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2 Q3 2020 Semi-Annual Report

THE WEITZ PHILOSOPHY

Finding quality at a discount

There are no shortcuts in value investing. At Weitz, we dig for opportunities using a robust quality scoring process. We analyze hundreds of ideas to find strong, well-managed but undervalued companies that offer reasonable risk-adjusted returns. It’s simple – but it’s not easy. We do the due diligence, analyze, ask tough questions and push for answers. We wait for the right opportunities. Then, and only then, do we invest your money.

Fundamental Research-Driven Process

Our research-driven investment approach means deeply understanding our investable universe so we can capitalize on opportunities that arise out of market inefficiencies. Each of our analysts focuses on finding opportunities in specific industries, ensuring deep, ongoing research within their own areas of expertise. We also encourage a generalist mentality where all investment team members vet new ideas. All investment decisions are backed by thorough analysis, logical strategies, extensive debate and our team’s commitment to long-term growth.

Bottom-Up Focus

Our focus is on finding well-run companies with strong fundamentals and outstanding long-term prospects. Valuation is our North Star. When a security is selling at a significant discount to its intrinsic value, that’s when we buy. And when it’s not selling at a discount, we have the discipline and patience to wait for the price to come our way.

High-Conviction Investing

We believe there are a limited number of great investment ideas and that intrinsic value doesn’t change with the daily ebbs and flows of the market. Our high-conviction approach means we know what we own inside and out, allowing our funds to be highly concentrated.

Today we are responsible for approximately $3 billion in investments for our shareholders – individuals, corporations, pension plans, foundations and endowments. And our commitment remains the same: to put your goals first. Always. We do so through our expertise, our flexibility, and our drive to uncover investments that can help you preserve and grow wealth.

We’re right beside you

Weitz employees have a strong commitment of investing their own assets in our mutual funds. By aligning our goals with yours, you can have confidence that we’re treating your money as if it were our own.

Q3 2020 Semi-Annual Report 3

Beginning on January 1, 2021, paper copies of the Fund’s shareholder reports will no longer be sent by mail unless specifically requested from the Fund or from your financial intermediary (such as a financial adviser). Instead, the reports will be made available at weitzinvestments.com and you will be notified by mail each time a report is posted. You will continue to receive other Fund regulatory documents (such as prospectuses or supplements) in paper unless you have elected to receive all Fund documents electronically.

If you would like to continue to receive the Fund’s future shareholder reports in paper free of charge after January 1, 2021, you may make that request (1) by contacting your financial intermediary; or (2) if you invest directly with the Fund, by calling 800-304-9745.

If you already receive shareholder reports and other Fund documents electronically, you will not be affected by this change, and you need not take any action. If you do not receive shareholder reports and other Fund documents electronically but would like to do so, contact your financial intermediary or, if you invest directly with the Fund, call 800-304-9745. An election to receive shareholder reports electronically will apply to all Funds held with the Weitz Funds and may apply to all funds held with your financial intermediary.

 

The management of Weitz Funds has chosen paper for the 80 page report from a paper manufacturer certified under the Sustainable Forestry Initiative ^® standard.

Portfolio composition is subject to change at any time and references to specific securities, industries, and sectors referenced in this report are not recommendations to purchase or sell any particular security. Current and future portfolio holdings are subject to risk. See the Schedules of Investments included in this report for the percent of assets in each of the Funds invested in particular industries or sectors.

4 Q3 2020 Semi-Annual Report

VALUE MATTERS

October 6, 2020

Dear Fellow Shareholder,

What a Recovery Looks Like

    While the stock market has roared to new highs in recent months, we likely face a longer journey to reach a full economic recovery. But we believe there will be opportunities for investors along the way.

The third quarter was a good one for our equity and conservative allocation portfolios. Mega-cap technology and “work from home” (WFH) stocks continued to pace the market’s advance. This is partly because they are better businesses for today’s economy, but also because a lot of the cash created by the Federal Reserve (Fed) for its quantitative easing program found its way into the stock market, much of it directed by index investors so it boosts those same stocks. Year-to-date returns for our equity funds reflect their relative exposure to these favored stocks.

While our focus here is primarily on equities, our fixed income portfolios also showed good quarterly and year-to-date returns. Weitz fixed income portfolio managers Tom Carney, CFA, and Nolan Anderson provide bond market perspectives in their Q3 Fixed Income Insights. In addition, you can find more specific information for all of our funds in our portfolio managers’ individual fund commentaries.

Where Are We Now?

The S&P 500 lost about one-third of its value between its February high and March low as investors reacted to the COVID-19 crisis and the shutdown of the economy. Since then, stocks have roared back to new highs, at least as measured by the S&P 500. We share investor optimism about the future, but we suspect the economic recovery will take longer and will be more uneven than the market’s rebound would suggest.

In fact, the S&P 500’s performance belies divergent trends among economic sectors. Zoom, Amazon and Netflix are actual beneficiaries of the pandemic. Airlines, hotels and theaters have been crushed. Most companies have experienced both positive and negative impacts, and investors’ affections have vacillated. Our take is that the good, the bad and the ugly alike will be mispriced from time to time and that patient investors will be able to take advantage over the next year or two as we get a clearer vision of what a new version of “normal” will be like. Here are some of the factors we are watching and trying to analyze:

Controlling the Virus

The scientific community is still learning about the coronavirus and is working overtime to develop treatments and vaccines. Policymakers are seeking a balance between shutting down for safety and opening up for economic health. In the absence of an effective vaccine, the primary public health measure available today is a regimen of testing, tracing, isolating and wearing masks. With inadequate availability of testing along with a persistent resistance to mask-wearing, we continue to experience new surges of infections (recently in the Midwest and Northwest, as this letter goes to press). Nevertheless, a combination of behavioral changes and medical advances should eventually allow for a relatively open economy. The pace of recovery is likely to be uneven, and it may be years before a majority of people are comfortable in theaters, restaurants and airplanes.

We own several companies (Danaher, LabCorp, Thermo Fisher) that provide COVID diagnostic testing and/or make instruments and supplies used in testing and developing therapeutics and vaccines. We do not own any of the drug companies that are competing to invent vaccines because we do not know how to handicap the race or to estimate the profitability of the winning product(s). As for policy measures, we citizens can have influence by voting and modeling good behavior. But the whack-a-mole nature of outbreaks would suggest that the virus will be with us for some time.

Fiscal and Monetary Policy – Debt and Deficits – Induced “Wealth Effect”

The Fed and Treasury have each injected trillions of (freshly created) dollars into the U.S. economy. Budget deficits are at record highs (by a wide margin) and the national debt has risen sharply. This spending has helped stabilize financial markets and sustain consumer spending, but it has done little to promote economic growth.

Theoretically, this money creation should be inflationary, yet potent deflationary forces (technology, globalization, excess productive capacity) have kept inflation at bay. This apparent contradiction has been puzzling to us.

