Value pool's returns hit bottom of tally among peers
Veteran managers insist their investments will pay off
Longleaf’s long run of robust returns has hit a wall.
The $4.3 billion Longleaf Partner’s Fund beat the stock market for two decades by buying undervalued stocks and waiting for them to appreciate. This year the value formula has gone haywire, leading to a 24 percent loss as of Oct. 1 and making Longleaf the poorest performer of any diversified U.S. equity mutual fund with at least $1 billion in assets, according to data compiled by Bloomberg.
Value investors have suffered some of the worst losses in the market rout this year because the stocks they favor, such as industrials and financials, have been beaten down more than technology and health care. Longleaf, run by O. Mason Hawkins and G. Staley Cates, has sunk to the bottom mainly from its stakes in energy and casino companies. The funds holds three of the five poorest performing stocks in the Standard & Poor’s 500 Index this year.
“Their trademark is to hold on until stocks come back,” said Gregg Wolper, an analyst with Chicago-based Morningstar Inc. “When the stocks don’t come back it can be very painful.”
Longleaf’s losses in 2015 have damaged the fund’s long-term record -- it trails 97 percent of similar funds over five years -- and put it far from its goal of delivering returns of 10 percent a year plus inflation over time. Assets in the fund have declined more than 60 percent since 2007.
“I don’t think they have suddenly taken stupid pills,” said David Mendels, an adviser at Creative Financial Concepts in New York who holds shares of Longleaf. He said the managers use the same investment process that has worked over time so there is reason to think it will succeed again.
Hawkins and Cates find companies that sell at a discount to their underlying value, occupy strong competitive positions and are run by talented managers. The fund was created in 1987 by Southeastern Asset Management in Memphis, Tennessee. Hawkins, 67, has managed the fund since the beginning; Cates became a co-manager in 1994. Southeastern’s employees collectively are the biggest owners of the firm’s four mutual funds.
In its first 20 years, Longleaf returned 14 percent a year, including reinvested dividends, compared with a gain of 11 percent for the S&P 500 index. During the technology bust from 2000 to 2002, the fund rose 22 percent while the overall market lost 38 percent. Hawkins and Cates were named U.S. stock managers of the year for 2006 by Morningstar.
This year energy has been the biggest drag on returns. The fund held shares in Consol Energy Inc., Chesapeake Energy Corp. and Murphy Oil Corp. as oil prices fell from more than $100 a barrel in 2014 to roughly $45 now. In 2015 the stocks are down about 71 percent, 60 percent and 49 percent, respectively.
The managers told shareholders in a second-quarter letter that they were confident the stocks “should be meaningful contributors to strong returns” in the future. Hawkins and Cates declined to comment on their performance.
Buying Wynn Resorts
They pointed out that their energy companies are cutting costs and selling assets to offset the impact of lower prices. Chesapeake said Sept. 29 it would dismiss one in six employees to improve its financial condition.
The fund bought shares of Wynn Resorts Ltd.in the first two quarters of the year, on the assumption that weakness in the gaming market in Macau offered a chance to buy the stock at a discount. A Chinese government crackdown on corruption has slashed gambling by high rollers in Macau.
Gaming revenues have continued to plummet and Wynn is down 57 percent this year. Wynn climbed the most in six years on Oct. 2 after a report said China would support the economy in the gaming center.
Cates refused to call the investment in Macau a mistake in a June interview in Value Investor Insight.
“Do I have anything to get excited about in the next year?” he said. “Probably not. But do all those clouds lift in three to five years? We believe they will.”
Longleaf Beats S&P
Some of the fund’s other picks have also misfired. Franklin Resources Inc., an asset management firm, is down 32 percent this year. Scripps Networks Interactive Inc., which operates television and Internet businesses, fell 34 percent.
Hawkins and Cates said in their 2014 end-of-year letter to shareholders that the momentum-driven stock market reminded them of the 1990s and that then, as now, the trends could not continue indefinitely. They predicted a return to an “environment where the merits of individual holdings are more likely to be properly weighted by the market and value investment approaches are more likely to be rewarded.”
In 2015, the Russell 1000 Value Index, a benchmark for value stocks, is down 11 percent as of Oct. 1 compared with a decline of 2.3 percent for the Russell 1000 Growth Index.
Still, Longleaf is beating the S&P 500 Index over its lifetime, according to data compiled by Bloomberg. That long-term track record gives comfort to Mendels, the financial adviser, who admits he is tired of having to apologize to his clients for the fund’s performance.
“What they are doing make sense to me, so I haven’t given up yet,” he said, referring to the fund’s management team. “I hope I am right.”