shareholderletters-09q1

8/14/2019 shareholderletters-09Q1

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This publication does not constitute an offer or solicitation of any transaction in any

securities. Any recommendation contained herein may not be suitable for all investors.

Information contained in this publication has been obtained from sources 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 not intended to be a forecast of future events, a guarantee of

future results or investment advice. Views expressed are those of the portfolio manager and

may differ from those of other portfolio managers or of the firm as a whole. Also, please

note that any discussion of the Funds holdings, the Funds performance, and the portfolio

managers views are as of January 31, 2009, and are subject to change without notice.

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 the prospectus and carefully

consider investment objectives, risks, charges and expenses before you send money. Past

performance is no guarantee of future results. Investment return and principal value will

fluctuate so that an investors shares, 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 most recent month-end performance data or a copy of our

prospectus. Current performance results may be lower or higher than performance numbers

quoted in certain letters to shareholders.

M.J. Whitman LLC, Distributor. Date of first use February 17, 2009.


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Number of Shares Positions Eliminated (continued)

47,457 shares Sears Holding Common Stock(Sears Common)

480,500 shares Standex International Common Stock(Standex Common)

1,697,500 shares Tokio Marine Holdings Common Stock(Tokio Marine Common)

139,212 shares Westwood Holdings Group CommonStock (Westwood Common)

Except for the sale of the GMAC 714%s, all the othersecurities sales were solely for the purpose of raising cash tomeet redemptions. During the quarter ended January 31,2009, the number of shares of TAVF outstandingdecreased by 9.3%, or by 14.2 million shares.

The Fund owns three issues of GMAC Senior Unsecuredswhich were acquired at yields to maturity of 30% to 50%on the theory that the probabilities were that theinstruments would remain performing loans over theirlives. Since purchase, these GMAC Senior Unsecuredshave become materially credit enhanced, as GMACbecame a bank holding company receiving funds from thegovernment Troubled Asset Relief Program (TARP) therepayment of which is subordinate to the SeniorUnsecureds. Also, GMAC received an equity infusion

from General Motors. Against this background, Fundmanagement decided to sell the GMAC SeniorUnsecureds at a dollar price equal to a yield to maturity of12%, or less. The only sale completed during the quarterwere for $12,000,000 principal amount of 714%s.

The Nortel Seniors were acquired at around 17 on thedollar. Nortel, a giant world-wide provider oftelecommunications services and equipment, is now inbankruptcy operating under the Canadian CCAABankruptcy Statute and U.S. Chapter 11. It appears as ifthe sale of the company, or much of its asset base, to afinancially strong U.S. telecommunications company is areasonable prospect. However, much uncertainty attachesto Nortel. There is comfort, though, in the 17 price and

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in the knowledge that the Nortel Seniors are the most

senior issue in the Nortel capitalization.

The Forest City Seniors, the GMAC 734%s, and the MBIASurplus Notes were acquired at yields to maturity of 26%or better. These are far higher yields for performing loansthan anything we remember in our careers, which stretchback to 1950. Analysis suggests strongly that all three loansare likely to remain performing loans over their lives, or inMBIAs case, until call in January 2013. The probability ofthem remaining performing loans seems to be on the orderof 70% to 80%. However, if MBIA must undergo areorganization or rehabilitation, Fund Managementestimates that little or no loss will be suffered by holdingthese credit instruments. Assuming that the loans stayperforming loans, little, or no, attention need be paid tomarket prices. Held to maturity, or call, the return on theinvestments will be approximately 26%, or better. One

drawback that ought to be noted about these distress debtinvestments is that for U.S. tax purposes, income,including interest and all or a portion of any realizedgains, is likely to be taxable as ordinary income, as opposedto capital gain.

Forest City Common and POSCO Common wereacquired at prices that seem to reflect deep depressioneconomic conditions. The long-term upside potential forboth issues appears to be huge.

THERE REALLY IS NO PLACE TO HIDE UNLESS YOU CAN PICK A MARKET

BOTTOMFUND MANAGEMENT CANT

The multi-trillion dollar stimulus packages could result inrampant inflation during the next two to three years. Thestimulus packages dont necessarily have to have aninflationary result, but they easily could. If so, the worst

place to have funds invested is in cash or cash equivalentssuch as U.S. Treasuries paying, say, 2% to 4% interest.Holders of such assets could suffer a very meaningfuldecline in real income, even though their incomemeasured in money terms would be safe.


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To guard against this inflation possibility (or probability),

both of us have been relatively heavy buyers of TAVFcommon shares during 2009 and in the last six months of2008. Martin Whitman has acquired over $3 million ofThird Avenue Value Fund shares and Ian Lapey hasacquired $550,000. Given the great uncertainties,however, neither of us has borrowed any money to makethese investments.

INVESTING IN NET-NETS

About three quarters of the Funds common stockportfolio are invested in what Fund Management describesas Net-Nets. A Net-Net is defined as a common stock issue where the market value of high quality assets, usuallyreadily saleable, exceeds by a comfortable margin themarket value of the companys equity capitalization afterdeducting all liabilities.

