VALUE ADDED


A Superb Fund Rebounds

Steven Goldberg

Climb aboard Longleaf Partners, one of the best value funds you can find. It's on fire after a horrible 2008.



Few, if any, stockpicking strategies work better than identifying companies with first-rate, long-term records that are temporarily off their game -- and whose stock prices have been knocked down accordingly.

I think the same rule applies to mutual funds. Even a fund with smart managers, a consistent strategy and a great long-term record will occasionally fall flat on its face. When returns sour and panicked investors flee, it's time to get interested.

Case in point: Longleaf Partners (symbol LLPFX). From its inception in April 1987 through May 29, the fund returned an annualized 10% -- an average of two percentage points per year better than Standard & Poor's 500-stock index. Over the past ten years, the fund bested the index by an average of nearly four points per year. During the 2000-02 bear market, Longleaf actually gained 15%, while the S&P 500 shed 47%.

But the recent disaster was unforgiving for Longleaf. From October 9, 2007, through March 9, 2009, which may have marked the end of the bear market, the fund plunged 65%, compared with a loss of 55% for the S&P. That includes a loss of 51% in 2008, 14 points more than the S&P surrendered. The fund's managers made some boneheaded stock picks, such as UBS, the giant Swiss bank, and insurance company Aon. Their purchase of GM bonds also proved untimely.

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A turnaround

This year has been an altogether different story. Year-to-date through May 29, Longleaf has gained 22.4%, clobbering the S&P 500 by more than 19 percentage points. The fund has rocketed 51% since the market's March 9 bottom.

Longleaf's managers say the best is yet to come. They are Mason Hawkins, who has been on the job since the fund's launch, and Staley Cates, who became co-manager in 1994. Before they buy, the pair employ a variety of tools to determine what they call the price-to-value ratio of a stock. Price is the current stock price; value is what they think a company is really worth.

By those measures, Longleaf's portfolio -- at a price-to-value ratio of just 37% on March 31 -- was about as cheap as it had ever been. "We've never owned better companies at cheaper prices across the board ... than we owned on March 9, 2009, and we confidently believe we have the foundations in place to produce the fund's best returns," Hawkins said at the fund's annual shareholders' meeting in May.

The reason for Hawkins's confidence: Last year's bruising selloff was indiscriminate, knocking down premier companies as well as lousy ones. "What distinguished this bear market from all others was the fact that many best-in-class industry leaders were offered" at bargain-basement prices, Hawkins said. "These powerhouses had underperformed each year from 2002 to 2007. The fourth quarter of 2008 teed them up for long-term investors like no time before."

Hawkins and Cates are self-assured stock pickers, as indicated by their willingness to pile a huge percentage of Longleaf's assets into just a handful of companies. As of March 31, multimedia entertainment conglomerate Liberty Media (LMDIA) made up 14% of assets. Once-dominant computer maker Dell (DELL) accounted for 10%. Chesapeake Energy (CHK), an oil-and-gas producer, and Sun Microsystems (JAVA), which is being acquired by Oracle Corp., together made up 16%.

Longleaf usually holds only about 20 stocks. That makes the fund volatile -- about 40% more volatile than the S&P 500. As a result, it's common for Longleaf to deliver very good years and, occasionally, very bad years. As a result, you should probably put Longleaf in a supporting role in your portfolio, not at its center. The fund requires a $10,000 initial minimum investment.

In addition to feeling good about their holdings, the managers are bullish about the overall stock market. Emulating Benjamin Graham, the founder of modern security analysis, Hawkins values the market by comparing its average earnings yield (the inverse of the price-earnings ratio) over the past five years to the yield on the ten-year Treasury note. Based on that computation, stocks are about as cheap as they've been at any time over the past 45 years. "The S&P 500 has never been more attractive compared with the return you would receive from lending to the U.S. Treasury," says Hawkins.

Steven T. Goldberg (bio) is an investment adviser.



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