One clue to how we might transition from deflation to inflation may lie in consumer expectations. So far, while government spending has risen dramatically, a large proportion of the cash has ended up as savings or debt reduction. In monetary policy language, the quantity of money has increased, but not its velocity. It seems plausible to us that if inflationary expectations rise, spending will accelerate. Spending in anticipation of price increases can create a feedback loop that pushes the inflation rate higher. The Fed is trying to push inflation up to a 2% annual rate, and once it begins to succeed, it may well over-achieve.

We have no idea when, or if, this might happen. But higher inflation generally means higher interest rates and lower P/E ratios for stocks as fixed income securities offer more potent competition for equities. No businesses are immune to inflation, but we have always favored companies that have pricing power over highly competitive and commodity-related businesses that have little control over their (pricing) destiny. Payments companies like Visa and Mastercard whose fees are tied to spending are direct beneficiaries of inflation. Subscription businesses like cable and broadband (Liberty Broadband and Comcast) and satellite radio (Liberty Sirius XM) should find it relatively easy to pass through price increases. Finally, JPMorgan, First Republic and Schwab should be able to increase their net interest margins in a higher-rate environment.

A by-product (or perhaps a primary objective?) of the Fed’s extraordinarily generous monetary policy is that trillions of new dollars have to go somewhere, and, with rates at or near zero, there is no alternative to equities. In October of 2018, when the Fed took its first baby step towards withdrawing the plentiful “free” money from the system, the S&P dropped about 20% in a few weeks. As

 

Q3 2020 Semi-Annual Report 5

economist Herb Stein said, “If something cannot go on forever, it will stop.” The end, or the threat of an end, to the current pace of monetary expansion could well cause the stock market some heartburn.

Disproportionate Impact on Poor and Low-Wage Workers

Income inequality was already a significant issue in the U.S. before COVID struck. One recent study, conducted before the pandemic, found that about 40% of American families could not afford a $400 surprise expense. This group seems more likely to include people employed in the service industry or other essential workers, more subject to infection and layoff, and likely to face catch-up payments after mortgage or rent forbearance. White-collar and other workers who have been able to work from home are less likely to have been severely impacted. While the aggregate economic indicator numbers are improving, full recovery to 2019-level economic activity will require that the “have-nots” of the economy participate as fully as the “haves.”

November Election

Whether the election results in the status quo, a Democratic sweep or something in between, there will be plenty of uncertainty as to future monetary, fiscal, tax, pandemic response, foreign policy and any number of other policy matters. The big issues, including those discussed above, will need to be addressed by whoever is in office. From the purely self-interested viewpoint of an investor, it is very hard to say that one side or the other is “best” for stocks or bonds. There are bigger issues involved than one’s portfolio, though, so we urge our clients to join us in voting.

Outlook

These are interesting times. We believe some things are different this time. The U.S. economy is resilient, and we are already seeing creative responses to the pandemic and an explosion of new products and businesses. We are optimistic about a return to a recognizable version of normal. Our quibble with the conventional wisdom, at least as reflected in today’s stock prices, is the assumption that the recovery will be quick and painless – the “V” recovery.

We believe that there will be surprises along the way and that investors’ emotional reactions will ensure plenty of volatility over the next year or two. The virus, the economy, the election, our relationship with China, persistent demands to address issues of diversity and inclusion, and the effects of climate change are all part of the mix that could keep investors off balance. Uncertainty and volatility have a way of creating opportunities for flexible investors. We are excited about the possibilities.

Thanks again to our shareholders and clients who have entrusted their investment capital to us. We appreciate your confidence.

6 Q3 2020 Semi-Annual Report

DISCLOSURES

Data quoted is past performance and current performance may be lower or higher. Past performance is no guarantee of future results. Investment return and principal value of an investment will fluctuate, and shares, when redeemed, may be worth more or less than their original cost. All investments involve risks, including possible loss of principal. Please visit weitzinvestments. com for the most recent month-end performance.

Investment results reflect applicable fees and expenses and assume all distributions are reinvested but do not reflect the deduction of taxes an investor would pay on distributions or share redemptions. Net and Gross Expense Ratios are as of the Fund’s most recent prospectus. Certain Funds have entered into fee waiver and/or expense reimbursement arrangements with the Investment Advisor. In these cases, the Advisor has contractually agreed to waive a portion of the Advisor’s fee and reimburse certain expenses (excluding taxes, interest, brokerage costs, acquired fund fees and expenses and extraordinary expenses) to limit the total annual fund operating expenses of the Class’s average daily net assets through Contractual Expiration Date of 07/31/2021. The Net Expense Ratio reflects the total annual fund operating expenses of the Fund after taking into account any such fee waiver and/or expense reimbursement, if any; total returns would have been lower had there been no waivers or reimbursements.

Performance quoted for the Balanced, Partners Value and Value Funds’ Institutional Class shares before their inception is derived from the historical performance of the Investor Class shares, which have not been adjusted for the expenses of the Institutional Class shares, had they, returns would have been different.

Performance quoted for the Partners III Opportunity and Short Duration Income Funds’ Investor Class shares before their inception is derived from the historical performance of the Institutional Class shares, which have not been adjusted for the expenses of the Institutional Class shares, had they, returns would have been different.

Index performance is hypothetical and is shown for illustrative purposes only. You cannot invest directly in an index. See page 81 for a description of all indices. The Since Inception return for the Russell 1000 Value and CPI + 1% is from 5/31/1986 and 12/31/1988, respectively. All other indices Since Inception return are since the Fund’s inception. The inception date of the Bloomberg Barclays 1-3 Year U.S. Aggregate and 5-Year Municipal Bond was 12/31/1992 and 1/29/1988, respectively.

On 12/29/2006, the Nebraska Tax-Free Income Fund succeeded to substantially all of the assets of Weitz Income Partners Limited Partnership. On 12/31/1993, Partners Value Fund succeeded to substantially all of the assets of Weitz Partners II Limited Partnership. On 12/30/2005, Partners III Opportunity Fund succeeded to substantially all of the assets of Weitz Partners III Limited Partnership. The investment objectives, policies and restrictions of the Funds are materially equivalent to those of the Partnerships, and the Partnerships were managed at all times with full investment authority by the Investment Adviser. The performance information includes performance for the Partnerships. The Partnerships were not registered under the Investment Company Act of 1940 and, therefore, were not subject to certain investment or other restrictions or requirements imposed by the 1940 Act or the Internal Revenue Code. If the Partnerships had been registered under the 1940 Act, the Partnerships’ performance might have been adversely affected.

Effective 12/16/2016, the Ultra Short Government Fund revised its principal investment strategies. Prior to that date, the Fund operated as a “government money market fund” and maintained a stable net asset value of $1.00 per share. Performance prior to 12/16/2016 reflects the Fund’s prior principal investment strategies and may not be indicative of future performance results.

Effective 12/16/2016, the Short Duration Income Fund revised its principal investment strategies. Since that time the Fund has generally maintained an average effective duration between one to three and a half years. Prior to that date, the Fund maintained a dollar–weighted average maturity of between two to five years. Performance prior to 12/16/2016 reflects the Fund’s prior principal investment strategies and may not be indicative of future performance results.