The concept of Net-Nets was invented by Graham andDodd, the godfathers of value investing. Third Avenue hasrefined the Graham and Dodd definition of Net-Nets.Graham and Dodd define Net-Nets on pages 561 and 562of the 1962 edition of Security Analysis, Principles andTechniqueas follows:

Net-Current-Asset Value We feel on more solid ground indiscussing these cases in which the market price or the computedvalue based on earnings and dividends is less than the netcurrent assets applicable to the common stock. [The reader willrecall that in this computation we deduct all obligations and preferred stock from the working capital to determine thebalance for the common.] From long experience with this typeof situation we can say that it is always interesting, and thatthe purchase of a diversified group of companies on thisbargain basis is almost certain to result profitably within a

reasonable period of time. One reason for calling such purchasesbargain issues is that usually net-current asset values may beconsidered a conservative measure of liquidation value. Thus asa practical matter such companies could be disposed of for notless than their working capital, if that capital is conservativelystated. It is a general rule that at least enough can be realized

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for the plant account and miscellaneous assets to offset any

shrinkage sustained in the process of turning current assets intocash. [This rule would nearly always apply to a negotiated saleof the business to some reasonably interested buyer.] Theworking capital value behind a common stock can be readilycomputed. Consequently, by using this figure (i.e., net net assetvalue) as the equivalent of minimum liquidating value wecan discuss with some degree of confidence the actualrelationship between the market price of a stock and the

realizable value of the business.While Graham and Dodd seem to have invented the ideaof Net-Nets, TAVF uses that idea with a number ofmodifications. First, the Fund is not interested in Net-Netsunless the company is extremely well financed. A largequantity of current assets, especially if they consist ofinventories, billings in excess of costs, or receivables fromless than credit-worthy customers, probably cannot help

the common stock of a company which cannot meet itsobligations to its creditors. Second, many current assetsclassified as current assets under Generally AcceptedAccounting Principles (GAAP) are really fixed assets ofthe worst sort. Take department store merchandiseinventories. If the department store is to be liquidated,merchandise inventories are indeed a current asset,convertible to cash within 12 months at prices that

conceivably could be close to book value, although muchless than book value may be realized if the merchandise isdisposed of in a GOB (Going Out of Business) sale. Onthe other hand, if the department store is a going concern,merchandise inventories are a fixed asset of the worst sort.The merchandise inventories have to be replaced, are hardto value, and are subject to markdowns, obsolescence,shrinkage, seasonality and misallocation. The Toyota

Industries portfolio of marketable securities, the majorityof which consists of Toyota Motor Common Stock, seemsto be much more of a current asset than department storemerchandise inventories even though, for GAAP purposes,Toyota Industries marketable securities are not considereda current asset. Third, the Graham and Dodd formulationdoes not account for off-balance sheet liabilities which


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may, or may not, be disclosed in footnotes; nor do Graham

and Dodd take into account excessive expenses or losses.At TAVF, such expenses or losses are capitalized and addedto liabilities. Fourth, Graham and Dodd only seem torecognize partially that certain fixed assets, e.g., property,plant and equipment, can sometimes create cash. Forexample, under Section 1231 of the U.S. Internal RevenueCode, the sale at a loss of such assets used in a trade orbusiness, usually gives rise to an ordinary loss for income

tax purposes. Such loss will generally produce cash savingsby reducing current year tax liability, or if the business hasan overall operating loss, the corporation may be able toget a quickie cash refund of certain prior year taxes fromthe IRS.

The identification of Net-Nets hasnot proved that difficult for theFund, even though most of the

new investments now are outsidethe United States. The toughestproblem faced by TAVF, by far, isto identify managements andcontrol groups of these Net-Netswho are both able and consciousof the interests of outside, passive,minority investors, such as Third

Avenue. When all is said and done,however, TAVF Managementowes an enormous debt of gratitude to Graham and Doddfor introducing the concept of Net-Nets. It remains themost important single part of the Funds common stockportfolio.

Also in the Net-Nets in the Funds portfolio, TAVFManagement likes to focus on common stocks where wethink the prospects are good that over the next five years netasset values will be increasing by not less than 10% per yearcompounded. For example, in the case of ToyotaIndustries, Toyota Motors market penetration may bepoised to increase dramatically, especially if General

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Motors, Ford or Chrysler were to cease operations in North

America. No part of the real estate and private equityworlds seem better situated for rapid growth than mainlandChina. All of the companies in Hong Kong in which TAVFhas invested have huge presences in mainland China.

A CASE FOR MUTUAL FUNDS

During the Bear Market of 2008, there seemed to benowhere for investors to hide other than in Treasury

bonds, though as we point out above, that also has itsproblems. As we have discussed in previous letters, the2008 performance of TAVF was dismal. However, we havecontinued to increase our personal holdings in TAVF

because we believe that theportfolio is currently veryattractive, and we believe that theprobabilities favor that long-term

investors in the Fund will berewarded by the extraordinaryopportunities presented by thecurrent markets.

This is not the case for manyinvestors in hedge funds, privateequity funds or, most of all, Ponzischemes, such as the one alleged

in the Bernard Madoff scandal.During the fourth quarter of2008, there were almost dailyreports of large, well-regarded

hedge funds restricting investor redemptions. Some hedgefunds that used excessive leverage were wiped out after afew years of strong performance that richly rewarded theirmanagers because of their yearly incentive fee structure.

Many private equity funds that bought companies at thepeak of the market using extraordinary leverage have beenexercising capital calls in apparent support of these ill-fatedinvestments. Worst of all, recently uncovered cases ofpotential fraud, such as those involving Madoff and TomPetters, appear likely to result in almost complete wipe-outs for many investors.

. . . we have continued toincrease our personal holdings

in TAVF because we believe thatthe portfolio is currently veryattractive, and we believe that

the probabilities favor that long-term investors in the Fund will

be rewarded by the extraordinary

opportunities presented by thecurrent markets.


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Investors in mutual funds, like TAVF, seem immune to

Ponzi schemes. Funds registered under the InvestmentCompany Act of 1940, as amended, offer the followingprotections and advantages compared to some other formsof investment vehicles:

Highly Regulated. Mutual funds are heavilyregulated under the Investment Company Act of1940, as amended. The Fund is required to bediversified. Transactions with affiliates are subject toextreme scrutiny. TAVF has an independent boardand custodian (Custodial Trust Company/JPMorganChase) and is audited by PricewaterhouseCoopers.The Fund engages prominent law firms, such asSkadden Arps, for legal advice.

