Dear Fellow Shareholder:
The stock market bounced around during the 2nd quarter and ended up roughly unchanged. The Greek debt situation dominated the headlines but continued sluggishness in the U.S. recovery and mixed economic signals from China contributed to investor unease. Nevertheless, our Funds enjoyed a profitable first half.
The stock funds generally broke even in the 2nd quarter of 2011 and showed reasonable gains for the first six months of the year. The table below shows 1st quarter, 2nd quarter and 1st half results as of June 30, 2011.
|Total Returns||Average Annual Total Returns|
|1st Qtr||2nd Qtr||YTD||1 Year||5 Year||10 Year|| Since|
|Partners III Opportunity*||6/01/1983||8.5||-0.1||8.4||32.4||6.2||7.3||13.4|
|S&P 500** (b)||5.9||0.1||6.0||30.7||2.9||2.7||--|
These performance numbers reflect the deduction of each Fund's annual operating expenses. Annual operating expenses for the Value, Partners Value, Partners III Opportunity, Research and Hickory Funds, as stated in the most recent Prospectus are 1.21%, 1.21%, 1.53%, 1.81% (estimated gross), and 1.28%, respectively, of each Fund's net assets. The returns assume redemption at the end of each period and reinvestment of dividends. Total returns shown include fee waivers and expense reimbursements, if any; total returns would have been lower had there been no waiver of fees and/or reimbursement of expenses by the investment adviser. This information represents past performance and past performance does not guarantee future results. The investment return and the principal value of an investment in any of the Funds will fluctuate so that an investor's shares, when redeemed, may be worth more or less than the original cost. Current performance may be higher or lower than the performance data quoted above. Performance data current to the most recent month end may be obtained at www.weitzfunds.com/performance/monthly.asp.
* Performance of the Partners Value and Partners III Opportunity Funds is measured from June 1, 1983, the inception of Weitz Partners II Limited Partnership ("Partners II") and Weitz Partners III Limited Partnership ("Partners III"), respectively. Performance of the Research Fund is measured from April 1, 2005, the inception of Weitz Research Fund, L.P. ("Research L.P."). On the last business day of December 1993, 2005 and 2010, the Partners Value, Partners III Opportunity and Research Funds (the "Funds") succeeded to substantially all of the assets of Partners II, Partners III and Research L.P. (the "Partnerships"), respectively. The investment objectives, policies and restrictions of the Funds are materially equivalent to those of the respective Partnerships and the Partnerships were managed at all times with full investment authority by Wallace R. Weitz & Company. The performance information includes performance for the period before the Funds became investment companies registered with the Securities and Exchange Commission. During these periods, none of the Partnerships were registered under the Investment Company Act of 1940 and therefore were not subject to certain investment or other restrictions or requirements imposed by the 1940 Act or the Internal Revenue Code. If any of the Partnerships had been registered under the 1940 Act during these periods, the respective Partnerships' performance might have been adversely affected.
** Index performance is hypothetical and is shown for illustrative purposes only.
(a) The investment adviser has agreed, in writing, to limit the total annual fund operating expenses (excluding taxes, interest, brokerage commissions and acquired fund fees and expenses) to 0.90% of the Fund's average daily net assets through July 31, 2012.
(b) The S&P 500 is an unmanaged index consisting of 500 companies generally representative of the market for the stocks of large-size U.S. companies.
Please review our complete Performance Summary which presents investment results over a number of longer time periods and includes relevant market indices and related disclosures.
Portfolio Review and Market Commentary
For the past two years, our message to shareholders has been that the liquidity crisis, the "Great Recession" and the bear market of 2007-09 have ended but that the "deleveraging" process may take several more years and act as a damper on the U.S. economy. We have no special expertise in economic forecasting, but this still seems like a reasonable description of the current state of affairs. The housing market remains very weak—too many homes for sale and uncertainty as to how many more homes will come onto the market through foreclosure. Austerity budgets at the state and local level and hesitancy on the parts of both borrowers and lenders have also contributed to the subpar pace of recovery.