Effective 03/29/2019, the Hickory Fund invests the majority of its assets in the common stock of medium–sized companies, which the Fund considers to be companies with a market capitalization, at the time of initial purchase, of greater than $1 billion and less than or equal to the market capitalization of the largest company in the Russell Midcap Index. Prior to that date, the Fund invested the majority of its assets in the common stock of smaller– and medium–sized companies, which the Fund considered to be companies with a market capitalization, at the time of initial purchase, of less than $10 billion.

 

 

 

8 Q3 2020 Semi-Annual Report

FIXED INCOME INSIGHTS

October 20, 2020


Dear Fellow Shareholder,

While the fixed income markets continue to be challenging, Weitz fixed income funds delivered positive returns in the third quarter. The Weitz Short Duration and Weitz Core Plus Income Funds in particular exhibited strong performance. This outcome is especially gratifying after the market value declines of portfolio holdings earlier in the year. As noted in our second quarter letter, we were not forced sellers during the March upheaval, and we used our liquidity to take advantage of market volatility during the first quarter. That fact along with the strong rebound in the market values of our portfolio holdings speaks to solid credit work to date.

Weitz equity and conservative allocation funds also posted gains in the third quarter. Please see Co-Chief Investment Officers Wally Weitz and Brad Hinton’s Value Matters for more details as well as the individual fund quarterly commentaries for full analyses on all of our portfolios.

Fixed Income Market Update

The graph below shows the changes of select U.S. Treasury rates over the past quarter and year.

Source: Bloomberg

The Treasury curve hardly budged in the third quarter as shorter rates (2-, 3- and 5-year) remained anchored near zero while longer rates (10- and 30-year) rose ever so slightly.

Spreads on corporate bonds continued to decline in the third quarter, resulting in outperformance compared to U.S. Treasury bonds. A broad measure of investment-grade corporate bond spreads, compiled by ICE BofA, declined modestly in the quarter – from 160 basis points as of June 30 to 144 basis points on September 30. The chart below depicts the path of investment-grade credit spreads for the past five years (blue line) against the one- (orange) and five-year (gray) averages.

Source: Federal Reserve Economic Data (FRED) – St. Louis Fed

Overall, corporate bond credit spreads have meaningfully retraced the large spike upward that peaked in March of this year. Credit spreads remain above where they have been over the last five years, but coupled with very low ‘base’ rates (U.S. Treasury) on which nominal returns are set, forward returns on offer for corporate bonds are reaching (or have reached) all-time lows.

Index challenges – “Houston, we have a problem”

While attending an Asset TV panel a year ago, Nolan said that we believe bonds generally have a ‘math problem,’ given that forward returns across a broad swath of the fixed-income marketplace would be meaningfully reduced. If that was true a year ago, it has become even more so today – especially for broad index categories. Illustrative of that return dilemma is seen in the primary indexes for two of the Weitz taxable bond funds, namely the Bloomberg Barclays US Aggregate Bond Index (AGG) and the 1-3 year subsegment of the AGG. The table below highlights certain characteristics for the AGG and the 1-3 year subset of the AGG alongside corresponding characteristics for the Weitz Core Plus Income and Weitz Short Duration Income Funds.

Key takeaways – events of the past few years have reduced the yield to worst and yield to maturity for the indexes referenced above and for investments that follow those indexes. We believe that our Funds, with carefully selected securities outside of what the indexes hold, and currently with materially higher yield to worst and yield to maturity, offer a better opportunity to escape the aforementioned ‘math problem.’ We further note that our Funds have lower duration profiles than the indexes (duration is commonly used as a measure of an investment’s future interest rate risk).

Federal Reserve – lower for much longer

The Federal Reserve (Fed) made no changes in short-term monetary policy during the quarter (leaving rates at or near zero), but in August the Fed unanimously adopted a new monetary policy framework that, while incremental to the agency’s long-term policy goals of promoting maximum employment and stable prices, may result in a lower for a lot longer short-term interest rate environment.

The Fed’s new policy framework establishes an average inflation targeting regime as well as a rather remarkable combination of factors to wait for before moving short-term interest rates off zero. Namely, the Fed expects to maintain the current Federal Funds rate (between zero and 25 basis points) until the labor market reaches full employment and inflation has consistently averaged 2% over a one-, three-, or five-year time period. In other words, the Fed appears willing to allow inflation to overshoot 2% for some amount of time to allow the labor market to reach the Fed’s

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Q3 2020 Semi-Annual Report 9

view of full employment. Using the Fed’s long-standing measure of 4.1% unemployment as the measure of full employment and the Fed’s favored inflation gauge of PCE (personal consumption expenditures), these conditions have been an extreme historical anomaly, rarely occurring together at the same time. The Fed’s new inflation targeting regime has something in common with Samuel Beckett’s tragic comedy “Waiting for Godot” – they’re both waiting for something that may never happen. As one macro strategist suggests by analogy, the Fed is attempting to cast itself as a sort of monetary Peter Pan who wants the economy to come visit Never-Never Land.

While this new policy framework by the Fed may be more evolutionary than revolutionary, it does appear to have important implications for fixed-income investors. The acronym ZIRP (Zero Interest Rate Policy) that came into being after the Great Recession of 2008, and that resulted in short-term interest rates remaining at zero for six years could easily be eclipsed by the Fed’s new average inflation targeting and full employment directive.

Taking the Market’s Temperature

“Chaos and volatility are what “value” investors live for, and if we can muster the right combination of common sense and courage, we might just thrive.” – Wally Weitz August 2020

While we refrain from making bold (if any) market predictions/ prognostications, we do fully subscribe to Howard Mark’s wise advice of taking stock of the marketplace’s proverbial temperature. Speaking of temperature, 2020 has witnessed temperature swings like few, if any, others in history. Thanks to the patient, value-oriented investment approach instilled by our founder, whose recent but timeless quote began this section, our investment approach has always been to take advantage of the opportunities the market provides – by gradually expanding our circle of competence and patiently searching for pockets of favorable risk/ reward investments. The ‘chaos and volatility’ (high temperature) of 2020’s first quarter has given way to a much calmer environment (mild temperature). Entering the home stretch of a historically challenging year, this is what we see:

•  A ‘pedal to the metal’ monetary policy that will keep short-term interest rates lower for longer, and a stated intention to allow inflation (when it returns) to run hotter (higher) than the Fed’s previous 2% target, in order to aid in the labor market recovery. The result, absent yield curve control by the Fed (a potential topic for another time), may be a steeper yield curve that should have less negative impact on lower duration portfolios.

•  An economic recovery that progresses in fits and starts (not V-shaped) where the handoff from a massive fiscal and monetary stimulus will be tricky and likely volatile.

•  We may still be in the economic ‘eye’ of the Category 5 hurricane caused by the response to limit the spread of COVID-19; that is, it may be calm at present, but we continue to expect turbulence as we navigate to the other side of the storm’s ‘eyewall.’

•  The Fed’s direct buying of assets (Treasuries, mortgages, corporate bonds, ETFs) has reduced the value and forward return opportunities in many areas of the marketplace, and we believe active managers can add value by seeking out the most promising market sectors.