No Leverage. TAVF does not use leverage. The Fundcan only borrow for emergency purposes and such

borrowings are limited to 5% of total assets. Additionally, the non-distress portion of the Fund(88% of assets) consists of extremely well-financedcommon stocks and cash.

Low Fees. TAVF has an annual expense ratio of1.1%. There is no incentive fee. This structureencourages Fund Management to focus on the longterm as opposed to short-term investmentperformance. Furthermore, given low turnover rates,TAVF investors enjoy very low transaction costs.Total costs to investors low expenses, lowtransaction costs and no sales loads are markedlylow compared with hedge funds.

Transparency. TAVF is priced daily. The vastmajority (99.5%) of the positions are valued based

on market prices. The full portfolio is publishedquarterly, along with letters that share our thoughts

on the portfolio and other topics. Monthly portfolio

summaries, consisting of the top 10 holdings along with sector and geographic breakdowns, are alsoposted on our web site.

Daily Liquidity. TAVF offers daily liquidity to itsinvestors. The only restriction is a 1% redemption feefor shares held less than 60 days to discourage markettiming. Despite significant outflows in 2008, Fund

Management met all redemption requests on a timelybasis while maintaining a cash cushion equal to 8.2%of net assets as of January 31, 2009.

Management Ownership.At Third Avenue we eatour own cooking. As of January 31, 2009, Martin Whitman (and his wife), and Ian Lapey (and his wife) held over 1,700,000 and 30,000 shares ofTAVF, respectively. These shares are fully vested and

were purchased with cash at market value (net assetvalue) at the time of the purchase.

We shall write you again after the April 30, 2009 quarter end.

Martin J. WhitmanChairman of the Board

Ian LapeySenior Research Analyst

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Dear Fellow Shareholders:

At January 31, 2009, the end of the Funds fiscal firstquarter, the unaudited net asset value attributable to the

83,876,027 common shares outstanding of the ThirdAvenue Small-Cap Value Fund (Small-Cap Value or theFund) was $13.32 per share, compared with the Fundsaudited net asset value of $15.56 per share at October 31,2008, and an unaudited net asset value at January 31,2008 of $22.02 per share, both adjusted for a subsequentdistribution. At February 13, 2009, the unaudited netasset value was $13.49 per share.

QUARTERLY ACTIVITY

During the quarter, Small-Cap Value established two newpositions, added to 15 of its 68 existing positions,eliminated one position and reduced its holdings in ninecompanies. At January 31, 2009, Small-Cap Value heldpositions in 64 common stocks, the top 10 positions ofwhich accounted for approximately 34% of the Funds net

assets.

Number of Shares,

Rights or Face Amount New Positions Acquired

$22,475,000 W&T Offshore, Inc. 8.25% SeniorNotes Due June 15, 2014(WTI Senior Notes)

3,390,400 rights Timberwest Forest Corp. Rights(Timberwest Rights)

Positions Increased

$13,000,000 Ply Gem Industries 11.75% First LienSecured Notes Due June 15, 2013(Ply Gem Notes)

$13,500,000 Saint Acquisition Term Loan B DueMay 6, 2014 (Swift Bank Debt)

264,010 shares Ackermans & van Haaren N.V.(AvH Common)

7,796 shares Alexander & Baldwin, Inc.(Alex Common)

225,600 shares Bristow Group, Inc. Common Stock(Bristow Common)

75,000 shares Cimarex Energy Co., Common Stock(Cimarex Common)

462,544 shares Cross Country Healthcare, Inc.Common Stock(Cross Country Common)

270,493 shares Derwent London Plc Common Stock(Derwent Common)

201,400 shares Genesee & Wyoming Inc. CommonStock (Genesee Common)

556,419 shares Investment Technology Group, Inc.(ITG Common)

75,000 shares Lanxess AG Common Stock(Lanxess Common)

Third Avenue Small-Cap Value Fund

CURTIS R. JENSENCO-CHIEF INVESTMENT OFFICER &PORTFOLIO MANAGER OF THIRD AVENUE

SMALL-CAP VALUE FUND

* Portfolio holdings are subject to change without notice. The following is a list of Third Avenue Small-Cap Value Funds10 largest issuers, and the percentage of the total net assets each represented, as of January 31, 2009: Parco Co., Ltd., 4.40%;Sapporo Holdings, Ltd., 4.18%; Viterra, Inc., 3.49%; Tidewater, Inc., 3.45%; Synopsys, Inc., 3.39%; St. Mary Land andExploration Co., 3.36%; Encore Wire Corp., 3.14%; Lanxess AG, 3.01%; Brookfield Asset Management, 2.97%; and

Ackermans & van Haaren NV, 2.88%.


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Number of Shares Positions Increased (continued)

94,000 shares Parco Company Ltd. Common Stock(Parco Common)

75,000 shares St. Mary Land and Exploration Co.,Common Stock (St. Mary Common)

170,500 shares Synopsys, Inc. Common Stock(Synopsys Common)

229,845 shares Vail Resorts, Inc. Common Stock(Vail Common)

Positions Decreased

132,878 shares Arch Capital Group, Ltd. CommonStock (Arch Common)

1,234,100 shares Canfor Corp. Common Stock(Canfor Common)

239,200 shares CommScope, Inc. Common Stock(CommScope Common)

30,741 shares FBL Financial Group, Inc. CommonStock (FBL Common)

157,867 shares Haverty Furniture Co., Inc. CommonStock (Haverty Common)

422,508 shares Herley Industries, Inc. Common Stock(Herley Common)

10,000 shares Lexmark International, Inc. CommonStock (Lexmark Common)

28,500 shares Superior Industries International, Inc.Common Stock (Superior Common)

125,000 shares Sybase, Inc. Common Stock(Sybase Common)

Positions Eliminated

175,000 shares Whiting Petroleum CorporationCommon Stock (Whiting Common)

QUARTERLY ACTIVITY

As I like to say, pessimism, scorn and adversity can be thefriends of a long-term investor like the Fund, and each ofthese friends contributed to the utter chaos that markedthe closing chapters of 2008. As a point of reference, morethan 85% of the Funds 35%1 decline in value during the2008 calendar year occurred between Labor Day andHalloween. On many days it felt as if the Fund was thebuyer of last resort. While painful as holders of risked

capital, the tumultuous and rapidly deteriorating marketconditions enabled Fund Management to expand both itsexisting equity holdings and its burgeoning stable ofdistressed debt ideas at ever improving prices.

