers for the second quarter of the year have been solid

at 4%. First quarter numbers were revised upward from ‐2.9% to ‐2.1%. The economy grew by

1.8% during the first half of the year. In 2015 and 2016, the median estimate among eighty four

economists is that U.S. GDP will grow by 3%.2 In light of these auspicious numbers, and as

expressed on several occasions, the U.S. Federal Reserve is prepared to take its foot off the gas

this fall. This is a good sign. Voting members are saying Fed Funds rate (the overnight rate)

should be higher, at 4%. The average overnight targeted rate since 1971 was 5.6%, including the

last five years where it was set at 0%. Econ 101 tells us that in an expanding economy, the yield

curve tends to be upward sloping. There is little doubt that if the Fed Funds rate climbs to 4% or

5% (almost twice the current 10 year U.S. Treasury rate of 2.5%), longer term rates will be

higher.

The backdrop of an eventual rise in interest rates and its impact over financial assets is one of

the fears haunting investors today. Although rates have been falling globally so far this year (the

yield on the high quality 10 year Treasuries dropped from 3% to 2.4% and even Portugal has

moved from 6% to 3%), near zero interest rates in developed countries, coupled with the Fed’s

announced changes to monetary policy make a hike in rates almost certain going forward.

The first thing to consider in a rising rates environment is that not all fixed income will react in

the same way. We expect high duration assets to give back years of returns should rates rise by

200 to 300 basis points. Exhibit 1 below compares returns across different fixed income assets

during last summer’s ’taper tantrum‘ episode and compares it to the decrease in rates

environment during 2014. During the ‘taper tantrum’ the U.S. 10 year Treasury yield rose by

about 100 basis points, from 1.63% to 2.57%, and credit spreads widened another 100 basis

points. So far in 2014 the U.S. Treasury yield dropped 60 basis points, from 3.0% to 2.4%. The

reaction across different assets within fixed income varied substantially.

This is not surprising; higher quality assets with longer duration underperformed as rates rose,

just as they are outperforming now as rates fall. The Focused Credit Fund (Fund) suffered

smaller losses than most of the fixed income benchmarks on the following chart during the last

summer and outperformed all of them during the year to date period.

2 Estimates from Bloomberg survey on the U.S. economy, August 27, 2014.


30

Exhibit 2 provides an illustrative example of how the mathematics of bond duration and yield

would affect how different securities absorb rate increases. We analyze three hypothetical

scenarios: a rise of 100, 200 and 300 basis points in rates, for different securities. The numbers

show that a rate change has a larger impact on price the greater the duration of the security,

assuming that pricing only moves in relation to the rate change. In addition, the analysis suggests

that higher yield helps mitigate the effect of a rate rise. Thus, the J.P. Morgan High Yield Index,

which has the lowest duration and highest yield, would generally experience the smallest effect of

rate increase on price. Our calculations are consistent with the fact that ‘junk’ bonds have

historically been less sensitive to interest‐rate swings than Treasuries or high‐grade corporate

debt. The logic behind the result is that prices of high yield securities are more closely linked to

the credit quality of individual issuers (although macro factors affecting interest rates, and vice

versa, can have significant effects on high yield bond pricing and default rates).

‐10%

‐5%

0%

5%

10%

10‐yr Tsy Barclays Agg HY BB B CCC Loans TFCIX HFRI Event Driven:Distressed/Restructuring

Index

May 1 to June 25, 2013

January 1 to July 31, 2014

Exhibit 1: Returns across fixed income in rising and falling interest rate environments

Source: Bloomberg, HFRI and Third Avenue Management for Fund data. Notes: We define the ‘taper tantrum’ period between May 1to June 25, 2013 as this captures a rise in 100bps in interest rates which allows us to evaluate the effect of duration on price; the year to date period was defined as the most recent period in which we’ve seen a fall in interest rates. 10 year U.S. Government Treasury Notes (10‐yr Tsy) are a debt obligation issued by the United States government that matures in 10 years. The Barclays U.S. Aggregate Bond Index (Barclays Agg) is a broad‐based flagship benchmark that measures the investment grade, US dollar‐denominated bonds. The J.P. Morgan Institutional High‐Yield Index is designed to mirror the investable universe of the U.S. dollar domestic high yield corporate bond market, excluding the most aggressively rated bonds and those trading at distressed levels. J.P. Morgan BB, B, CCC and High Yield Indexes are designed to mirror the investable universe of the U.S. dollar domestic BB, B, CCC and High Yield corporate debt markets, respectively. The HFRI Event Driven: Distressed/Restructuring Index (Distressed) is composed of strategies which employ an investment process focused on corporate fixed income instruments, primarily on corporate credit instruments of companies trading at significant discounts to their value at issuance or obliged (par value) at maturity as a result of either formal bankruptcy proceeding or financial market perception of near term proceedings.