Our fixed-income funds have broad, flexible mandates that, we believe, allow us to navigate the increasingly lower return environment by identifying investment opportunities away from price-insensitive index investors and less influenced by Fed intervention (such as structured products).

Our goals remain the same. Namely, to (a) preserve capital, (b) maintain a strong liquidity position, (c) understand evolving risks and opportunities, (d) selectively take advantage of favorable risk/ reward opportunities, and (e) conduct consistent/thorough credit surveillance. We remain ready to take advantage of valuation disparities that may develop, and we hope to continue to earn your trust.

 

Definitions: Investment Grade: We consider investment grade to be those securities rated at least BBB- by one or more credit ratings agencies. Yield to maturity (YTM): the total return anticipated on a bond portfolio if the bonds are held to maturity. Yield to worst (YTW): the lowest potential yield (most conservative yield) that can be received on a bond without the issuer actually defaulting. YTW is calculated by using worst-case scenario provisions, including prepayments, calls and sinking funds. Furthermore, YTW is a forward-looking estimate that ignores capital gains.

 

10 Q3 2020 Semi-Annual Report

ANALYST CORNER

First Republic Bank (FRC)

Sean R. Pompa,

CFA Research Analyst

Service That Delights… From a Bank

     “Costco has an enormous appeal to its constituency, and they surprise and delight their customers, and there is nothing like that in business. If you haven’t delighted customers, you’re a long way home.”

-- Warren Buffett, BRK’s 2018 Shareholder Meeting

First Republic Bank (FRC) is an ultra-high-touch bank and wealth management company offering personal banking, business banking, trust and wealth management services. The bank caters to low-risk, high-net-worth clientele (households with $1 million+ in investable assets) as well as households that are likely to become high-net-worth in the future. The San Francisco-based company was co-founded by current Chairman/CEO Jim Herbert in 1985 with eight employees and $8 million in bank assets. Since then, FRC has grown to become the twenty-fifth largest bank in the U.S. with 4,800+ employees, $133 billion in bank assets, and a combined $168 billion in client wealth management assets under management (AUM) and assets under administration (AUA).

The Business Model:

We view FRC less like a commodity spread lender (even though net interest income comprises over 80% of pre-provision revenue) and more like a rarified luxury service organization making money through banking and wealth management services. FRC’s earnings growth is less a function of market interest rates (although higher rates certainly wouldn’t hurt) and credit cycles, and more fueled by the efficient acquisition of customers with high lifetime values that grow over time. This focus has historically driven consistent increases in bank assets and client AUM/AUA, and we believe this will continue long into the future.

Most banks – community, regional, and money center – employ attempted cost leadership strategies that are meant to serve a broad customer base and keep operation costs low in order to support attractive pricing. FRC on the other hand takes a differentiation focus approach aiming to serve a narrower customer base with high-touch service that provides high utility. This differentiation strategy has been consistent since the company’s founding and has many interesting, interdependent aspects, including:

1)   Focusing on high-net-worth and young professional households in a handful of large U.S. metropolitan areas where target households are concentrated and growing. FRC’s core markets are the San Francisco Bay Area, Southern California, New York City and Boston. Concentrating infrastructure in locations with large and growing addressable markets supports a more favorable operating leverage profile, where much of the incremental profits can be reinvested back into the business to support continued growth.

2)   Giving these households – particularly the younger ones that are earlier in their earnings lifecycle – an incentive to become clients by offering favorably priced jumbo residential mortgage loans (originated balances over $725,000), student loan refinancing (FRC only wants to refinance clients that have already graduated – predominantly from graduate schools – and have attractive credit profiles), and professional loans (e.g. loans backed by the client’s equity in their law firm, medical practice, private equity firm, etc.).

3)   Offering top-notch client service to attract, retain and expand client relationships. FRC’s superior service starts with a difficult-to-replicate organizational structure – one that emphasizes intimate personalization and teamwork rather than hierarchy, red tape and competing fiefdoms. When a new client walks in the door looking for a specific product, whichever frontline advisor (relationship managers, business bankers, wealth managers, etc.) services the transaction becomes that client’s point person (or “face of the bank”) for the entire duration of that employee’s tenure at FRC, regardless of career progression. As the client’s relationship grows (e.g. expanding beyond personal banking products to business banking and/or wealth management services), the point person quarterbacks each transaction across the organization in a way that creates little friction for the client.

Our view is that FRC’s primary selling point is not just having a comprehensive menu of financial products, but saving clients’ time, energy and peace-of-mind as they navigate evolving financial situations. FRC attracts customers who want banking and wealth management to be a pleasant, even enjoyable experience rather than an extended chore. The return on this differentiated client service can be evaluated across multiple data points. First, FRC’s Net Promoter Score (a widely adopted measure of customer satisfaction) has historically been roughly double that of the banking industry average and runs above leading non-bank brands like Apple, Ritz-Carlton and Southwest Airlines. Second, annual deposit attrition is just 2% versus the bank industry average of 8%, making it much easier to grow the business and do it with low-cost funding. Finally, over half of the bank’s growth is coming from expanded relationships with existing clients and nearly a third from new clients brought on by existing client referrals.

4)   Sustaining the service engine through exceptional employee retention, achieved by offering high compensation, the right incentives, and more capacity to service customers. FRC’s focus on well-heeled clientele naturally translates to more complex banking needs (the average FRC client has a high-single-digit number of products at the bank) and higher average client balances. As a result, FRC employees handle a large amount of assets/AUM/AUA/deposit dollars, yet those dollars are tied to a much smaller-than-average number of client accounts. To highlight this efficiency, it’s worth noting that FRC’s bank assets per employee ratio is 1.5x that of peer banks, annual revenue per employee is around 1.75x that of peers at roughly $700,000, and the number of deposit accounts is just one-fourth that of peers. This translates to more bandwidth to service clients and a sustained ability to pay the average employee more than 2x that of peers. We would venture to guess that this is a primary driver behind FRC’s low-single-digit frontline employee turnover each year. Such retention coupled with matching bankers and clients in the same age cohort help reinforce the “personal banker for life” value proposition.

The client’s personal banker is ultimately compensated on each client’s customer lifetime value while bankers who serve in support roles on a given transaction are incentivized to provide exceptional service because they share in the incremental compensation pool. Aside from driving client growth and cross-selling, frontline employee incentives importantly emphasize conservative underwriting through aggressive clawbacks (i.e. paying back 4-7x the bonus paid

 

Q3 2020 Semi-Annual Report 11

on an impaired loan). Further, executive compensation is geared to maintaining pristine credit, strong regulatory performance, and double-digit returns on equity.

The end result is a bank that has consistently grown its earning assets at a high-teens annualized growth rate and AUM/AUA at a slightly faster rate, all while maintaining attractive returns.

With low-risk clients, exemplary underwriting, and correspondingly benign credit costs (cumulative net charge-offs just 0.12% on all loans originated since 1985), net income tends to track earning asset growth plus or minus impacts from changes in the net interest margin¹. Earnings per share (EPS) growth is slightly lower due to share count growth (FRC partially finances its rapid balance sheet growth by periodically issuing equity, staying above target capital ratios). Over the last five years, earning assets have grown 19% annualized, net income has grown at 15%, and EPS has grown at 11%.