In the quarter ended January 31, 2009, Fund Managementinitiated a new position in WTI Senior Notes, the Fundsfourth distressed debt holding. The WTI Notes, issued in

June 2007 in unregistered form

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, are senior obligations ofW&T Offshore, an independent oil and gas explorationand production company with its primary assets in theU.S. Gulf of Mexico. At least three forces conspired tocreate the opportunity in the WTI Notes: i) pessimismengulfed virtually all oil and gas related names during thelast half of the year, as commodity prices tumbled fromtheir record summer peaks W&T common stock, forexample, fell from a high of $58 per share in June to a low

of $10 per share in December; ii) Gulf of Mexico-exposedproducers, in particular, came under additional pressureduring the fall as Hurricanes Ike and Gustav interruptedproduction in the region; and iii) forced selling at year-endby leveraged pools of capital (e.g., hedge funds, banktrading desks, insurance companies) exacerbated alreadyintense downward pressure on securities prices andorphaned many less liquid instruments like the WTI

Notes. In these circumstances, we like to think of our job asissuers of exit visas from Hell.3

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1 The Funds five-year and ten-year average annual returns for the period ended December 31, 2008 were -0.08% and 6.38%, respectively.2 The securities were originally sold to qualified institutional buyers without being registered under the Securities Act of 1933, asamended, in compliance with the exemption from registration provided by Rule 144A under the Securities Act.3 The phrase exit visas from Hell was made most famous, in my mind, by Jack Byrne, the former Chairman of WhiteMountains Insurance.


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While W&T management has struggled to evidence

organic growth in reserves and production, and whileoffshore oil and gas producers are, more generallyspeaking, fraught with higher operational risk, from acreditors perspective, like that of the Fund, there appearsto be significant downside protection, including:

i) A management team that, as majority-owners of thecommon stock, overtly manages for high marginsand cash generation;

ii) As implied by the Funds cost basis in the Notes, aconservative valuation of W&Ts reserves andacreage, even allowing for a dramatic year-end assetimpairment required under GAAP accounting;

iii) Reasonable protection in theform of sensible covenantsembedded within the

companys bank credit facilityas well as in the terms of theNotes;

iv) Strong liquidity with $350 million of cash and anundrawn, fully available bank revolver totaling $500million as of December 31, 2008.

Should commodity prices remain depressed in coming

periods, as seems likely, W&Ts reported earnings and cashflow ought to fall dramatically this year, as the companyhas little hedging in place for 2009. Given the companysacquisitive history and strong liquidity, it seems likely thatmanagement could embark on another acquisition thisyear. One source of comfort in such a potentially riskyscenario is that asset prices are generally very depressed,and a thoughtful deal could make a lot of economic sense,

particularly if it extends the companys relatively shortreserve life, lowers the companys persistently high findingand development costs or brings a higher degree ofrepeatability to the drilling program.

Our expectation is that the WTI Notes have a high

probability of remaining performing credits. The Fundscost basis, near 60% of face value, implies a yield tomaturity of nearly 20%, a 13% current yield, and a yieldto first call (2011) of nearly 30%. These return profilesmeet Fund Managements definition of equity-likereturns and seem attractive relative to the business risk.

Within the distressed debt portion of the Fund - whichstood at roughly five percent of assets at period end - Fund

Management also added significantly to its positions in PlyGem Notes and Swift Bank Debt. The experience ofbuilding a position in distressed debt at year-end 2008 wasnothing short of excruciating, as every purchase seemed tobe followed by another precipitous drop in prices. If you

can imagine a Black Friday salebeing followed by a BlackMonday sale and then a Black

Tuesday sale and so on throughthe whole week, then you get thepicture. We continuously reviewed

our investment theses, backed up our bids and continued tobuild positions as much as the Funds liquidity would allow.For the moment, the torrent of selling has abated and wecontinue to monitor both the market and numerousindividual securities for more opportunities in distressed

debt, more on which follows below.RUMMAGING THROUGH WALL STREETS GARBAGE BINS

Fund Managements attraction to the opportunities indistressed debt investing deepened during the last half of2008. Newspaper headlines, like the one above4, recognizedthat something unusual was happening in the worldscapital markets and that the phenomenon would likely

persist for a time: mark-to-market accounting had collidedviolently with highly-leveraged institutional investors andother pools of capital, which became involuntarilydesperate sellers of marked down merchandise. The BearStearns meltdown, the rescue of AIG and the worlds largestbankruptcy case (that of Lehman Brothers) were the most

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4 Source: Financial Times, October 9, 2008


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rates ought to be much higher than in the past), and ascorporate debt levels certainly within the buyoutcontext were much higher than in the past.

Return profiles ought to account not only forunderlying business/reorganization risk, but are

competitive with prospective returns in competingequity instruments.

Owning a piece of distressed debt may allow theholder an additional path toward value enhancementinasmuch as it offers the chance to participate in a re-organization or restructuring. The value throughrestructuring option contrasts with the avenuesavailable to passive owners of equities, who generally

do not initiate restructuring events.

Unlike a common stock dividend, owning an interest-bearing instrument allows the Fund to get currentincome in the form of a legally binding contract whilewaiting for business conditions to improve.