Exhibit 2: Interest Rates and Returns

Duration Price RatePrice if…

+ 100bp + 200bp + 300bp

JPM High Yield 3/2/2019 3.7 105.0 5.71% 101.2 97.3 93.5

% change ‐4% ‐7% ‐11%

Barclays Aggregate 12/11/2022 6.5 108.3 1.75% 101.3 94.3 87.3

% change ‐6% ‐13% ‐19%

5 Year Treasury 1⅝ 07/31/19 4.8 99.3 1.77% 94.7 90.3 86.2

% change ‐5% ‐9% ‐13%

10 Year Treasury 2½ 05/15/24 8.7 99.5 2.55% 91.4 83.9 77.2

% change ‐8% ‐16% ‐22%

30 Year Treasury 3⅜ 05/15/44 19.0 101.2 3.31% 84.4 71.2 60.8

% change ‐17% ‐30% ‐40%

Source: Data from Bloomberg. As of July 31, 2014 Bloomberg stated maturity of 8.3 years implies 12/11/22 maturity date for Barclays Aggand JPM High Yield Index is 4.5 years to YTW date. Price change calculations for Treasuries from Bloomberg. Price calculations for J.P. Morgan High Yield Index and Barclays Agg by Third Avenue Management using a simplifying assumption where duration is calculated linearly, not incorporating convexity. The formula used to calculate the price impact of a change in rates is: price*(1‐(% change in rates*(duration/100)). The J.P. Morgan U.S. High Yield Index (High Yield) is designed to mirror the investable universe of the U.S. high yield corporate debt market. The Barclays U.S. Aggregate Bond Index (Barclays Aggregate) is a broad‐based flagship benchmark that measures the investment grade, US dollar‐denominated bonds. U.S. Government Treasury Notes (5yr, 10yr and 30yr) are debt obligations issued by the United States government that mature in 5, 10 and 30 years, respectively.

Focused Credit Fund


31

Focused Credit Fund

The returns in the exhibit above assume an immediate shift in rates. In reality the shift in rates

would occur over time. Thus, as interest rates rise coupons will be paid (coupons currently are

2.5%, 3.3% and 6.5% for the 10 year Treasury, the Barclays Agg and JPM High Yield, respectively);3

and spreads will compress, as they typically do in these market environments. Both the coupon

and the spread compression are tailwinds for high yield, further enhancing the performance of

high yield relative to the other segments of the fixed income market . Assuming again, that these

changes are not accompanied by market dislocations like we have seen before.

While other factors also affect the performance of below investment grade securities, higher yield

and low duration are generally the most important ones in a rising rates environment. Thus, the

yield offered by lower rated stressed and distressed securities appears more attractive in these

environments, assuming that default rates do not change materially or that market sentiment feels

that it must flee to safety.

Most high yield funds, and possibly even most loan funds, have 90% of their holdings with

moderate to meaningful interest rate risk. A high yield fund with a portfolio that yields only 5% will

still lose money in the quite likely scenario of a 2% increase in interest rates in the 5 to 10 year part

of the curve, all else equal. The Focused Credit Fund’s current positioning is such that interest rate

risk is much less important than default risk. The Fund has the benefit of having a low portfolio

duration (1.9 years or almost half the duration of the J.P. Morgan High Yield Index) with a high

dividend payout and SEC yield of 8.71% as of July 31, 2014.4 This helps cushion returns when rates

rise and should provide extra return when they fall, as seen in Exhibit 1.

Why We Are DifferentTwo thirds of the portfolio should be relatively uncorrelated with rising interest rates.5 The Fund

deploys capital opportunistically and across the risk spectrum. Thus, the portfolio is typically a

combination of opportunities in:

o Performing Bonds and Loans

o Stressed Performing Credits

o Capital Infusions

o Distressed6

o Debt for Equity

As of July 31, 2014, the portfolio is composed as follows: 12% cash, 36% special situations

(including names that we have discussed previously, such as Altegrity, Affinion, Lehman and TXU),

17% stressed (including Vertellus and First Data discussed later in the letter), all of which are

almost totally uncorrelated with rising rates. The remaining 35% of the portfolio is in performing

bonds and loans. All of the of top 10 holdings (34% of the portfolio) are under the category of

what we would say makes the fund ’different’.

While the businesses we invest in may benefit from low rates, our investment process favors

opportunities where the ’issue‘ is not about refinancing at a lower rate. The companies we3 Data from Bloomberg as of July 31, 2014.4 SEC yield above is for the Institutional Class. SEC yield for the Investor class is 8.48%. 5 This is the allocation of the portfolio to cash, and stressed and special situations securities. Stressed securities are securities that are more senior in the debt capital structure of companies that have a higher level of uncertainty. Special Situations are issuers that we believe may experience a corporate event, such as (1) a restructuring, recapitalization, or liquidation, (2) capital infusions, or (3) issuers whose securities trade at a spread of greater than or equal to 1000 bps above corresponding Treasuries.6 Distressed securities implies a higher probability of default and where we believe the issuer may experience a corporate event such as arestructuring, recapitalization or liquidation.