The Long-Term Outlook

Going forward, we believe FRC can sustain low teens EPS growth and maintain a premium valuation multiple (although we seek to buy aggressively at attractive discounts).

On one hand, there’s a risk that earning asset and AUM/AUA growth moderates relative to historical growth rates, at least in the near-to-medium term due to potentially weaker high-net-worth household growth and deterioration in target client financial health. Additionally, the COVID-19-led recession may result in near-term credit costs that exceed what occurred in the Great Financial Crisis of 2008-2009. However, we think such costs are likely to be very manageable and well below whatever industry average shakes out due to a stronger borrower profile and high collateral coverage (~80% of the loan book is secured by real estate, and loan balances to real estate appraisal values are below 60% on average across lending lines). Further, our comfort around prospective credit performance takes into account FRC’s historically stable and diversified loan mix, which notably has low exposure to direct impacts from pandemic-related social distancing (i.e. low exposure to restaurants, hotels, and travel-related borrowers, and no credit card or auto loans).

Balancing the risks, the long-term earning asset growth setup appears attractive when accounting for a 10+ year strategic initiative that has skewed the client mix towards younger demographics (i.e. less mature banking relationships = more room for cross-selling and account balance growth), a big remaining cross-selling gap between the bank and wealth management divisions, and the ability to take target client share in a downturn via the attractively priced “client acquisition” loans (e.g. jumbo residential mortgages) previously discussed. FRC has consistently taken high-net-worth household market share over its history, yet the bank’s penetration of these target clients remains just under 5% within its operating footprint. We think the runway for growth is quite long.

Finally, while FRC’s net interest margin is somewhat less sensitive to movements in market interest rates, suffice it to say that the decade-plus low-rate environment has been a headwind. However, with the Federal Reserve’s current zero interest rate policy and many years of adverse balance sheet repricing baked in the cake, the odds of net interest margin just staying neutral or becoming a meaningful tailwind to earnings (something we’re still hesitant to build into our base model) are now much better, thus offering additional upside optionality that seems far from embedded into today’s stock price.

As of 09/30/2020, First Republic Bank (FRC) constituted a portion of the net assets of the following Weitz Funds: Hickory Fund (1.6%), Partners Value Fund (1.6%).

As of 09/30/2020 Apple Inc. (APPL), Marriott International, Inc. (MAR) (parent company of The Ritz-Carlton Hotel Company), and Southwest Airlines Co. (LUV) were not held in any Weitz Funds.

Holdings are subject to change and may not be representative of the Fund’s current or future investments.

¹ A function of market interest rates and balance sheet mix, net interest margin is the difference between interest income on average earning assets and interest expense on average liabilities all over average earning assets. Net interest margin multiplied by average earning assets = Net Interest Income, FRC’s chief source of revenue.

Sean Pompa, CFA, joined Weitz Investments in 2019. Prior to joining the firm, he was an equity analyst at First Pacific Advisors. Previously, he was an associate national bank examiner at the Office of the Comptroller of the Currency. Sean has a BSBA in finance and a BA in political science from West Virginia University and an MBA from UCLA’s Anderson School of Management.

 

12 Q3 2020 Semi-Annual Report

BALANCED FUND

Portfolio Manager: Brad Hinton, CFA

Investment Style: Conservative Allocation

The Balanced Fund’s Institutional Class returned +4.27% for the third quarter compared to +3.61% for the Morningstar Moderately Conservative Target Risk Index (the Fund’s primary benchmark). Year to date, the Fund’s Institutional Class has returned +3.49% compared to +4.42% for the primary benchmark. Over the longer term, total returns well above inflation have helped our investors retain and steadily build wealth.

Overall, it was a good quarter for Fund investors. Equities posted strong gains while bond returns moderated as the gravitational pull of low interest rates took hold. After a long, hot summer of scorching equity returns and Robinhood trading success stories, our approach probably seemed a bit stodgy. September provided a reminder of the virtues of our conservative allocation strategy. Stocks stumbled, especially the white-hot favorites, and bonds provided no relief. In contrast, the Fund posted a flat return for the month. While we place no emphasis on short-term results, we do believe that protecting gains is as important as generating them.

Thermo Fisher Scientific and Danaher again paced the Fund’s quarterly contributors. Both companies experienced revenue tailwinds from helping society deal with the COVID-19 pandemic, and their core businesses showed resilience. After lagging in the first half of 2020, Berkshire Hathaway’s stock rebounded strongly in the third quarter. We thought the battleship was simply priced too cheaply, and the market eventually took notice. Charter Communications posted another set of strong results driving the stock to new all-time highs. Analog Devices was the only modest detractor in the quarter, with a single-digit price decline that was not noteworthy.

The year-to-date story is similar. Thermo Fisher, Microsoft and Danaher tallied gains of over 30%, while timely first-quarter purchases of S&P Global added nicely to results. Financial companies topped the list of detractors. We wrote about Redwood Trust’s challenges in the first quarter. After weathering the worst of the storm, the mortgage REIT’s business is on firmer footing and the stock has rallied nearly 50%. We remain resolute on the multi-year outlooks at Charles Schwab and JPMorgan Chase. While both face current headwinds, they offer contrarian exposure to a potentially steeper yield curve (someday).

We added one “meat and potatoes” stock during the quarter, Fidelity National Information Services (FIS). We owned this leading core bank and payment processor in the mid-2010s, so our team knows the company and industry well. FIS acquired Worldpay last year, adding to the company’s capabilities, strengthening its moat, and enhancing its profit growth story. FIS is riding several industry tailwinds, and for the next few years has the chance to power through broader economic turbulence. While the risk/reward skew is favorable, the stock is more likely to be a role-playing grinder than a superstar.

We also bought two hybrid securities that offer equity-like return potential. Redwood Trust’s convertible bonds, due in 2024, have a favorable risk/reward skew from a price well below par. While the conversion feature is worth little, the bond component yields over 8% to the nearly four-year maturity. Qurate Retail distributed new 8% cumulative preferred securities to owners as part of a broader capital structure shuffle. We were pleased to buy at favorable prices as some common equity owners sold the new security that did not fit their investment mandates.

“The 60/40 Portfolio is Dead.”

Variations of this storyline have been making the rounds in the latest financial news cycle. Brazen headlines generate more clicks than plain statements like, “Returns are going to be harder to come by…for all assets.” Interest rates are pinned near zero, punishing savers. Financial asset prices have been bid higher across the board. The harsh reality is that investors are going to have to work harder for less return. That outlook does not light up marketing decks, but it sounds a lot like the lived experience of millions of Americans for the past decade(s). Our response is simple, “Let’s pick up the lunch pail, roll up our sleeves, and get on with it.”

