Portfolio Manager: Wallace R. Weitz
The Partners III Opportunity Fund-Institutional Class declined-12.8% in the third calendar quarter, less than the-13.9% loss for the S&P 500. For the calendar year-to-date, the Fund declined-5.5% compared to a-8.7% decline for the S&P 500. Investors digested a stream of mostly negative news dominated by Europe's sovereign debt and banking woes, Washington's poor handling of the U.S. debt ceiling debate, and increasing reports that the global economic recovery was losing steam. While few stocks were spared from temporary markdowns, large-cap bellwethers on balance held up much better than their small-cap counterparts.
SandRidge Energy(SD) (-48%), Redwood Trust(RWT) (-25%) and Live Nation Entertainment (LYV)(-30%) were the largest detractors from results during the quarter. These three companies are investing for the future in the face of tough current conditions. SandRidge announced a more aggressive three-year growth plan to accelerate its oil production. Redwood continued to build out its mortgage investing relationships and platform. The company is well positioned to take advantage when private capital inevitably returns to play a larger role in this important market. Live Nation worked to integrate three unique businesses (ticketing, concerts, artist management) brought together with last year's merger. In each case, we think patient investors will be rewarded from today's prices. As expected in a declining market, the Fund's short positions in small and mid-cap ETF's registered meaningful gains. Grand Canyon Education (+14%) also rose from depressed levels after reporting solid results that included a better-than-expected outlook.
Valeant Pharmaceuticals (VRX) was one of our largest new purchases during the quarter. Valeant is a multinational specialty pharmaceutical company with operations throughout North America, Central & Eastern Europe and Latin America. The company brings a unique, financially-driven approach to the business of manufacturing and selling drugs. Valeant has a diversified product portfolio, limited exposure to U.S. government reimbursement and minimal patent expiration risk. CEO Michael Pearson is a talented owner/operator with a track record of doing intelligent things with the company's ample excess cash flow. Other new stocks included Coinstar (CSTR), National CineMedia (NCMI), CNA Financial (CNA), Iconix Brand Group (ICON), Apache (APA) and Hewlett-Packard (HPQ).
Partners III Opportunity has the broadest toolkit of our equity funds. Several transactions during the quarter highlight the Fund's unique features.
- We initiated small new positions in several exchange traded funds ("ETF's"). One invests in home builders, another invests in domestic banks, and a third shorts long Treasury bonds.
- We closed out the Discovery Communications share class pair trade with a nice gain. The dollar spread between the two classes (finally) narrowed significantly during the quarter, which was the objective when we initiated the position in early 2010.
- We wrote options on a few of our stocks as volatility soared. At a high level, option writing is another way to capitalize on fear in the market. We view it as a supplemental tool rather than a core strategy.
- We used synthetic shorts rather than ETF's for some of our short position. We create a synthetic short by buying a put and writing a call on an underlying ETF. In a volatile market, this approach provides additional flexibility to take advantage of extreme price swings.
Partners III Opportunity invests in companies of all sizes, and typically maintains short positions to help manage risk. On balance we were fairly aggressive buyers during the summer market swoon. As a result, Partners III is 86% "net long" at quarter end, up from 74% at June 30, 2011. Long positions increased to 96% of net assets, while short positions (including option-related shorts) declined to 10% of net assets. The Fund's short positions remain tilted to broad-based small and mid-cap stock ETF's.