Longleaf Partners Funds Shareholder Letters

One of the early books that impacted my investing philosophy was Unconventional Success: A Fundamental Approach to Personal Investment by David Swensen. As a very successful manager of the Yale Endowment, he offered common-sense explanations of why low-costs are good and which core asset classes make the most sense to own.

In addition, he pointed out the characteristics to look for in successful active management:

• Hold a limited number of stocks. Bet boldly on fewer companies (high “active share”), as opposed to being a “closet index fund”.
• High rate of internal investment. The managers should have a high percentage of their own net worth in the same funds that they ask you to invest in. They should “eat their own cooking.”
• Limit assets under management. If there is more money flowing in than they can invest efficiently, they should close the fund to avoid asset bloat. This requires them to turn down more money!
• Reasonable management fees. Active management hash higher internal costs than a passive strategy, but you can still charge less than average.

Swensen pointed out Southeastern Asset Management as an example of a company that most clearly displayed all of these characteristics, but don’t miss the last part of the quote:

Southeastern Asset Management (sponsor of the Longleaf Partners mutual-fund family) exemplifies every fundamentally important, investor-friendly characteristic conducive to active-management success. Portfolio managers exhibit the courage to hold concentrated portfolios, to commit substantial funds side by side with shareholders, to limit assets under management, to show sensitivity to tax consequence, to set fees at reasonable levels, and to shut down funds in the face of diminished investment opportunity.

Even though all the signs point in the right direction, investors still face a host of uncertainties regarding Southeastern’s future active-management success.

Due to this recommendation, I try to keep up with the Longleaf Funds shareholder letters. (You can register for free e-mail updates, even if you don’t own their funds.)

Reading the shareholder letters helps illustrate the many difficulties of active management. Here’s how most of their shareholder letters go, along with specific commentary on individual stocks.

• Our Partners Fund only holds these 15-25 stocks. Our performance has been [x.xx%]. We have done [better/worse] than our benchmarks.
• We continue to believe we will generate alpha in the future because we only companies at a significant discount to our conservative appraisals.
• We claim no ability to predict short-term market moves.
• We believe that our bottom-up intrinsic value investing approach has positioned the Funds with less risk of permanent capital loss than the relevant indices across all of our strategies.

Their flagship Longleaf Partners Fund (LLPFX) has had attractive performance if you look from inception in 1987:

However, what if you read Swensen’s book when it was popular in 2005 and thought… I should buy some of that! You would have fallen far behind a simple S&P 500 index fund.

Here’s what Morningstar has to say about it:

Although Longleaf Partners’ 2016 rebound was welcome, past missteps continue to drag down its record and raise concerns about its prospects.

Longleaf again closed their flagship Longleaf Partners Fund (LLPFX) to new investors in June 2017. Their Small Cap fund has been closed to new investors since 1997. This shows that they are still holding true to the positive characteristics listed above. They could make more money by staying open, but they aren’t. Here’s a snippet from their 2017 Q2 Shareholder letter:

The eight-plus year bull market in the U.S. has made finding qualifying opportunities more difficult, particularly in larger cap companies. In addition, this year’s strong returns in most markets outside of the U.S. have made our on-deck list of prospective investments light around the world. Because we have sold and trimmed businesses whose prices have moved closer to our appraisals, our cash reserves are higher than normal. In June, we closed the Longleaf Partners Fund due to limited new investments and a high cash position.

I respect Southeastern Asset Management and I enjoy reading their shareholder letters. They might end up kicking butt in the future. However, I hold no position on any Longleaf funds because I don’t have the level of faith required to maintain my position. It’s a tough world out there, even when you are doing the “right” things. Note that LLPFX charges 0.95% of assets and multiple large-cap index funds only charge 0.05%. Consider that as of this writing, the trailing 15-year total return of LLPFX is 7.12% annualized. The trailing 15-year total return of the S&P 500 is 9.58% annualized. If you held this in a taxable account, the gap would be even wider.

Bottom line. Longleaf Partners Fund continues to be an example of promising characteristics for an investor-friendly, actively-managed mutual fund. However, their recent performance has still been questionable. They may outperform in the future, but will you stick around to see? Reading their free shareholder letters is a good way to learn about what it’s like to invest in a traditional value-oriented, actively-managed strategy.