To be clear, the “bond math” challenges are very real. The primary issue for passive allocation investors is that the gravy train from investing in longer-term bonds is over. Investors have ridden strong, dual tailwinds of declining interest rates and tightening credit spreads to generate healthy returns from capital gains in their bond portfolios. The popular indexes still have high interest rate exposure (i.e., long durations), which increasingly offer what Jim Grant eloquently described as “return-free risk.” Our short, high-quality bond approach has not used this playbook for the past decade, so we do not need to find a new one.

We manage a very different kind of allocation strategy, and our differences give us advantages. Security selection is our calling card. We start by investing 40-50% of the Fund in common equities. Stock picking is where we expect to generate most of our long-term returns. We also intend to keep roughly a quarter of the Fund in liquid, high-quality securities focused first on return of capital, rather than return on capital. This allocation provides ballast that helps make the Fund an all-weather port in any market storm (such as the one that began in the first quarter of 2020).

Beyond those core allocations, we have the freedom to flex the rest of the portfolio. We look throughout the capital structure for opportunities, as evidenced by the hybrid security purchases described earlier. Our fixed income team specializes in sourcing investments that are not available through indexes. These idiosyncratic, off-the-beaten-path assets often trade by appointment, a credit to the relationships Weitz fixed income portfolio managers Tom Carney, CFA, and Nolan Anderson have built over the years. Examples include asset-backed securities (6.6%), non-agency mortgage-backed securities (2.1%), and other structured products (2.7%). We take a conservative approach to how and where we invest, with a focus on spreading risk across sponsors, asset types, vintages, and structures. We also know that market conditions are not static, meaning that today’s opportunity set is not the only one open to us. In the investing long-game, disciplined patience is often rewarded when you least expect it.

The resulting portfolio continues to evolve with market conditions. We own common equity stakes in 29 companies totaling 40.2% of net assets. High-yielding, hybrid securities represent another 2.6% of the Fund. Fixed income holdings include investment-grade corporate bonds (5.9%), securitized debt (11.3%), Treasury securities (27.0%), and cash equivalents (13.6%). We have plenty of capacity to lean into new opportunities as our team uncovers them.

We think the Fund remains well-positioned to provide long-term capital appreciation and capital preservation. Meaningful current income will be more challenging for the time being. As always, we encourage investors to evaluate the strategy on a total-return basis over longer time horizons. Thank you for your investment and continued confidence in the Fund and our firm.

Definitions: Investment-grade bonds are those securities rated at least BBB- by one or more credit ratings agencies.

Data quoted is past performance and current performance may be lower or higher. Past performance is no guarantee of future results. Investment return and principal value of an investment will fluctuate, and shares, when redeemed, may be worth more or less than their original cost. All investments involve risks, including possible loss of principal. Please visit weitzinvestments.com for the most recent month-end performance.

Investment results reflect applicable fees and expenses and assume all distributions are reinvested but do not reflect the deduction of taxes an investor would pay on distributions or share redemptions. Net and Gross Expense Ratios are as of the Fund’s most recent prospectus. The Fund has entered into fee waiver and/or expense reimbursement arrangements with the Investment Advisor. The Advisor has contractually agreed to waive a portion of the Advisor’s fee and reimburse certain expenses (excluding taxes, interest, brokerage costs, acquired fund fees and expenses and extraordinary expenses) to limit the total annual fund operating expenses of the Class’s average daily net assets through 07/31/2021. The Net Expense Ratio reflects the total annual fund operating expenses of the Fund after taking into account any such fee waiver and/or expense reimbursement, if any; total returns would have been lower had there been no waivers or reimbursements.

See page 8 for additional performance disclosures. See page 81 for a description of all indices.

The Fund receives credit quality ratings on portfolio securities when available from credit rating agencies. The Fund itself has not been rated by a credit rating agency. Ratings and portfolio credit quality may change over time. A security is “investment grade” when it has received a credit quality rating of at least BBB. If a security has received different ratings from more than one rating agency, then the highest rating is used. Mortgage related securities issued and guaranteed by government sponsored agencies such as Fannie Mae and Freddie Mac are generally not rated by rating agencies. Securities which are not rated do not necessarily indicate low quality. Fannie Mae’s and Freddie Mac’s senior long-term debt are currently rating Aaa and AAA by Moody’s and Fitch, respectively.

Contributions to Fund performance are based on actual daily holdings. Securities may have been bought or sold during the quarter. Return shown is the actual quarterly return of the security or combination of share classes.

Source (Fixed Income Attributes, Credit Quality, and Maturity Distribution): Bloomberg Analytics Source (Top Performers, Bottom Performers): FactSet Analytics

 

14 Q3 2020 Semi-Annual Report

CORE PLUS INCOME FUND

Portfolio Managers: Tom Carney, CFA & Nolan Anderson

Investment Style: Intermediate-Term Bond

The Core Plus Income Fund’s Institutional Class returned +2.21% for the third quarter compared to a +0.62% return for the Bloomberg Barclays US Aggregate Bond Index (the Fund’s primary benchmark). Year to date, the Fund’s Institutional Class returned +7.58% compared to a +6.79% return for the benchmark. A further tightening of credit spreads (particularly in high-yield bonds) and better-than-expected credit performance in our asset-backed security (ABS) and commercial mortgage-backed security (CMBS) portfolio drove our third-quarter outperformance.

While significant economic uncertainty remains, we continue to be pleased with the credit performance of our portfolio. Due to the strong quarterly and year-to-date performance, the Fund’s overall yield to worst (YTW) declined to 3.8% as of September 30, from 4.9% as of June 30 and 6.6% as of March 31. As a reminder, YTW has historically been a reasonable predictor of forward returns. And while favorable reinvestment opportunities are becoming increasingly difficult to uncover, we continue to like what we own, and our YTW at quarter-end remains quite favorable compared to the benchmark’s yield to worst of 1.18%.

Portfolio Positioning

The table below shows the change in allocation to various sectors, from Q2 2020 to Q3 2020 and from September 30, 2019, to September 30, 2020. This summary shows how we have allocated capital over time. Since our goal is to invest in sectors we believe offer the best risk-adjusted returns, our allocations may change significantly over time.

+	High-Yield exposure (as of 09/30/2020) consists of investments in the Corporate, Corporate Convertible, ABS and CMBS sectors.

New investment activity moderated from the first half of the year as we remain patient in seeking qualifying investment opportunities. Most noteworthy was our new ABS investments in corporate collateralized loan obligations (CLOs) (see Corporate CLOs section that follows). We also made investments in Qurate Retail. Qurate’s shopping offerings across pay-TV, dot-com and other digital channels were well suited for the current environment, driving a return to sales growth in the second quarter, the first in more than a year. Management also took steps to highlight the company’s resilient cash flow generation, distributing new 8% cumulative preferred securities to owners as part of a broader capital shuffle. Thanks to the strong collaboration of Weitz equity and fixed income teams (a special shout-out to equity portfolio manager Drew Weitz), the Fund purchased Qurate common stock, then received a distribution of its preferred securities, and then purchased additional preferred at attractive prices due to what we believe was largely technical selling pressure from index funds that are unable to hold preferred securities.