To the extent deflationary forces (e.g., industryovercapacity or oversupply) pressure asset and business

values, equity holders will absorb the lions share of thesqueeze on those values (conversely, if inflationaryforces take hold, then the holders of residual interestsin assets ought to benefit even more than debtholders).

vivid portrayals of this financial death spiral. It becameapparent that many of these institutions simply could nothold on, and would be forced to find a buyer, seekprotection from their creditors or jettison assets off theirbalance sheets like a stricken airliner dumping fuel before acrash landing. The table above attempts to illustrate in

very simplified form - the odyssey made by hundreds ofbillions of dollars of bank loans and bonds during the pastfew years, as the credit party really got rolling.

Fund Managements philosophy, expectations and rules ofthe road for the distressed debt portion of the Fund followbelow.

Invest with a bias toward the senior most obligations

of an issuer. Going lower in the capital structure maybe prudent only in certain circumstances (e.g., wherelarge holders are believed to have accumulatedpositions in more than one class, a tactic that canmuddy the reorganization waters). In cases wherethere is a higher probability of default, covenantbreach or formal restructuring, this means owningbank debt. Well happily trade off an element of

return for an added level of safety. Historic recovery rates of the past 15 to 20 years in

high yield bonds and leveraged loans may bemeaningless as guideposts inasmuch as the currenteconomic downturn is likely to rival anything the U.S.has experienced in the post war period (i.e., default

Typical Purchase Price

Time Period Institution Type (as % of face value) Comments/Examples

2003 First Banks, insurance companies, CLOs, 90% - 100% Institutions characterized by high financialHalf 2007 High Yield Funds, Securities Firms, leverage, in some cases extreme (e.g., 20:1).

Hedge Funds First Generation, Some institutions regulated, otherspar owners governed by murky contracts. Dividend

recapitalizations, private equity buyouts.

Second Half High Yield Funds, Hedge Funds, 70% - 80% Moderately leveraged vehicles (e.g., 2:1).2007 First Private Equity Vehicles Second PE and Hedge Funds purchasing/tradingHalf 2008 Generation owners busted buyout debt.

Second Half Third Avenue Funds; dedicated workout 30% - 60% Unleveraged, longer-term holders with2008 ? or distressed funds Third Generation bankruptcy competence.


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In cases where we assume a performing credit, credit

markets, in general, will have to attain a modest levelof repair before the earliest debt maturities come due(e.g., 2012 2014 and beyond) in order thatborrowers will be able to refinance the debt if need be.Some fragile signs of healing in credit markets havealready emerged (e.g., the drop in inter bank lendingrates; falling spreads on corporate debt; and recentlarge bond issues by investment grade borrowers).

Fund Management will attempt to diversify byacquiring securities that are likely to be performingcredits versus workouts that will tend to utilize a muchhigher level of our internal research resources.

I look forward to writing you again in when we publish

our Second Quarter Report, dated April 30, 2009. Thankyou for your continued support.

Sincerely,

Curtis R. JensenCo-Chief Investment Officer and Portfolio Manager

Third Avenue Small-Cap Value Fund


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Dear Fellow Shareholders:

At January 31, 2009, the end of the first fiscal quarter of2009, the unaudited net asset value attributable to the71,506,234 shares outstanding of the Third Avenue RealEstate Value Fund (the Fund) was $13.46 per share. Thiscompares with an audited net asset value of $15.78 pershare at October 31, 2008, and an unaudited net assetvalue of $27.12 per share at January 31, 2008, bothadjusted for subsequent distributions to shareholders. AtFebruary 13, 2009, the unaudited net asset value was$12.90 per share.

QUARTERLY ACTIVITY

The following summarizes the Funds investment activityduring the quarter:

Principal Amount New Positions Acquired

$6,215,000 Brookfield Asset Management, Inc.7.13% Senior Notes due June 2012(Brookfield Senior Notes)

Number of Shares

or Principal Amount New Positions Acquired (continued)

$12,500,000 Brandywine Operating Partnership3.875% Convertible Senior Notesputable October 2011(Brandywine Senior Notes)

$3,000,000 General Growth Properties Term Loan

Tranche A due February 2010(General Growth Term Loan)

$3,000,000 LandSource Communities First LienDIP Revolver due May 2009(LandSource DIP Loan)

$25,000,000 Macerich Company 3.25% ConvertibleSenior Notes putable March 2012(Macerich Senior Notes)

Positions Increased

$2,203,310 LandSource Communities DevelopmentLLC Senior Term Loan due May 2009(LandSource Senior Term Loan)

$14,400,000 LNR Property Corp. Floating RateSenior Term Loan due July 2011(LNR Senior Term Loan)

1,000,000 shares Forest City Enterprises, Inc. Class ACommon Stock (Forest CityCommon)

1,800,000 shares ProLogis Common Stock(ProLogis Common)

Positions Decreased

41,152 shares Associated Estates Realty Corp.Common Stock

(Associated Common)

Third Avenue Real Estate Value Fund

MICHAEL H. WINERPORTFOLIO MANAGER OF THIRD AVENUE

REAL ESTATE VALUE FUND

* Portfolio holdings are subject to change without notice. The following is a list of Third Avenue Real Estate Value Funds10 largest issuers, and the percentage of the total net assets each represented, as of January 31, 2009: Brookfield Asset Management,8.32%; Henderson Land Development Co., Ltd., 7.30%; Forest City Enterprises, Inc., 6.57%; ProLogis, 5.74%; Wheelock &Co., Ltd., 5.61%; Hang Lung Properties, Ltd., 5.11%; The St. Joe Company, 4.94%; Mitsui Fudosan Co., Ltd., 4.22%; VornadoRealty Trust, 4.13%; and Mitsubishi Estate Co., Ltd., 4.09%.


