The Partners III Opportunity Fund’s Institutional Class returned +2.95% in the third quarter compared to +1.70% for the S&P 500 and +1.16% for the Russell 3000. For the year to date, the Partners III Opportunity Fund’s Institutional Class returned +27.60% compared to +20.55% for the S&P 500 and +20.09% for the Russell 3000.
Although the pace of gains slowed, the Fund’s positive third quarter return (both absolute and relative) added to an already strong calendar year. Quarterly returns were led by Intelligent Systems (Q3: +44%), Alphabet (Q3: +13%) and Texas Instruments (Q3: +13%). Intelligent Systems recouped prior quarter declines on its way to new highs, as more investors have been attracted to the growth outlook for the CoreCard business. Alphabet shares rose after reporting reaccelerating organic growth, while Texas Instruments shares rose as investors began to gain confidence in reaching a “bottom” for the current cycle in analog semiconductors. Year to date, Intelligent System (YTD: +222%) shares more than tripled, contributing over one-third of the Fund’s total return. Other top contributors Liberty Broadband (YTD: +45%) and Mastercard’s (YTD: +45%) very strong year-to-date returns appear modest by comparison.
DXC Technology (Q3: -46%, YTD: -44%) was one of the Fund’s top detractors (among our long positions) in both periods. DXC is a business in transition from traditional IT outsourcing arrangements to helping clients migrate their IT infrastructure, software and business processes to modern cloud architectures. Revenue is shrinking as the new digital migration business has not yet reached sufficient volume to offset the declines in legacy contracts. Adding insult to investors’ injuries, management has been unable to accurately forecast when the business will return to organic growth. After a thorough re-underwriting of our investment, we have materially lowered several of our key modeling assumptions, resulting in a lower business value estimate. Even after these negative revisions, DXC shares trade at a mid-single-digit multiple of expected earnings and free cash flow. Put simply, the shares seem priced for nothing to go right. In our experience, when expectations are this low, even a modest improvement (which we expect) can lead to a positive rerating of the stock.
Rounding out the quarterly detractors are Qurate Retail (Q3: -17%) and Liberty Global (Q3: -10%). Investors remain skeptical of Qurate’s future prospects, despite its solid cash flow generation. Liberty Global’s lackluster results underwhelmed investors who are also concerned that the planned sale of its Swiss assets will be blocked. We remain confident in the management teams of both companies and believe both stocks trade too cheaply. On a year-to-date basis, Box (YTD: -2%) joins DXC and Qurate (YTD: -47%) in the penalty box. Overall, the Fund’s short position against the S&P 500 was the top detractor from year-to-date results.
The Fund initiated a new pair trade during the quarter, initiating a long position in Dollar Tree while shorting a similar amount of Dollar General. Although currently modest in size, the position is an example of the “extra tools in the toolbox” of this long-biased portfolio. We are not specifically negative on Dollar General. Rather, we believe investors’ expectations for Dollar Tree’s acquired Family Dollar business are too low. This pair trade attempts to isolate the potential embedded value of a recovery for Family Dollar. During the quarter we also closed our positions in Booking Holdings and Wesco Aircraft. We realized quick gains from a small position in Booking. Signs of a turnaround at Wesco were encouraging, ultimately attracting a “take private” bid that led us to sell our shares.
The Fund’s short exposure remained unchanged at 15% of net assets while the effective net long drifted modestly lower to 78% of net assets. We anticipate that this current era of slow/no inflation and low/negative interest rates will, at some point, give way (see our Value Matters Letter for additional market commentary and outlook). In the interim, we feel confident that the businesses we own will be able to successfully navigate, and potentially capitalize on, whatever may come next.
Data quoted is past performance and current performance may be lower or higher. Past performance is no guarantee of future results. Investment return and principal value of an investment will fluctuate, and shares, when redeemed, may be worth more or less than their original cost. Please visit weitzinvestments.com for the most recent month-end performance.
