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Martin Whitman’s Third Avenue Q3 Letter: Passive markets seems to be inefficient

Martin Whitman's letter to Third Avenue Fund shareholders for the period ended July 31, 2015.

Dear Fellow Shareholders,

There are those who believe that markets are efficient—finance academics, traders, owners of Index Funds and ETFs, and market participants who study market price and security price movements while ignoring the study of companies and the securities they issue. They are wrong. There are those who believe that markets are inefficient—value investors, active investors, distress investors, control investors, many credit analysts and those who are first and second stage venture capital investors. They are also wrong.

The fact is that some markets are highly efficient, or tend to be, and some markets are grossly inefficient, or tend to be. It is a matter of individual differences among and between disparate markets. In one very important sense academic finance and economics seem to be immature social sciences compared with say, law, psychology or sociology. In academic finance and economics the emphasis is on discovering general laws while in law, psychology and sociology, the focus is not on general laws, but rather on individual differences on a case by case basis.

It is helpful to define efficiency. At Third Avenue Management (TAM) we believe efficiency breaks down into three parts:

  1. Value Efficiency: At TAM value efficiency is defined as that price, and other terms, which would be arrived at in a transaction between a willing control buyer and a willing control seller, both with knowledge of the relevant facts, and neither under any compulsion to act.
  2. Process Efficiency: Prices that would be arrived at outside of control markets. Such prices usually will be much below value efficiency prices where there are little or no prospects for resource conversions, especially changes of control, going private, or massive distributions to equity holders; where particular securities issues may lack marketability; where there is a lack of disclosures to passive investors, either through regulatory filings or management communications; or where there is an absence of regulatory protections for passive investors. Such prices also may be far higher than value efficiency prices. This especially seems to be the case where companies have access to capital markets at super attractive prices such as is the case of equity offerings of high tech companies during the IPO boom. Prices in excess of value efficiency prices are tricky because in the hands of competent management, overpriced common stocks can be a business’s most important and most valuable asset.
  3. Transaction Efficiency: Prices to be realized in sudden death situations where there are likely to be readily determinable work-outs in readily determinable periods of time; and where the securities are analyzable by reference to only a limited number of computer programmable variables. Such securities include options and warrants; pending merger transactions; tender offers; voluntary exchanges; balance sheet arbitrage, especially convertible arbitrage; and certain liquidations and spin-offs. Day traders too, deal in markets...