As of September 30, our high-yield exposure was 16.3%, up from 15.1% on June 30 (the portfolio’s high-yield limit is 25%). In terms of overall portfolio metrics, the average effective maturity declined to 5.5 years from 5.8 years and the average effective duration declined to 4.4 years from 4.7 years (versus 6.0 years for the benchmark as of September 30). These measures provide a guide to the Fund’s interest rate sensitivity. A lower average effective maturity and shorter average effective duration reduce the Fund’s price sensitivity to changes in interest rates (either up or down).

Top Quarterly Contributors

Sector allocation and security selection were the key drivers of performance.

•     Corporate and Convertible Bonds: Our corporate bond segment drove almost half of the total return during the quarter as credit spreads, particularly in high-yield, continued to decline. Retail holding L Brands, consumer finance company One Main Financial, leisure holding SilverSea Cruise Finance (a subsidiary of Royal Caribbean), E&P producer Matador Resources and Redwood Trust convertible bonds were the standout high-yield credits.

•     Asset-Backed Securities (ABS): Our ABS investments across all categories (e.g. auto, consumer, equipment, fleet lease) provided solid coupon income and capital appreciation while also continuing to exhibit better-than-anticipated credit performance given the economic environment.

•     Commercial Mortgage-Backed Securities (CMBS): Our CMBS segment contributed strong price appreciation in the quarter as business plans continued to progress among our various commercial real-estate collateralized loan obligations (CRE CLOs), such as Granite Point and ReadyCap, and our single asset single borrower (SASB) holdings from Hilton and Retail Value.

Top Quarterly Detractors

•     While no sector materially detracted from performance, the bonds of NGL Energy Partners gave back some of what they recovered in the second quarter. The energy sector is suffering from multiple headwinds, most important of which is the current low-price environment. Low oil prices have negatively impacted the near-term production volumes of NGL’s producer customers, which use NGL’s midstream infrastructure located in the Permian Basin in Texas and the DJ Basin in Colorado. Recently, NGL’s largest counterparty in Colorado filed for bankruptcy and there is significant uncertainty as to the value of the midstream contract going forward. These risks caused NGL’s bonds to be downgraded by Moody’s from B2 to B3. We have spoken to NGL’s management and believe the company is responding to these challenges, including a potential renegotiation of its midstream contract. A reasonable solution should also help NGL negotiate an extension of its credit facility that matures in October 2021. Given the quality of the assets and the long-term cash flow potential, we like the risk/reward at current bond prices.

 

Q3 2020 Semi-Annual Report 15

Corporate Collateralized Loan Obligations (Corporate CLOs)

The Core Plus Income Fund made its first corporate CLO investments in the second quarter. While this represents new territory for Weitz, we believe it is a natural progression and builds on the securitized products work we have done over the past decade. As with all securitized products, the investment process for corporate CLO investing is focused on the underlying collateral characteristics, the quality of the sponsor, and the securitization’s structural features and investor protections. There are two distinct corporate CLO markets: the larger broadly syndicated loan (BSL) market and the smaller middle market (MM). While there are pros and cons for each, we believe CLOs backed by middle market loans offer particularly attractive risk/reward characteristics for us at this time.

In terms of the underlying collateral, typical MM CLOs are backed by first-lien, senior secured loans issued to private companies who do not have publicly rated debt. To help offset the investor risks associated with smaller size and scale, we have seen that MM loans generally have wider spreads, exhibit lower leverage, and have better loan structures and covenant protections than BSL loans. Unlike BSLs, MM loans are more idiosyncratic in nature whereby the sponsor is more directly involved in negotiating lending terms with each borrower. Financial covenants and control language in the event of a workout or event of default are specifically tailored for borrowers within each credit agreement. The individualized characteristics of MM loans tends to lead to a lack of liquidity in the underlying loans.

Given the unique risks involved in middle market lending, sponsor skill is critical to strong credit performance. To that end, we came away from our months of due diligence very impressed with the size, scale, and sophistication of many of the top-tier middle market sponsors. Many of these sponsors have proven track records through multiple credit cycles. Another distinguishing factor in the middle market is the alignment of interest between MM CLO investors and sponsors. Middle market sponsors tend to retain the bottom 15-25% of their securitizations, representing significant “skin-in-game.” In the BSL market, sponsors typically retain only the legally required minimum of 5.0%.

For the MM CLOs we have purchased, credit enhancement is provided through overcollateralization, the subordination of cash flows and excess spread (similar to the credit enhancement structures for other ABS). We believe these particular MM CLOs have demonstrated resiliency through multiple credit cycles, and we like their risk/reward profiles (especially their coupon payments) in today’s challenging fixed income environment.

Taking the Market’s Temperature – excerpt from Q3 2020 Fixed-Income Insights.

“Chaos and volatility are what “value” investors live for, and if we can muster the right combination of common sense and courage, we might just thrive.” – Wally Weitz August 2020 While we refrain from making bold (if any) market predictions/ prognostications, we do fully subscribe to Howard Mark’s wise advice of taking stock of the marketplace’s proverbial temperature. Speaking of temperature, 2020 has witnessed temperature swings like few, if any, others in history. Thanks to the patient, value-oriented investment approach instilled by our founder, whose recent but timeless quote began this section, our investment approach has always been to take advantage of the opportunities the market provides – by gradually expanding our circle of competence and patiently searching for pockets of favorable risk/reward investments. The ‘chaos and volatility’ (high temperature) of 2020’s first quarter has given way to a much calmer environment (mild temperature). Entering the home stretch of a historically challenging year, this is what we see:

•     A ‘pedal to the metal’ monetary policy that will keep short-term interest rates lower for longer, and a stated intention to allow inflation (when it returns) to run hotter (higher) than the Fed’s previous 2% target, in order to aid in the labor market recovery. The result, absent yield curve control by the Fed (a potential topic for another time), may be a steeper yield curve that should have less negative impact on lower duration portfolios.

•     An economic recovery that progresses in fits and starts (not V-shaped) where the handoff from a massive fiscal and monetary stimulus will be tricky and likely volatile.

•     We may still be in the economic ‘eye’ of the Category 5 hurricane caused by the response to limit the spread of COVID-19; that is, it may be calm at present, but we continue to expect turbulence as we navigate to the other side of the storm’s ‘eyewall.’

•     The Fed’s direct buying of assets (Treasuries, mortgages, corporate bonds, ETFs) has reduced the value and forward return opportunities in many areas of the marketplace, and we believe active managers can add value by seeking out the most promising market sectors.

Our fixed-income funds have broad, flexible mandates that, we believe, allow us to navigate the increasingly lower return environment by identifying investment opportunities away from price-insensitive index investors and less influenced by Fed intervention (such as structured products).

Our goals remain the same. Namely, to (a) preserve capital, (b) maintain a strong liquidity position, (c) understand evolving risks and opportunities, (d) selectively take advantage of favorable risk/reward opportunities, and (e) conduct consistent/thorough credit surveillance. We remain ready to take advantage of valuation disparities that may develop, and we hope to continue to earn your trust.