32

typically invest in are what we believe are good businesses with high quality assets, but

(temporarily) weak balance sheets. We look for companies and industries undergoing structural

turmoil or change due to multiple factors. We tend to invest in ’complicated‘ situations that

involve untangling difficult balance sheets. We like companies and industries going through

cyclical down turns or adverse product pricing or cost of goods sold. We also take advantage of

opportunities presented by regulatory changes, CLOs/rules‐based investors, and forced economic

sellers (sellers who cannot hold underperforming debt, are unwilling to restructure, or prefer

coupon‐paying securities).

To be sure, we have real risks. The Fund is very concentrated. We typically hold credits in

approximately seventy issuers and many have significant credit risk. We recognize that there is a

variety of factors driving the Fund’s performance. We would expect the current portfolio to

underperform if the economy re‐entered a recession or goes through a prolonged period where

capital markets are shut down or where equity markets decline 20% to 30%. Our portfolio

construction process takes both credit and interest rate risk in consideration. We believe the

current portfolio mitigates exposure to interest rate risk, assuming that a rising interest rate

environment does not accompany or cause a change in default rates.

Clearing Up a Misunderstanding: Distressed ≠ I l l iquidWe often hear about the high yield market and the loan market being less liquid than other higher

quality asset classes within fixed income. And it goes to reason that if you invest in the lower

quality part of the high yield and loan market you should expect even less liquidity. However,

while intuitive, this is not necessarily true. In fact, some of the Fund’s most distressed investments

are among the most liquid. Caesars, TXU and Lehman are almost 10% of the portfolio and are

some of the most liquid and actively traded bonds and loans in the market. The reason is size.

These credits have very large amounts of debt outstanding and that debt is held by large numbers

of investors.

Liquidity is mostly a function of the amount of debt outstanding, how many people own the debt

and ultimately the price at which you are trying to buy or sell. An investment grade Corporate or

Municipal bond that has $200 to $500 million debt outstanding owned by only a handful of

investors is likely to trade at a discount because of its illiquidity. The same is true in the high yield

and bank loan space. As a regulated mutual fund, we have a limit on securities we deem to be

illiquid of 15% of the portfolio. We generally try to avoid illiquid securities or will require a higher

expected IRR before investing. We pass on or sell out of many investments because they are

illiquid; our returns would likely be higher had we been able to buy more of these opportunities.

Not all of our distressed investments are in issuers with large outstanding debt. In fact, we do find

interesting opportunities in smaller issuers but seek to balance the expected return with the

liquidity constraints that arise due to size. One way in which we resolve this tradeoff is by

managing position size; we allocate less weight to opportunities where the issue is not sufficiently

large. Almost all of our portfolio (85% of the total market value of the portfolio as of July 31, 2014)

is independently priced every day by IDC (one of the two major pricing services most mutual funds

Focused Credit Fund


33

Focused Credit Fund

funds use) and so we believe that our net asset value reflects the reality of where we could sell the

securities in the market every day, absent some major dislocation in the market.

We’ve also been hearing that the dealers are not taking risk anymore, especially after 2008/9 and

since the implementation of the Volcker Rule. We hear that there is little trading. While it is true

that in relative terms there is less liquidity in the markets today than five years ago, this doesn’t

mean that liquidity has dried up. There is still $6 to $8 billion in high yield bonds trading every

day.7 The markets we invest in are large and growing, more than $3 trillion globally. While we

carefully manage the liquidity in the Fund we also view liquidity as an opportunity. We have often

used the Fund’s cash opportunistically; when a large seller emerges and needs to sell $25 to $50

million of a troubled company we can often provide that liquidity and purchase securities at

attractive discounts.

While we were not immune from the most recent July/ August round of heavy mutual fund out

flows, we believe that the level of outflows from our Fund was somewhat mitigated, primarily we

believe due to the quality of our investor base. They are not the ETF type, looking to make a ‘quick

buck’ or in for a trade. Investors in our Fund have done their homework and hopefully would be

investing, not selling, if markets moved lower. But of course it is everyone’s right to ask for their

money any day they want; most do not, but it is nice to have the option.

We also take a number of precautions that enable us to mitigate the negative impact of outflows

on the portfolio. First, we consider 5% cash to be a ‘fully invested‘ and often hold higher levels of

cash which allows us to deploy capital when opportunities arise or meet redemption needs

without being a forced seller. On average, over the last three years we have had more than 10%

cash. Second, a small credit line that amounts to 3% of the Fund is available. We have never used

this credit line. We are not planning to use this credit line but having it readily available helps to

mitigate liquidity risk. Third, our team has extensive experience managing portfolios through

different market cycles and has been able to raise cash effectively and without major disruptions

to the portfolio at different points in these cycles. Fourth, we believe that we will be able to raise

cash if necessary in most market environments. As stated above, we typically have approximately

seventy issuers in the portfolio with different levels of liquidity, and we generally believe we can

sell small pieces of the vast majority of these names quickly and with minimal price ramifications.