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Number of Shares Positions Decreased (continued)

200,500 shares British Land Company plc CommonStock (British Land Common)

50,000 shares Brookfield Asset ManagementCommon Stock (Brookfield AssetManagement Common)

16,800 shares Cousins Properties, Inc. CommonStock (Cousins Common)

653,200 shares Parco Company Ltd. Common Stock

(Parco Common)

1,341,000 shares Wheelock & Co Ltd. Common Stock(Wheelock Common)

Positions Eliminated

260,374 shares Crystal River Capital, Inc. CommonStock (Crystal River Common)

15,000 shares JER Investors Trust, Inc. Common

Stock (JER Investors Common)

DISCUSSION OF QUARTERLY ACTIVITY

During the quarter ended January 31, 2009, the Fundcontinued to take advantage of the dislocations in thecredit markets by adding debt securities trading atsignificant discounts to par value with expected yields-to-maturity, workout, or improved credit rating in excess of

20% at the time of purchase. The Funds investments indebt securities continue to increase, and so long as theseopportunities exist, Fund Management intends to makethe most of its flexible mandate and take advantage of what appears to be superior risk-adjusted returns. TheFund added to its existing positions in LNR Senior TermLoan and LandSource Senior Term Loan, and initiatednew positions in Brookfield Senior Notes, Brandywine

Senior Notes, General Growth Term Loan, LandSourceDIP Loan, and Macerich Senior Notes. The Fund alsoopportunistically added to Forest City Common andProLogis Common.

Macerich is a U.S. REIT that owns some of the mostdominant regional malls across the country, including a large

concentration of properties in Arizona and California.

Those markets continue to be disproportionately affectedby the slump in the residential market, which has led todeclining sales and slowing leasing activity at a number ofthe companys properties. In addition to deterioratingfundamentals, Macerich is facing about $3 billion of debtmaturities over the next three years. Notwithstanding weakbusiness fundamentals, the companys high quality assetsand managements strong track record as an operator leads

us to believe that Macerich will be able to utilize its assetbase to meet its maturities and preserve the companysequity value. If we are wrong and the company defaults onits debt obligations, the Senior Notes appear to be fullycovered in any restructuring scenario.

Brandywine Realty is a U.S. REIT that owns suburbanoffice properties, largely concentrated in Philadelphia andWashington, D.C. The portfolio is not located in high-

barrier-to-entry markets, which limits the prospects forsignificant appreciation in property values over the longterm. However, Brandywines portfolio is more than 92%occupied with a diversified tenant base that provides steadycash flows. Brandywine will likely face deterioratingfundamentals (albeit not as severe as retail) and, over thenext three years, it must address about $1.2 billion of debtmaturities. However, the companys high cash flow

coverage, manageable debt levels, and approximately $4billion unencumbered asset base, gives us confidence thatBrandywines Notes will remain performing. In theunlikely event of default, the notes should be fully coveredin a restructuring or liquidation.

The Fund opportunistically acquired Brookfield Senior Notesat a 20% yield-to-maturity. Given Brookfields super-strongbalance sheet and robust cash flows (which it retains as an

operating company), the only explanation for the bargainpricing is forced selling into a relatively illiquid market.

The Fund added to its position in LandSource SeniorTerm Loan and acquired a participation in the LandSourceDIP Loan at a discount to par value. The LandSource DIPLoan is a revolving credit facility that has super-senior

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priority in the LandSource bankruptcy. The Loan matures

in May 2009 and should provide an attractive return,although with a short duration. Fund Managementremains actively involved with the LandSourcerestructuring process by serving on the Senior LoanSteering Committee. We expect that LandSource willemerge from bankruptcy with an all-equity capitalstructure which should enable the company to takeadvantage of exceptional long-term prospects given its

prime land in Los Angeles County.General Growth Properties is one of the largest owners ofregional malls in the U.S. The company grew rapidlythrough acquisitions that werefinanced primarily with short-term debt. The company is facingsignificant near-term maturitiesthat it will likely have difficulty

refinancing in the current market.The Fund acquired a smallinterest in General Growth TermLoan at 22% of par value. Thereappears to be a high probabilitythat General Growth will filebankruptcy in the near future. Inthat event, we expect that there

will be more forced sellers and anopportunity to acquire more debtat steep discounts. In either event, we believe that in arestructuring or liquidation, the General Growth TermLoan should be fully covered.

The Fund opportunistically increased its holdings inForest City Common and ProLogis Common at pricesrepresenting substantial discounts to conservative

estimates of net asset value. The Fund purchased 3.5million shares of ProLogis Common in late November,after the ProLogis management presented its plan toalleviate concerns relating to its large development pipelineand began executing on that plan. In late December,ProLogis announced that it was selling its China

operations and a stake in its Japanese property funds for

$1.3 billion in cash. This news seemed to allay liquidityconcerns and the stock price increased nearly seven-foldfrom its November low. The Fund took advantage ofmarket pricing and sold 1.7 million shares.

The Fund reduced its positions in several common stocks,generally for portfolio management reasons, such asreallocating investments to securities expected to generatehigher risk-adjusted returns.

LONG-TERM, REAL ESTATE OFFERS HIGH RISK-ADJUSTED RETURNS

The Fund reported a loss of 44.7% in 2008, clearlymaking it the worst year in theFunds ten-year history. Otherthan holding cash in 2008, there were very few hiding places forinvestors to avoid significant

mark-to-market losses. FundManagement did not foresee theripple effect the sub-primemortgage crisis (which began in2007) would have on the globalcredit markets and the dramaticre-pricing of hard assets. TheFunds largest detractor during the

year was Forest City Common, which was down 85% during2008. Like most real estate companies with significantexposure to development projects, Forest City Commonwas subjected to unprecedented selling pressure caused byconcerns about liquidity and fear of losses ondevelopments. There is little doubt that Forest City willface challenges and may incur some losses on developmentprojects, but Fund Management believes the companysfinancial position is not at risk, and the stock is oversold.Despite the mark-to-market losses in 2008, the Fundsannualized return for the ten years ended December 31,2008 was 8.4%, which compares very favorably to realestate securities and general market indices. To wit:

13

Real estate securities

currently offer the highest risk-adjusted returns Fund

Management has seen sincethe inception of the Fund.


