Longleaf Partners Fund Q3 2023 Commentary

Longleaf Partners Fund declined -1.82% in the third quarter, holding up better than the S&P 500 and Russell 1000 Value, which fell -3.27% and -3.16%, respectively in a challenging, “risk-off” period. Most of our companies saw solid operational progress, translating into positive stock performance at some of our larger positions in a quarter when only Energy and Communication Services were positive absolute sectors for the S&P 500 (SP500, SPX).

The Partners Fund has no exposure to the small handful of mega-cap stocks that have dominated the market and are trading at historic valuation multiples. Many headlines refer to the “Magnificent Seven,” but we prefer to look at the top 11 most actively traded stocks globally, all of which are in the US. These 11 stocks (comprised of the Magnificent Seven + Advanced Micro Devices, Adobe, Broadcom and Netflix) have a combined market cap of just over $11 trillion and a weighted average price to earnings ratio (P/E) of 29x, while the rest of the S&P 500 trades at approximately 15.5x. These already huge companies are facing increased competition against one another coming off all-time-high aggregate profits on the back of increased interest rates. By contrast, Partners Fund owns high-quality businesses, led by management teams that are executing across the board, and the portfolio trades at 13x P/E on not yet optimized earnings, even after returning 25% over the last 12 months. We are confident in the portfolio’s positioning for future relative outperformance in multiple market environments.

We encourage you to watch our video with Portfolio Managers Ross Glotzbach and Staley Cates for a more detailed review of the quarter.

Contribution To Return As Of September 30, 2023

Portfolio Activity

After a busy first half of the year, we initiated one new position in the quarter in a business we have successfully owned previously and were able to buy again at a discount within a new corporate structure. We opportunistically trimmed and added to several positions throughout the quarter, and we exited General Electric (GE) and our small position in Hasbro after the share price ran away from us. GE was a multi-year portfolio holding for us that started out rocky but ultimately was a good illustration of owning a “quality” business that was temporarily viewed as “value” (aka, perceived as low quality) before ultimately being weighed properly by the market. CEO Larry Culp was a great partner, creating significant value for shareholders and closing the priceto-value gap. Under his leadership, GE materially improved its operations and is well under way on plans to simplify the business by separating it into three world-class companies. The market has finally caught up with reality versus perception and is pricing GE accordingly. Unfortunately, this means we no longer see a margin of safety for the business but will continue to watch GE and Culp closely and hope to have the opportunity to partner with him again.

Outlook

The Fund held its own in a challenging market with investors increasingly turning to an ever-narrower group of mega-cap companies or, on the other side of the barbell, retreating to cash that now earns something. As the valuation gap between what has worked and the rest of the market stretched even wider, we have grown more confident in our outlook for the portfolio from here. We own competitively entrenched businesses with strong balance sheets and management teams that are on offense. Our portfolio holdings in aggregate have grown their values this year. The portfolio ended the quarter with a price-to-value ratio in the low-60s%, offering meaningful upside potential. As more bottom-up opportunities have qualified this year, we have improved the quality of the portfolio over the last several quarters and have a strong and growing pipeline of new investments. We are confident our businesses will continue to deliver and are grateful for your continued partnership.

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