Some of this diversification comes in handy to some extent in periods of market stress. This is the

way in which we typically handle flows into the Fund as well (i.e., buying and selling smaller lots of

our existing positions). Our final level of comfort is our investor base, formed by sophisticated

investors that have a good understanding of the strategy and how to utilize it within their asset

allocation.

7 Data provided by Trade Reporting and Compliance Engine (TRACE).


34

Fund PerformanceFor the year‐to‐date period ending our third fiscal quarter, July 31, 2014, the Third Avenue

Focused Credit Fund returned 10.9%,8 versus 3.5% for Morningstar’s High Yield Bond Category9

average, 4.4% for the JPM US High Yield index and 1.9% for Morningstar’s Bank Loan Category10

average. The S&P 500 Index returned 5.7% for the period. The strong rally in Treasuries resulted

in higher quality bonds outperforming lower quality bonds. Investment grade bonds returned

5.7% (JPM Investment Grade), BB bonds returned 4.8%, B returned 4.0% and CCC returned 3.7%.

While the Fund does not have much exposure to the high quality securities that have benefitted

from the rally in Treasuries, performance year to date continues to be positive. The Fund

continues to outperform its benchmark and most segments of the fixed income market, as

depicted in Exhibit 3 below. Note as well that the Fund has handily outperformed other segments

of the fixed income market over the three year period.

8 The Fund’s one‐year and since inception (August 31, 2009) average annual returns for the period ended July 31, 2014 were 17.83% and 12.44%, respectively. Third Avenue Focused Credit Fund is offered by prospectus only. The prospectus contains more complete information on advisory fees, distribution charges, and other expenses and should be read carefully before investing or sending money. Past performance is no guarantee of future results. Investment return and principal value will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than original cost. The Fund’s returns should be viewed in light of its investment policy and objectives and quality of its portfolio securities and the periods selected. M.J. Whitman LLC Distributor. If you should have any questions, or for updated information (including performance data current to the most recent month‐end) or a copy of our prospectus, please call 1‐800‐443‐1021 or go to our web site at www.thirdave.com. Current performance may be lower or higher than performance quoted. 9 Average year‐to‐date return of the 720 funds included in the Morningstar High Yield Bond Category, for the period ended July 31, 2014.10 Average year‐to‐date return of the 240 funds included in the Morningstar Bank Loan Category, for the period ended July 31, 2014.

Exhibit 3: Year to Date, 3 Year Annualized and Cumulative Return as of July 31, 2014

11.58%9.78%

32.92%

28.84% 28.84%

34.47%

17.85%

39.88%

24.99%

0%

5%

10%

15%

20%

25%

30%

35%

40%

10‐yr Tsy Barclays Agg HY BB B CCC Loans TFCIX HFRI Distressed &Event Driven

YTD 7/30/14 3‐Yr (Annualized) 3 yr Cumulative Return

Source: Bloomberg and Third Avenue Management for Fund data. Notes: 10 year U.S. Government Treasury Notes (10‐yr Tsy) are a debt obligation issued by the United States government that matures in 10 years. The Barclays U.S. Aggregate Bond Index (Barclays Agg) is a broad‐based flagship benchmark that measures the investment grade, US dollar‐denominated bonds. The J.P. Morgan Institutional High‐Yield Index is designed to mirror the investable universe of the US‐dollar domestic high yield corporate bond market, excluding the most aggressively rated bonds and those trading at distressed levels. J.P. Morgan BB, B, CCC and High Yield Indexes are designed to mirror the investable universe of the U.S. dollar domestic BB, B, CCC and High Yield corporate debt markets, respectively. The HFRI Event Driven: Distressed/Restructuring Index (Distressed) is composed of strategies which employ an investment process focused on corporate fixed income instruments, primarily on corporate credit instruments of companies trading at significant discounts to their value at issuance or obliged (par value) at maturity as a result of either formal bankruptcy proceeding or financial market perception of near term proceedings.

Focused Credit Fund


35

Focused Credit Fund

Some MistakesLehman SIPA claims

Lehman SIPA (LBI) claims are among the top 10 holdings in the Fund, with a 4.8% weight. While

LBI had a few positive developments and was a solid contributor to performance during the

quarter, the big news happened after quarter end. We discuss each event in turn. First, LBI

reached a settlement with its Hong Kong and Singapore affiliates and will receive over $300 million

of additional assets, which will improve ultimate recoveries by 1 to 1.5 points. Second, LBI

received Bankruptcy Court approval to begin making periodic distributions to unsecured claim

holders. The Fund expects its first distribution to be in early September, which could be as large as

a quarter of the position. Due to the return of cash and enhanced downside protection, the Fund

increased its position in LBI in the quarter.