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Historical returns are no predictor of future returns. We donot disagree that many industries (including real estate)have yet to feel the full impact of the economic downturn.U.S. commercial real estate, in particular, is likely to facehigher vacancy rates and lower rental rates, resulting indeclining cash flows. Mortgages for commercial real estateand corporate financing for real estate companies are notreadily available due to the general lack of credit. U.S.

consumers and most industries are convulsing with theneed to de-leverage (which is not the case in Asia). We arepaying the price for years of easy credit. However,notwithstanding the current global economic downturn,Fund Management believes it is reasonable to assume thatreturns on real estate securities over the next ten years willbe in-line with or better than the last ten years. The pricesof most real estate securities (common stocks and debt

securities) seem to reflect all of the bad news reported todate and expectations of even worsening conditions overthe next few years.

From 2002 through 2006, it was easy to make money inreal estate securities. During this period, companyfundamentals (e.g., balance sheet strength, quality and

location of assets, management talent, etc.) were not givenmuch analytical weight by most market participants. It wasa bull-market feast that had a euphoric effect on investors.However, behavioral finance studies show that,proportionately, investors dislike losses much more thanthey like gains. We are currently in a period whereindicators of uncertainty are at or near all-time highs. Theuncertainty leads to fear, which paralyzes investors,

consumers and businesses. This behavior, in turn, feeds thecrisis which has led to a massive flight from risky assets.Despite the fact that real estate is generally comprised oftangible assets that have the ability to generate recurringcash flow from long-term leases with tenants representingdiversified businesses, investors have fled the sector basedon uncertainty and fear. Savvy investors that can afford tobe patient through this period of market volatility and

focus on fundamentals, instead of market sentiment, willbe the long-term beneficiaries of todays bargain prices.

The period of easy money ended in early 2007. The key tomaking above-average risk-adjusted returns in real estateover the next five to ten years will be picking the survivors.Once again, corporate fundamentals matter. Fund

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Annualized Returns as of December 31, 2008__________________________________________

1-year 3-year 5-year 10-year____________________________________________________________Third Avenue Real Estate Value Fund -44.75% -13.05% -0.76% 8.38%

S&P 500 Index1 -36.55% -8.18% -2.12% -1.36%

Dow Jones Industrial Average2 -33.84% -3.95% -1.07% 1.67%

MSCI World Index3 -39.67% -7.29% 0.13% -2.20%

MSCI US REIT Total Return Index4 -37.97% -11.13% 0.67% 7.18%

FSTE EPRA/NAREIT Global Index5 -43.83% -19.40% -3.96% 0.55%

1 The S&P 500 Index is an unmanaged index (with no defined investment objective) of common stocks.2

The Dow Jones Industrial Average seeks to represent large and well-known U.S. companies. It covers all industries with theexception of Transportation and Utilities.3 The MSCI World Index is a free-float weighted equity index, which includes developed world markets, and does not includeemerging markets.4 The MSCI US REIT Total Return Index is a capitalization-weighted, total return index comprising the most actively traded realestate investment trusts and is designed to be a measure of real estate equity performance.5 The FSTE EPRA/NAREIT Global Index is designed to track the performance of listed real estate companies and REITS worldwide.


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Management has always focused on corporate

fundamentals. It is interesting to note that, during the bullmarket, Wall Street analysts were primarily focused on theincome statement and rarely mentioned balance sheetstrength. Lately, however, it is difficult to find a researchreport that does not mention financing concerns.

The investment business is a probabilities business. Marketparticipants talk about risk-adjusted returns and the goalof earning returns that are at least as good as, or better

than, the rest of the market on a risk-adjusted basis. Everyinvestment comes with risks including, but not limited to,investment risk, market risk, credit risk, interest rate risk,inflation risk, currency risk, etc. Fund Managementsprimary concern is avoiding investment risk or the riskthat an investment will suffer a permanent impairment ofvalue. When attempting to analyze the risk/reward ratio,risk is considered to reflect the probability of not achievingthe expected return (including the probability of incurring

a loss).

Third Avenue is in the probabilities business. Everyinvestment is thoroughly analyzed using Third Avenuessafe and cheap* investment approach, in which weevaluate financial strength, management talent, qualityand quantity of assets and specific issues relating to thebusiness. We also give appropriate weight to macro-economic conditions based on our view of how such

factors might affect the long-term viability of the business.However, after completing our analysis, we still must makean educated guess about probabilities. For instance, if weare considering the purchase of a corporate bond, we haveto estimate the probability that the bond will perform andultimately be paid off at maturity. We also have to estimatethe amount and probability of recovery value in the eventthe bond does not perform. Estimating these probabilitiesis more art than science. We generally give very littleweight in our analysis to the credit rating or the tradingprice of the security. We are much more focused on thequality and quantity of the companys resources, covenantprotection in the bond indenture and determining a

recovery value in the event the debt instrument defaulted

and we have to go through a workout or liquidation.The following example illustrates the calculation of therisk-adjusted return of a high-yielding corporate bondcompared to a U.S. Treasury note. In this example it isassumed that the U.S. Treasury note will earn a 3% return(the risk-free yield) and the corporate bond has anexpected return of 22% (1,900 basis points over the risk-free return). We assign a 75% probability that the bond

will perform and pay off at maturity; and a 25%probability that the bond will default and a workout willresult in a recovery of half the investment.

