Don’t Play In the Street: Equity, Even In Fixed Income
At Weitz we use a collaborative research process driven by bottom-up, fundamental research. Ongoing communication between our equity and fixed income team members promotes the cross-pollination of ideas. As such, the Weitz fixed income funds have a long history of being managed a bit differently than many of their peers, by holding a small equity allocation. According to the Investment Company Act of 1940*, a fund adopts a policy to invest, under normal circumstances, at least 80% of the value of its assets in the particular type of investments suggested by the fund’s name. The other 20% may be invested in other securities, like but not limited to, equities. In addition to their fixed income investments, the Weitz fixed income funds often take advantage of the 20% rule to invest a small percentage of total assets (generally less than 5%) in a few equity positions. We have consistently held a small equity allocation in our fixed income strategies since 9/30/1998.
As of September 30, 2016, the Weitz Short-Intermediate Income Fund (WEFIX/WSHNX) had equity exposure of 1.2% (since Tom Carney took over management responsibilities in 1996, the fund’s equity exposure has averaged 1.1%), and the Weitz Core Plus Income Fund (WCPBX/WCPNX) had equity exposure of 1.5% (since inception on 7/2014, the fund’s equity exposure has averaged 2.5%).
There are a number of factors we look for in order for an equity position to be included in the fixed income portfolio(s). First and foremost, our estimate of intrinsic value should be higher than that of the current stock price. Additionally, the “cone of outcomes” should be narrow, meaning we must have a high confidence level in the future stock price trajectory. Finally, the equity position should either pay a current dividend or have a probable dividend yield in the future. Similar to our process with regard to fixed income investing, our fixed income team looks to purchase equities whose potential yield and capital appreciation prospects are more attractive relative to the returns of ownership found with similar fixed income securities (i.e., high-yield) while the risks of the relative investments are comparable. The bottom line is, we generally will have a small equity exposure in our fixed income portfolios if we believe we are appropriately being compensated for the risks we are taking.
The equity allocations in our fixed income portfolios have generally been additive to returns over the long term. One example is our position in Redwood Trust (RWT) within our Short-Intermediate Income Fund. Redwood Trust, a REIT, invests in mortgage-related and other real estate-related assets and is engaged in residential and commercial mortgage banking activities. Through 9/30/2016, our current RWT equity allocation (initiated in 6/2007) has produced an average annual dollar-weighted return of approximately 15%. Including prior periods (initiated in 5/2003), our RWT equity allocation has produced an average annual dollar-weighted return of approximately 20%. As of 9/30/2016, RWT had a dividend yield of approximately 8%.
Other examples of equity holdings (as of 9/30/2016):
Weitz Short-Intermediate Income Fund
|Equity Ticker||Initiation Quarter (Calendar)||Quarter Sold (Calendar)||Current Dividend
|Ave. Annual Dollar Weighted
Return, Since Initiation
|EQC||2Q ‘15||3Q ‘16||No Dividend||11.4%|
Weitz Core Plus Income Fund
|Equity Ticker||Initiation Quarter (Calendar)||Quarter Sold (Calendar)||Current Dividend Yield||Ave. Annual Dollar Weighted Return, Since Initiation|
|MNR||3Q ‘14||2Q ‘16||~4.5%||21.6%|
|CPGX||3Q ‘15||1Q ‘16||Prior to its acquisition by TransCanada,
(approximately 2 Quarter
|EQC||2Q ‘15||N/A||No Dividend||11.9%|
For the Weitz fixed income funds, our primary investment objectives are capital preservation and current income. In addition, our Core Plus Income Fund has a secondary objective of capital appreciation. Based on our process, a few select stocks can help boost the returns of our fixed income funds without materially increasing the funds overall risk dynamics. As value investors, we patiently seek out areas of opportunity like those mentioned above and invest one security at a time, relying on a fundamental, research-based investment approach. With duration on the shorter-side, we are well positioned to take advantage of any market weakness.
*Section 35d-a “Investment Company Names” (a)(2)(i)
Past performance does not guarantee future results. The investment return and the principal value of an investment in any of the Funds will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than the original cost. Average annual total returns for the Short-Intermediate Income Fund’s Institutional and Investor Class for the one, five and ten year periods ended September 30, 2016 were 3.19%, 2.23% and 3.76% and 2.94%, 2.01% and 3.64%; respectively. The returns above assume reinvestment of dividends and redemption at the end of each period, and reflect the deduction of annual operating expenses, which as stated in the most recent Prospectus are 0.63% and 0.92% (gross) of the Short-Intermediate Income Fund’s Institutional Class and Investor net assets, respectively. The returns above also include fee waivers and/or expense reimbursements, if any; total returns would have been lower had there been no waivers or reimbursements. The investment adviser has agreed in writing to limit the total annual operating expenses of Investor Class shares (excluding taxes, interest, brokerage costs, acquired fund fees and expenses and extraordinary expenses) to 0.85% of the Class’s average daily net assets through July 31, 2017. Investor Class shares became available for sale on August 1, 2011. For performance prior to that date, the above returns include the actual performance of the Fund’s Institutional Class (and uses the actual expenses of the Fund’s Institutional Class), without adjustment. For any such period of time, the performance of the Fund’s Investor Class would have been similar to the performance of the Fund’s Institutional Class, because the shares of both classes are invested in the same portfolio of securities, but the classes bear different expenses.
Average annual total returns for the Core Plus Income Fund’s Institutional and Investor Class for the one and since inception periods ended September 30, 2016 were 7.04% and 4.60% and 6.82% and 4.39%; respectively. The returns above assume reinvestment of dividends and redemption at the end of each period, and reflect the deduction of annual operating expenses, which as stated in the most recent Prospectus are 1.38% (gross) and 2.36% (gross) of the Fund’s Institutional Class and Investor Class net assets, respectively. The returns above also include fee waivers and/or expense reimbursements, if any; total returns would have been lower had there been no waivers or reimbursements. The investment adviser has agreed in writing to limit the total annual operating expenses of Institutional Class shares and Investor Class shares (excluding taxes, interest, brokerage costs, acquired fund fees and expenses and extraordinary expenses) to 0.65% and 0.85% of the respective Class’s average daily net assets through July 31, 2017.
Current performance may be higher or lower than the performance data quoted. Performance data current to the most recent month end may be obtained here.
As of 9/30/2016: Our RWT equity exposure in our Short-Intermediate Income Fund comprised 0.9% of net assets; NCMI 0.3%. Our RWT equity exposure in our Core Plus Income Fund comprised 0.7% of net assets; EQC 0.8%. Portfolio composition is subject to change at any time. Current and future portfolio holdings are subject to risk.
Investors should consider carefully the investment objectives, risks and charges and expenses of the Funds before investing. The Funds’ Prospectus contains this and other information about the Funds and should be read carefully before investing. The Prospectus is available from Weitz Investment Management, weitzinvestments.com, 800-304-9745 or 402-391-1980. Portfolio composition is subject to change at any time. Current and future portfolio holdings are subject to risk.
Weitz Securities, Inc. is the distributor of the Weitz Funds.