As you may recall, Lehman was sold to Barclays in a rushed sale over the weekend of September

15, 2008. Documentation and the sales contract were not clear and in certain situations

contradicted each other. Our original thesis on the LBI investment was based on the estate having

$0.40 to $0.42 cents of cash and a cheap option on the litigation with Barclays for disputed assets

from the rushed sale in bankruptcy. If LBI lost its litigation with Barclays for $7 billion of disputed

assets, we estimated our maximum downside was 5% to 10%. If LBI was awarded just $2.3 billion

of the $7 billion from the litigation, which was the original bankruptcy court ruling, LBI had 50%

upside, in our opinion. Thus, we estimated the likelihood of the Barclays litigation resulting in a

negative outcome for our investment at less than 20%. Based on our analysis, our probability of

winning was much higher than 20% but slightly lower than 50%. Thus we purchased LBI claims

with an average cost of $0.44. It subsequently traded up to as high as $0.47 this quarter in

anticipation of a ruling.

After quarter end, the Court of Appeals for the Second Circuit ruled against the LBI Trustee and

awarded all $7 billion to Barclays. We are disappointed with the ruling and the fact that the

Appellate Judges ignored key pieces of information that aided the bankruptcy court’s initial

decision in favor of LBI. Our LBI claim has traded down to the $0.42 range. However, our

expectation is that LBI will ultimately recover $0.44‐$0.46 in a year, which is breakeven to slightly

above our cost basis. We expect to reduce the position as it starts trading towards our ultimate

recovery estimates over the next several months.

We underwrote LBI as an investment with limited downside and very attractive upside potential.

Unfortunately, the limited downside part came true and the cheap option for 50% upside expired.

No situation is certain, each has its unique risks, and individual catalysts may or may not play out.

Nonetheless, a portfolio of well underwritten investments will do very well over time and have

limited correlation to the markets. Going forward, if we see a new situation that has similar

downside and upside potential and probabilities as LBI, we will invest again. Hopefully the

attractive upside potential will play out.

Altegrity

Altegrity is among the top ten holdings in the Fund, with a 4.1% weight. The company recently

went through an out of court capital structure reorganization process but it is still struggling to

date.


36

Altegrity is a global, diversified risk and information services company serving commercial

customers and government entities. The company includes three major business segments and

operates via three main subsidiaries. Kroll offers corporate background checks and advisory,

information security, e‐discovery, loan verification services. HireRight specializes in technology‐

enabled employment background screening, drug and health screening and employment eligibility

checks. Finally, USIS is the leading provider of security clearance and background investigations to

the U.S. government. Providence Asset Management LLC has nearly $800 million invested in the

company. This is one of the largest equity investments for the $40 billion asset management firm.

In its current form Altegrity represents $2.4 billion in transactions. USIS was bought in 2007 for

$1.5 billion, HireRight was bought for $250 million in 2008, and Kroll for $1.2 billion in 2010.

Explore Information Services was sold for about $520 million in 2011. At today’s prices these

assets are valued in $1.5 billion.

There has been plenty of headline risk. Operations and cash flow are the weakest in recent history.

The government has cut and is scrutinizing what it is paying many service providers from

healthcare to education, and USIS is no exception. As a result, profitability has been cut in half.

Still, USIS has maintained its leadership position with a 50% market share and more recently won a

long term $200 million contract with the government, over a competitor who is currently

contesting the outcome. And given concerns about security, and issues like Edward Snowden (a

USIS search), we believe the need is for more, not less, background checks. Kroll earnings have

also suffered for the last two years, but we believe the areas where the company has recently

focused its hiring efforts (Cyber Security & Financial Investigations and Global Corporate

Compliance) will bear fruit in the next couple years.

Finally, the entire capital structure was due in 2015 ($1.5 billion of debt), a significant overhang.

As one of the three largest holders of the Senior notes, we worked with other debt holders,

including Providence equity, and the company’s financial advisors (Goldman Sachs and Evercore)

to put in motion and complete the transaction that allowed Altegrity to push its maturities to

2019, while providing Senior note holders a coupon bump of 200 to 250 basis points. We believe

this temporal flexibility will allow the company to work through transient problems.

In early August, the U.S. government announced that it temporarily suspended much of its work

with USIS when the firm discovered that it was the victim of a cyber‐attack. We take some

comfort in the fact that the cyber‐attack was known dating back to mid‐June, concurrent with the

sponsor’s decision to make a significant capital addition into the company, and before the lawyers

signed the documents to close the transaction on July 1.