On the other hand, public companies are finding ways to cut costs, focus on their most profitable lines of business and generate strong profit growth. We have written regularly about the seeming disconnect between the economic and political malaise that dominate the news and the relative prosperity of our portfolio companies. In this period of fragile recovery and multiple global uncertainties, we have tilted our portfolios towards larger companies with stronger balance sheets. These companies are doing very well in the current environment and have the staying power to cope with more adverse conditions that may develop.
A year ago, we wrote about nine large, high-quality companies—Accenture (NYSE:ACN), Aon (AOC), Dell (DELL), Diageo (NYSE:DEO), Microsoft (NASDAQ:MSFT), Omnicom (NYSE:OMC), Praxair (NYSE:PX), Texas Instruments (NASDAQ:TXN), and UPS (NYSE:UPS). These companies offered reasonable growth prospects in an uncertain economy and balance sheets that would protect them in a downturn and allow them to expand and/or buy back stock if conditions warranted. We still own all nine although we have taken some profits in the strongest performers (e.g. Accenture) and added to our holdings in others (e.g. Microsoft). As a group they have returned 39% (in the year ended June 30) and our estimate of the average price-to-value ratio of the group has moved up from 66% to 80%. Their stocks have appreciated faster than their underlying business values have grown, but they are still reasonably priced and we would expect to add to our positions during the inevitable dips that will occur.
Our analysts are also continuing to build our "on-deck" list of businesses we would like to own if they are available at the right prices. Some of these are new ideas. Others we have followed for years but have never owned. Finally, there are old favorites we have owned before and have continued to follow.
An example in the "old favorites" category is Wells Fargo (NYSE:WFC) ($28). We have owned Wells several times over the past 25-30 years. Wells' business has evolved over time. When we first owned the stock, it was a San Francisco-based commercial real estate lender. Later, it was acquired by Minneapolis-based Norwest, though the Wells name (and Stagecoach logo) survived. Under Norwest's management, its emphasis shifted somewhat towards consumer lending, but it retained Wells' conservative approach to loan underwriting.
This lending discipline kept it out of serious credit trouble in the commercial real estate crisis of the early 1990's and during the more recent residential real estate crisis. In fact, Wells' strong financial position led U.S. regulators to allow/encourage it to acquire Wachovia on very favorable terms during the depths of the crisis. Wachovia had been an aggressive commercial lender and had acquired Golden West, a west coast purveyor of "pick-a-pay" residential mortgages. This acquisition brought with it troubled assets but it also gave Wells billions in stable, low cost deposits and a national footprint that leaves the company very well-positioned for future growth.
We owned Wells during the recent bear market, and while we made money by writing calls against our position, buying more shares during the panic selling would have been even more profitable. When the stock bounced back towards $30 in 2009, we believed that investors were expecting a little too much, too soon, from its prospective recovery and we sold our position.
Nearly two years later, we have been able to come back to Wells. At $28 per share, the stock sells for about 10 times 2011 earnings per share (EPS) and roughly 8.5 times estimated 2012 earnings. Even with a subdued housing market, a sluggish overall economy, and higher capital requirements for banks, we believe that Wells can grow earnings at a double-digit pace that should take EPS to over $4 by 2014 or 2015. We expect that, by then, Wells will have returned its dividend payment to its historic level of 30-40% of earnings. Investors are very skeptical of bank stocks today, but we believe that a few years of earnings growth and rising dividend payments will restore investor confidence and Wells' premium valuation of 12-14 times earnings.
Most of the companies in our portfolios have outlooks that are roughly similar to that of Wells. They are at least moderately undervalued today. Their businesses are growing in value. They are generating more cash than they need for day to day operations so they have the options of expanding their operations, making acquisitions, paying higher dividends and/or buying back stock (making our holdings more valuable on a per share basis). There are plenty of problems in the world and managements make mistakes—anything can happen in the short-run—but we believe that our portfolio companies, as a group, are very likely to generate good investment returns for us over the next several years.
We appreciate the confidence you show by allowing us to invest your capital. If you have questions about this letter or any of the information found on Weitzfunds.com, please feel free to call our client service representatives.