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Wallace Weitz's 2012 Investor Letter
Posted by: Holly LaFon (IP Logged)
Date: January 18, 2013 05:20PM
Dear Fellow Shareholder:
For all the handwringing about the “fiscal cliff,” the European debt crisis, Hurricane Sandy, a slowdown in China, and turmoil all over the Middle East, 2012 turned out to be a very good year for the stock market and our Funds. The deeper structural problems of paying for promised healthcare and other social programs, in both the U.S. and Europe, went mostly unaddressed, and certainly not solved. We’ll discuss our take on where we stand entering 2013, but first we can enjoy the 2012 results.
Our stock funds were positioned fairly defensively most of the year. As prices rose in the face of deteriorating economic fundamentals, we trimmed positions and ended the year with substantial cash reserves (18-31%). In a year when the S&P 500 rose +16.0%, cash was a drag on performance, but our stock funds earned respectable-to-very good returns. The short-term patterns of returns of our stock funds vary, reflecting the funds’ market cap mandates and portfolio manager tactics, but the underlying investment philosophy is the same for all. The 3-year returns (period of market recovery) and 5-year returns (beginning near previous market peak) show more tightly clustered results.
Our Performance Summary shows results for all of our Funds since their inceptions. As always, we suggest focusing on the longer-term returns—they are the ones that matter.
If stocks were “fairly-priced” most of the year, bond prices moved from “over-priced” to “extremely over-priced.” The Federal Reserve’s attempts to stimulate the economy by pushing interest rates to artificially low levels and the continuing exodus of individual investors from stocks (and stock funds) to the apparent safety of bonds kept bonds firmly in “unattractive” territory. Given this handicap, results for both our balanced and fixed income funds were very good.
The Balanced Fund had an excellent year, earning a total return of +10.9%. The Short-Intermediate (Institutional Class) and Nebraska Tax-Free Funds earned total returns of +4.0% and +2.1%, respectively. As it turned out, we could have earned higher coupon interest and capital gains with longer-term bonds, but Brad Hinton (manager of the Balanced Fund) and Tom Carney (manager of the Short-Intermediate and Nebraska Tax-Free Funds) maintained very defensive (short average maturity and duration) portfolios all year. There are very few “sure things” in investing, but we feel certain that interest rates will move higher in coming years. The arithmetic of bond pricing means that capital depreciation is likely to more than offset the higher coupon (cash interest payment) on longer-term bonds when rates begin rising. (Bond prices go down when interest rates rise, and the longer the time to maturity of the bond, the further the price falls.)
Our companies generally performed well in 2012 despite slowing economic growth in many parts of the world and recession in Europe. All companies are cyclical to some extent, but good companies can usually find ways to adapt to changing conditions and cope with sluggish economic growth. They may cut costs, adjust product lines and marketing efforts, make acquisitions, take advantage of low interest rates to extend maturities and lower interest expense, and buy back their own shares to help maintain earnings per share growth in a soft economic environment. We have always been partial to companies whose financial strength and management mindsets allow them to take advantage of adversity.
The “Portfolio Manager’s Discussion and Analysis” (MD&A) sections for each Fund provide detail as to what “worked” for each Fund (and what did not). Gains were spread broadly throughout the portfolios, but a few stocks made important contributions to several of our Funds: Redwood Trust (RWT) (+79%) and various Liberty Media (LMCA) offspring (Liberty Media +49%, Liberty Global +49%, Liberty Interactive +37%, Liberty Ventures +51% and Ascent Media +22%). We added a few new companies to the portfolios (DIRECTV, Express Scripts, CACI, TransDigm, Range Resources, Sapient and FTI Consulting) and our analysts have found several others that we would like to own at lower prices.
Our stock funds held substantial amounts of cash at year-end, ranging from 18% in Research to 31% in Hickory. High levels of cash reserves reflect (high) valuation levels of the stocks we would like to own rather than a market timing call. We are waiting patiently for bargains to emerge. Given the state of the world, it seems likely that we will have good opportunities to buy from time to time.
We write regularly about the fact that “uncertainty” is a natural part of investing life. The financial media and the general conversation among investors seem to over-emphasize less important near-term factors (“fiscal cliff”) and ignore more serious long-term issues (unsustainable entitlement spending and structural budget deficits). The big problems are real, and if not addressed and solved, they could eventually lead to the catastrophes that are predicted by the prophets of doom. However, U.S. political and business leaders almost always make enough incremental changes to allow for the economy and the country to “muddle through.” To paraphrase Churchill, they eventually do the right thing…after exhausting all the other possibilities.
Pollyanna investors are occasionally crushed by real bear markets and super bears tend to miss most of the long-term growth in capital that stocks can provide. Finding the right middle ground of intelligent risk-taking is part of the “art” of investing. Stock picking mistakes and occasional market corrections are inevitable. There will even be (very) occasional major bear markets like 1973-74 and 2008-09. The trick is to hold portfolios of strong companies that can compound value over long periods of time and to minimize permanent loss of capital in the down markets.
We like our companies and their prospects for future growth. We expect plenty of “seismic activity” in the financial markets in 2013 (next up, debt ceiling debate?), but we do not expect a repeat of the “big one” that shook the financial world four years ago. We have plenty of cash available to take advantage of opportunities, and we are optimistic about the outlook for the new year.
Our annual meeting will be held at 4:30 p.m. on May 23rd at a new location for our 30th Anniversary - Happy Hollow Country Club. As usual, the format will be primarily Q&A with the portfolio managers and analysts. We look forward to seeing you there.
Current performance data may be higher or lower than the performance data quoted in this letter. Click here for performance data current to the most recent month-end.
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