As of writing this letter, our debt trades at $78 (20% yield), below our cost, hence our thesis has

not played out yet. If the company gets back to where it once was (10% yield), our bonds should

trade up to $115, while collecting a 14% coupon, a 60% total return. Otherwise, we believe we are

in the fulcrum security in the next reorganization.

Nextel International

Nextel is a wireless phone provider domiciled in the U.S. but with the majority of its operations in

Brazil and Mexico. At the time of our investment over one year ago, it looked like the company

had several levers it could pull to avoid a bankruptcy filing, and if not we felt good about being in

Focused Credit Fund


37

Focused Credit Fund

the fulcrum security. Since our initial investment, the company has continued to disappoint and

now will most likely restructure. Nextel is now a small position in the Fund.

Cash flow has been lower than expected due in part to higher than anticipated churn, and lower

average revenue per user. The swift deterioration hurt liquidity, bond prices, and the ability of

banks to market the company in order to keep capricious capital markets open for Nextel. The

company did in fact monetize some of its assets but at undisclosed levels (our read: discounted).

Still, they formed strategic alliances with Telefonica (enterprise value of over $100 billion), and

others showing franchise value. We also made an aggressive investment decision in this case. We

moved out of the secured bonds (11 3/8% notes) into the unsecured and lowest dollar price 7

5/8% notes in the 30s and 40s. At the time we believed that this part of the capital structure

would be the fulcrum, and the best potential return profile. As we write today, we did shed some

of our position, but not enough. The 7 5/8% notes are currently trading in the teens. An added

wrinkle is that even in the same level of security, there are complex legal angles that are playing

out and impacting trading levels. We still would point out that the market is seeing value in the

upper 60s for the 11 3/8% notes.

Some Successes Vertellus Specialties

Vertellus produces and supplies specialty chemical products across a wide variety of markets

(agricultural, industrial, nutrition, personal care, pharmaceutical and medical, polymer and plastic,

sealant and adhesive markets; and coatings, inks, and imaging markets). It offers its products

through distributors to customers in the United States and internationally. Here’s an excerpt from

our discussion about Vertellus in our second quarter 2013 letter. “We started purchasing the only

tradable debt in the capital structure, the 9 3/8% bonds in the high 70’s with a 22% yield. The

bonds were as high as 105 in late 2011. Vertellus is a middle‐market company with about $450

million of debt outstanding. The company got into trouble as new supply of B‐3 came on line in

Asia, depressing prices for one of their key products. We examined the capital structure and dug

deep into their other business, and believed they had the ability to continue to meet their

obligations on the bonds and that in the case we were off on timing or liquidity, there was very

little debt ahead of our bonds and we would love to own this business through a restructuring of

the balance sheet. The situation has improved and is now trading at 93, generating about a 20%

return in the past six months. We are continuing to hold our investment, as we believe it has the

potential for significant additional returns over the next year.”

Recently, on the back of great earnings (EBITDA increased over 30%) the company announced a

comprehensive refinancing. The company is concurrently raising incremental capital for M&A.

Trust has been restored with management as good stewards of capital. Our bonds are steadily bid

above par, and we have collected over nine points of coupon annually. The contrast with Altegrity

is significant. Altegrity’s earnings are still in transition and the company had to pay a higher

coupon to extend its maturity profile. Vertellus has just announced its plan to refinance its debt at

a coupon lower than its current coupon of 9 3/8%. Although this is subject to the market, we

believe the refinancing plan is attractive for the company and investors.


38

First Data Corp

First Data Corp (FDC) was one of our largest holdings during the last 6 to 9 months, and provided

us a 30% IRR in the past year. First Data Corporation provides electronic payments processing to

customers in thirty five countries and offers a variety of processing solutions including credit,

debit, check, and pre‐paid payments, along with value added information, and internet based

services. In the company’s own words: “around the world, every second of every day, First Data

makes payment transactions secure, fast and easy for merchants, financial institutions and their

customers. Whether the choice of payment is by debit or credit card, gift card, check or mobile

phone, online or at the checkout counter, First Data takes every opportunity to go beyond the

transaction”. We love the company’s business model and leading market share, and invested in

the security that would improve the most in value, if its heavily levered capital structure were

fixed. The Fund was invested in the 12.625% and 14.5% notes, weighted to the larger coupon

issue. These notes were issued at 94.5 in the beginning of 2014, and we accumulated most of our

position at these levels.

On June 19, the company announced a transformative deleveraging $3.5 billion capital market

transaction. This went a long way toward fixing the company with over $20 billion of debt on its

balance sheet. The $3.5 billion included $1.5 billion from existing investors and $2.0 billion from

new investors, including a diverse group of pension funds, mutual funds, asset managers and

wealthy individuals. KKR provided approximately $1.2 billion, including $500 million from its 2006

Fund and $700 million from its balance sheet. After closing the transaction, KKR's balance sheet

will have approximately $1.0 billion invested in First Data’s equity, through general partner and

limited partner interests. Liquidity was improved significantly and interest expense will be reduced

by nearly $400 million annually, a significant number in the context of $2.6 billion of earnings.