Risk-Expected Adjusted

Return Probability Return

U.S. Treasury note 3% 100% 3%

Corporate Bond 22% 75% 16.5%

-50% 25% -12.5%

4.0%

While the expected return on the corporate bond is 22%,due to the probability that the bond will default and resultin a loss of 50% of our investment, the calculated risk-adjusted return is 4%. If we could confidently rely on ourassigned probabilities, then it may seem that on a risk-adjusted basis, the corporate bond is a better investmentthan the U.S. Treasury note. In this case, the corporate

bond should earn a risk-adjusted return that is 100 basispoints higher than the risk free return.

The problem with calculating risk-adjusted returns is thatone can never be certain that the estimated probabilities ofexpected returns are valid. If the expected investmentholding period in the above example was ten years, there isa high likelihood that corporate events or macro-economicconditions during the investment period could

dramatically alter the initial probabilities. Therefore, inorder to compensate for the likelihood of invalidprobabilities, with respect to long-term investments, risk-adjusted returns should be significantly higher than risk-

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* Safe means the companies, in our judgment, have strong finances, competent management, and an understandable business.Cheap means that, in our judgment, we can buy the securities for significantly less than what a private buyer might pay forcontrol of the business.


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19

cheapness, and attractiveness of the companys industry or

assets. Sometimes, because of broader economic factors orindustry-specific issues, a group of companies related bygeography or activity become potential candidates forconsideration as investments for the Fund. Periodically, thenumber of such candidates in a given industry orgeography which find themselves in the portfolio issufficient enough that a casual observer might infer thatsuch a cluster of the Funds investments stemmed from abroader industry or geographic theme.

Traditional thematic investing starts with the identificationof bigger picture phenomenon (economic, sectoral,geographic, etc.) and the search for investments that fit thisover-arching belief (or beliefs) follows. Often, if a theme ortrend becomes evident at a macro level in this top-downapproach, there is a reasonable probability that this willalready be reflected at the security level, either in terms ofoperating performance or valuations. In contrast, when the

Funds bottom-up approach identifies a group of suchinvestments, usually one at a time, typically their depressedvaluations have tended to reflect a poor near-term outlookfor the business. In this latter approach, the payoffs areoften long term and the path taken by the business isunknown, as opposed to the theme-based approach wherethe drivers of the payoff (the theme) are known or at leastbelieved to be known.

An example of how the Fund accidentally chanced upona theme is the investments made in a number of oil servicecompanies during the 2003-2004 period. Our initialinvestment in this area began with the purchase of anoffshore oil driller in Norway. This was followed byinvestments in a holding company of another driller; acompany providing undersea construction services; acompany providing design and engineering of offshore oildrilling installations; a company that provided transport to

these installations; and another company which providedseismic services.

In making these investments, no particular theoreticalassumption was made about the path of future oil prices,other than the observation that oil companies had for anumber of years been relatively stingy in their spending inthe early stages of exploration and development (e.g.,

seismic shoots, land acquisitions, exploratory drilling, etc.),

which increased the likelihood of higher, rather than lower,oil prices in the future. This parsimony in spending isprecisely what had hurt the profitability of a number of theaforementioned companies, presenting us with attractiveinvestment opportunities. The companies themselves werewell capitalized in absolute terms, as well as relative to theirpeers, which increased the probability of their survival andability to potentially prosper as the ranks of their peersthinned. We had no preconceptions about the specific

source of the payoff, other than an awareness of the historyof a considerable amount of merger and acquisition activityin various segments of this industry. Indeed, the results ofthese investments were quite satisfactory, with returns fromthis group of investments coming both via resourceconversion, as well as by the gradually improving demandand pricing for their services which resulted in improvedprofitability. This foray into oil service companies was aconsequence of finding a number of companies in anindustry group which were ill understood or under-analyzed amid a depressed industry environment whichbegat unpopularity and undervaluation, despite theindustrys considerable long-term attractiveness.

One such accidental theme which is represented in theFunds current portfolio is that of companies operating inthe area of Insurance and Reinsurance. These companieshave been generally tarred by their association with the

convulsing financial sector and thus deemed dangerous bymany investors. To be sure, the companies whose shares theFund holds are a heterogeneous lot, but what they do havein common, along with their cheapness, is the absence of aneed to access capital markets to fund ongoing operationalneeds, a characteristic which has served them well in thesecapital-constrained times. Here too, the portfolio holdingswere added one-by-one on an opportunistic basis, starting with the Funds long-term holding in Brit InsuranceHoldings PLC (Brit). While Brits conservatism in capitalutilization and underwriting generally did not win favorwith investors in more benign times, it allowed the companyto approach the current period with a good balance sheet.Next, the Fund took advantage of the subprime fallout byinvesting in the common stocks of Montpelier Re HoldingsLtd. and Sompo Japan Insurance Inc., whose stock prices


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BOARD OF TRUSTEES

Jack W. Aber Marvin Moser

David M. Barse Eric Rakowski

William E. Chapman, II Martin Shubik

Lucinda Franks Charles C. Walden

Edward J. Kaier Mar tin J. Whitman

OFFICERS

Martin J. Whitman Chairman of the Board

David M. Barse President, Chief Executive Officer

Vincent J. Dugan Chief Financial Officer, Treasurer

Michael A. Buono Controller

W. James Hall General Counsel, Secretary

Joseph J. Reardon Chief Compliance Officer

TRANSFER AGENT

PNC Global Investment Servicing

P.O. Box 9802

Providence, RI 02940

610-382-7819

800-443-1021 (toll-free)

INVESTMENT ADVISER

Third Avenue Management LLC

622 Third Avenue

New York, NY 10017

CUSTODIAN

Custodial Trust Company

101 Carnegie Center

Princeton, NJ 08540

Third Avenue Funds

622 Third Avenue

New York, NY 10017

Phone 212-888-5222

Toll Free 800-443-1021

Fax 212-888-6757

www.thirdave.com

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