Monday, March 10, 2008

Analysis: Long Leaf Partners

In Unconventional Success, David Swensen wrote a long tirade against what he saw as the corrupt mutual fund industry. However, in that book, he also pointed to an extremely well-managed actively managed mutual fund company, SouthEastern Asset Management's Longleaf Partners Fund. He pointed to several factors that contribute to their success:
  • A clear strategy followed with discipline: Longleaf stayed out of the dot com "boom", even when many investors questioned this strategy and pulled their money out as a result. They therefore had outstanding performance in the bust, when everyone else was crashing.
  • Tax-Managed Approach: The company does not churn stocks.
  • Concentrated Portfolio: Their top-ten holdings constitute more than 50% of the entire portfolio. They have confidence in their bets, and they bet only on their best ideas.
  • Low fees: They don't impose loads or 12b-1 charges, and over the last 15 years, their fees have gone down from 1.5% to 0.89%. Obviously, these fees are still higher than Vanguard's or DFA's, but this is for an actively managed fund, so their expenses are expected to be higher.
  • Substantial Co-Investment: As of 2003, Longleaf trustees, employees, and family owned more than $400 million of Longleaf fund shares (4% of fund assets). Their code of ethics prohibit owning employee investments outside of the firm's mutual funds. This is not common industry practice and sets them apart.
  • Willingness to close funds to new investors: a major problem with active investment is that having too large a portfolio increases the likelihood of under-performance. It's very difficult to figure out what to do with new money constantly, and if you have a great idea but can't deploy a substantial amount of your cash on it because you would otherwise move the stock, then you end up with half-implemented strategies.
In fact, at the beginning of last year when I first read the book, I looked at Longleaf's web-site, and indeed all three of their funds were closed to new investors. So I put them aside for future consideration if the funds were to open again. Last week, I saw a notice in the Wall Street Journal that they were now opening to new investments:

Mason Hawkins and Staley Cates were looking ahead -- and finding numerous stocks fitting their investment criteria. In November, Longleaf appealed to its existing shareholders to send money; in December, it opened Partners to investors in other Longleaf funds. Their cash covered new Partners stakes in UBS AG and Walgreen Co., and boosted an existing stake in Symantec Corp.

It wasn't enough. Partners opened to new accounts in January -- "temporarily," the managers emphasized.

(WSJ Feb 26, 2008)

Thus I examined whether Swensen's evaluation of them was true. First, they do seem to invest in stocks I wouldn't consider: Dell, Level 3, Symantec, and Walgreen. I'm not sure I like those stocks, but that's less important than the fact that they have a strategy. Their fees are definitely lower than other actively managed funds, and the co-investment policy is exciting. The fact that they are likely to close to new investors in short order (as soon as they get enough funds to execute on all their ideas) means that the idea of placing a minimum $10k with them to have a shot at adding to it is appealing.

I wanted to compare them to an indexing approach, however, so I visited Google Finance and plotted out their performance against the Vanguard 500 Index fund and the DFA Tax Managed Market Wide Value U.S. Porfolio (DTMMX). The result was that yes, Longleaf did outperform the S&P 500, but only matched the DFA fund (the DFA fund beat it by less than 1%, which could easily be eaten up by the financial adviser that you have to pay to get access to the DFA fund. The Longleaf International fund did worse --- while it beat the Vanguard International Fund by a good 13% over the last 7 years or so, the DFA equivalent, the DFA Tax Managed International Value Portfolio(DTMIX) trounces it by almost 20%.

It certainly shocked me at first that in international markets, which are notoriously inefficient, that the indexed approach produced by DFA beat a well-regarded active manager. Then I noticed that Longleaf did beat the benchmark Vanguard funds by substantial amounts, despite higher expenses. As such, while the results of my quick analysis confirmed my earlier decision to buy (and stick with) DFA's value funds, this limited window of opportunity (while they are open to new investors) might be a good time to take a look at Longleaf's interesting offerings (which are more interesting to those who do not have access to DFA's funds). If their past actions are any indication, these funds will not stay open for long.

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