Looking ForwardWhile the Fund generated almost 11% return year to date through the end of July,11 we have given

back some of that in August as a result of some mistakes and some mark to market losses. Both of

these are to be expected over time as a result of the types of investments and the markets in

which we invest.

The Fund has ranked in the top half of all high yield bond funds for returns from income12 for the

last three calendar years and year to date, and in the top quartile of income for the last two

calendar years and year to date as of July 31, 2014. We are getting paid extra for the credit/

default risk (the probability that the company doesn't pay its coupon) and to some degree

11 The Fund’s one‐year and since inception (August 31, 2009) average annual returns for the period ended July 31, 2014 were 17.83% and 12.44%, respectively. Third Avenue Focused Credit Fund is offered by prospectus only. The prospectus contains more complete information on advisory fees, distribution charges, and other expenses and should be read carefully before investing or sending money. Past performance is no guarantee of future results. Investment return and principal value will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than original cost. The Fund’s returns should be viewed in light of its investment policy and objectives and quality of its portfolio securities and the periods selected. M.J. Whitman LLC Distributor. If you should have any questions, or for updated information (including performance data current to the most recent month‐end) or a copy of our prospectus, please call 1‐800‐443‐1021 or go to our web site at www.thirdave.com. Current performance may be lower or higher than performance quoted. The S&P 500 Index is a widely recognized benchmark of U.S. stock market performance that is dominated by the stocks of large U.S. companies.12 Income return is the portion of the holding period return that is attributed to dividend distributions. This calculation assumes that the investor incurs no transaction fees, pays no taxes at the time of distribution, and reinvests all distributions paid during the period. Data from Morningstar.

Focused Credit Fund


39

Focused Credit Fund

illiquidity premium on some of our smaller investments. We still believe (as we have written for

two to three years) that the US economy is on the mend, and that there will always be

opportunities for investors that are patient and take a contrarian view.

Soon after publishing this letter, on August 30, 2014, the Fund will achieve an important

milestone: our five year anniversary. As we prepare for this event it is inevitable to reflect on this

last five years. We’d like to highlight five features that speak to the success of the Fund:

1) We offer a unique and differentiated product: the Fund has low correlation to its benchmark,

the Barclays Capital U.S. Corporate High Yield Index 13 (53%) and is in the bottom quartile for

correlation versus its peers in the Morningstar U.S. High Yield Bond universe;14

2) We’ve assembled a quality team with vast experience;

3) We participated in over seventy five restructurings in the past five years;

4) The Fund generated top quartile returns for the one and three year periods;15

5) The Fund was awarded the Morningstar five stars rating in its U.S. High Yield Bond universe,16

plus we were also named a 2014 “Rising Star of Mutual Funds” by Institutional Investor.17

We know the past doesn’t predict the future but these are goals we committed to work on as we

launched the Fund and ones which we commit to going forward. And although hard to quantify in

a statistic, one of the achievements we are particularly proud of is building long term relations with

our investors. We thank you, as always, for your trust and your support of the Focused Credit

Fund.

13 The Barclays Capital U.S. Corporate High Yield Index comprises issues that have at least $150 million par value outstanding, a maximum credit rating of Ba1 or BB+ (including defaulted issues) and at least one year to maturity.14 One year daily returns correlations as of July 31, 2014. Data from Morningstar. 15 For the one, three and since inception (August 2009) periods the Fund ranked in the top quartile of Funds out of the 706, 568 and 497 funds included in the Morningstar High Yield category. The ranking is based on average annual returns as of July 31, 2014. Source: Morningstar. 16 For each retail mutual fund with at least a three‐ year history, Morningstar calculates a Morningstar Rating based on a Morningstar Risk‐Adjusted Return measure that accounts for variation in a fund’s monthly performance (including the effects of sales charges, loads, and redemption fees), placing more emphasis on down‐ ward variations and rewarding consistent performance. The top 10% of funds in each category receive five stars, the next 22.5% receive four stars, the next 35% receive three stars, the next 22.5% receive two stars and the bottom 10% receive one star. (Each share class is counted as a fraction of one fund within this scale and rated separately, which may cause slight variations in the distribution percentages.) The Overall Morningstar Rating for a retail mutual fund is derived from a weighted average of the performance figures associated with its three‐, five‐ and ten‐year (if applicable) Morningstar Rating metrics. Third Avenue Real Estate Value Fund was rated against the following numbers of U.S.‐domiciled funds in the Global Real Estate category over the following time periods: 159 funds in the last three years, 134 funds in the last five years, and 26 funds in the last ten years. With respect to these Global Real Estate funds, Third Avenue Real Estate Value Fund received a Morningstar rating of five stars, four stars and four stars for the three‐, five and ten‐year periods, respectively. Morningstar rating is for the Institutional share class only; other classes may have different performance characteristics. Ratings are © 2013 Morningstar, Inc. All Rights Reserved. The information contained herein: (1) is proprietary to Morningstar and/or its content providers; (2) may not be copied or distributed; and (3) is not warranted to be accurate, complete or timely. Neither Morningstar nor its content providers are responsible for any damages or losses arising from any use of this information. Formore detailed information about Morningstar’s Analyst Rating, including its methodology, please go to http:// corporate.morningstar.com/us/documents/MethodologyDocuments/AnalystRatingforFundsMethodology.pdf . Data as of July 31, 2014.17 Every year Fund Industry Intelligence (FII) and Fund Director Intelligence (FDI) scout the market for nominees for the Mutual Fund Industry Awards. The Rising Stars of Mutual Funds are up‐and‐comers whose accomplishments in, and contributions to, their firms and/or to the industry make them stand out among their peers and position them as future leaders. Stars may hold any position in any type of firm, and should meet some or all of the following criteria: (1) Leadership in their profession, firm and/or industry, (2) Outstanding contributions to innovations, product development, client service, sales and/or growth in assets or returns, (3) Formal recognition by their firm and/or industry groups , (4) Active contributor to the broader mutual fund community, and (5) No more than 10 years working in the mutual fund industry.


40

Focused Credit Fund

Finally, we would like to point out that the Fund has grown significantly over the past years, and

has been operating in its current size for some time now. Over this period we have become quite

comfortable with the Fund’s size. Both the operational as well as the performance record of the

Fund during 2014 reflect this. As we have said in the past, the size of the Fund will be bounded by

our level of comfort and at this point we are able to contemplate future growth.

We look forward to writing to you again at the end of the Fund’s fiscal year on October 31, 2014.

Sincerely,

Third Avenue Focused Credit Fund Team

Thomas Lapointe, Lead Portfolio Manager

Joseph Zalewski, Portfolio Manager

Nathaniel Kirk, Portfolio Manager

Edwin Tai, Portfolio Manager


41

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42

This publication does not constitute an offer or solicitation of any transaction in any securities. Any recommendationcontained herein may not be suitable for all investors. Information contained in this publication has been obtained fromsources we believe to be reliable, but cannot be guaranteed.

The information in these portfolio manager letters represents the opinions of the individual portfolio manager and is notintended to be a forecast of future events, a guarantee of future results or investment advice. Views expressed are thoseof the portfolio manager and may differ from those of other portfolio managers or of the firm as a whole. Also, please notethat any discussion of the Funds’ holdings, the Funds’ performance, and the portfolio managers’ views are as of July 31,2014 (except as otherwise stated), and are subject to change without notice. Certain information contained in thefollowing letters constitute “forward‐looking statements,” which can be identified by the use of forward‐lookingterminology such as “may,” “will,” “should,” “expect,” “anticipate,” “project,” “estimate,” “intend,” “continue” or“believe,” or the negatives thereof (such as “may not,” “should not,” “are not expected to,” etc.) or other variationsthereon or comparable terminology. Due to various risks and uncertainties, actual events or results or the actualperformance of any fund may differ materially from those reflected or contemplated in such forward‐looking statement.

Third Avenue Funds are offered by prospectus only. Prospectuses contain more complete information on advisory fees,distribution charges, and other expenses and should be read carefully before investing or sending money. Please read theprospectus and carefully consider investment objectives, risks, charges and expenses before you send money. Pastperformance is no guarantee of future results. Investment return and principal value will fluctuate so that an investor’sshares, when redeemed, may be worth more or less than original cost.

If you should have any questions, please call 1‐800‐443‐1021, or visit our web site at: www.thirdave.com, for the mostrecent month‐end performance data or a copy of the Funds’ prospectus. Current performance results may be lower orhigher than performance numbers quoted in certain letters to shareholders.

M.J. Whitman LLC, Distributor. Date of first use of portfolio manager commentary: August 29, 2014

622 Third Avenue, 31st floor | New York, New York 10017

www.thirdave.com

About Third Avenue ManagementThird Avenue Management LLC is a New York‐based global asset manager that has adhered to a proven value

investment philosophy since its founding in 1986. Third Avenue’s disciplined approach seeks to maximize long‐

term, risk‐adjusted returns by focusing on corporate financial stability, and price conscious, opportunistic

security selection throughout the capital structure. The firm offers its services to private and institutional clients,

and had approximately $13 billion in assets under management as of July 31, 2014.

If you would like further information about Third Avenue Funds, pleasecontact your relationship manager or email [email protected]

Q3 2014 TAM Shareholder Letters

Documents

Transcript of Q3 2014 TAM Shareholder Letters