Definitions: Average effective duration provides a measure of a fund’s interest-rate sensitivity. The longer a fund’s duration, the more sensitive the fund is to shifts in interest rates. Average effective maturity is the weighted average of the maturities of a fund’s underlying bonds. Investment-grade bonds are those securities rated at least BBB- by one or more credit ratings agencies. Non-investment grade bonds are those securities (commonly referred to as “high yield” or “junk” bonds) rated below BBB- by two or more credit ratings agencies. Yield to worst (YTW) is the lowest potential yield that can be received on a bond portfolio without the issuers actually defaulting.

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Data quoted is past performance and current performance may be lower or higher. Past performance is no guarantee of future results.

Investment return and principal value of an investment will fluctuate, and shares, when redeemed, may be worth more or less than their original cost. All investments involve risks, including possible loss of principal. Please visit weitzinvestments.com for the most recent month-end performance.

Investment results reflect applicable fees and expenses and assume all distributions are reinvested but do not reflect the deduction of taxes an investor would pay on distributions or share redemptions. Net and Gross Expense Ratios are as of the Fund’s most recent prospectus. The Fund has entered into fee waiver and/or expense reimbursement arrangements with the Investment Advisor. The Advisor has contractually agreed to waive a portion of the Advisor’s fee and reimburse certain expenses (excluding taxes, interest, brokerage costs, acquired fund fees and expenses and extraordinary expenses) to limit the total annual fund operating expenses of the Class’s average daily net assets through 07/31/2021. The Net Expense Ratio reflects the total annual fund operating expenses of the Fund after taking into account any such fee waiver and/or expense reimbursement, if any; total returns would have been lower had there been no waivers or reimbursements.

See page 8 for additional performance disclosures. See page 81 for a description of all indices.

The Fund receives credit quality ratings on portfolio securities when available from credit rating agencies. The Fund itself has not been rated by a credit rating agency. Ratings and portfolio credit quality may change over time. A security is “investment grade” when it has received a credit quality rating of at least BBB. If a security has received different ratings from more than one rating agency, then the highest rating is used. Mortgage related securities issued and guaranteed by government sponsored agencies such as Fannie Mae and Freddie Mac are generally not rated by rating agencies. Securities which are not rated do not necessarily indicate low quality. Fannie Mae’s and Freddie Mac’s senior long-term debt are currently rating Aaa and AAA by Moody’s and Fitch, respectively.

Source (Fixed Income Attributes, Credit Quality, and Maturity Distribution): Bloomberg Analytics

 

Q3 2020 Semi-Annual Report 17

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18 Q3 2020 Semi-Annual Report

HICKORY FUND

Portfolio Managers: Wally Weitz, CFA & Drew Weitz

Investment Style: Mid-Cap Value

The Hickory Fund returned +4.82% in the third calendar quarter compared to +7.46% for the Russell Midcap Index, the Fund’s primary benchmark. For the calendar year to date, the Hickory Fund returned -10.39% compared to -2.34% for the Russell Midcap Index.

Equities extended their rally during the third quarter, with some sectors once again reaching new highs. Our portfolio continued to recover as well, albeit at a slower pace than in the prior quarter. The U.S. economy continues to heal from the worst of the shutdown-induced trauma, but progress has somewhat lagged the pace set by the market. This is not unexpected, as stock prices reflect both companies’ current results and investors’ expectations for the future. For our part, we anticipate the recovery will continue but may have fits and starts along the way. The list of things that could cause near-term volatility remains long (debates over additional fiscal stimulus, progress in fighting the virus, and the U.S. presidential election, just to name a few). But in the long term, we remain bullish on the prospects for our collection of businesses.

The Fund’s largest holding, Liberty Broadband (owner of a 26% stake in Charter Communications), set the performance standard for both the quarter and year-to-date periods. As customers spend increasingly more time at home, the utility of Charter’s broadband offering has never been clearer, and the company’s continued execution against its growth plan drove its shares to new heights. Black Knight, another quarter and year-to-date standout, rose thanks to strong results from its core mortgage-related businesses, as well as the increased mark-to-market value of its investment in the newly publicly traded Dun & Bradstreet. Finally, Qurate Retail also placed in the quarter and year-to-date performance derbies. Qurate’s home shopping offerings across pay-TV, dot-com, and other digital channels are well suited for the current environment, driving a return to sales growth in the second quarter, the first in more than a year. Management also took steps to highlight the company’s resilient cash flow generation, paying a $1.50 cash dividend and distributing new 8% cumulative preferred securities to owners as part of a broader capital structure shuffle. Shares of the preferred initially traded at a significant discount to par, presumably for technical reasons, and we were happy to add to our position at attractive prices. Continued recoveries by shares of Ingersoll Rand and CoStar Group round out the quarter’s top five performers.

Our list of quarterly and year-to-date detractors similarly includes three common constituents. First Hawaiian shares have suffered as their customers have been forced to deal with (either directly or indirectly) COVID-19’s impact on travel and tourism along with the resulting hit to the Hawaiian economy. Although provisions for potential credit losses have increased, we are comfortable with the bank’s ability to manage the loan book through the current crisis. Liberty Latin America has similarly struggled with COVID-19 related lockdowns and downturns across its footprint. Nevertheless, we believe Liberty’s fixed and wireless connectivity businesses will prove resilient. Furthermore, money raised by the company’s recent equity rights offering (which we participated in) puts them in a position to close on two announced, attractive acquisition opportunities. Liberty SiriusXM remains on the quarterly and year-to-date laggards list given its difficult performance in the first quarter as auto-related businesses were hit by supply chain disruptions even before the pandemic fully took hold in the U.S. Shares have recovered in the months since, and we do not view the third quarter’s modest decline as particularly material. Guidewire Software and Box both appear in our quarterly top detractors list after giving back a portion of the second quarter’s very strong gains.

We initiated one new position during the third quarter. First Republic Bank is a San Francisco-based provider of personal and business banking, trust and wealth management services catering to low-risk, high-net-worth (or soon to be) clients. First Republic’s ultra-high-touch service model makes it less of a commodity bank and more of a rarified luxury service organization. This differentiated service model helps to grow customer lifetime values and allows the company to gain new customers simply through existing client referrals. Earnings growth is therefore less of a function of market interest rates (which would be upside to our investment thesis) but through customer growth driving bank and wealth management assets. For a deeper dive into First Republic’s business and our investment thesis, we encourage shareholders to read our Q3 2020 Analyst Corner feature, written by Weitz equity analyst Sean Pompa, CFA.

Our remaining portfolio activity during the quarter was tilted toward sells, including the sale of our remaining Equity Commonwealth shares. The net result leaves the Fund’s overall invested level modestly higher at 96% of net assets and, in our estimation, an overall portfolio price-to-value ratio in the low to mid 80’s at quarter-end.

 

 

Data quoted is past performance and current performance may be lower or higher. Past performance is no guarantee of future results.

Investment return and principal value of an investment will fluctuate, and shares, when redeemed, may be worth more or less than their original cost. All investments involve risks, including possible loss of principal. Please visit weitzinvestments.com for the most recent month-end performance.

Investment results reflect applicable fees and expenses and assume all distributions are reinvested but do not reflect the deduction of taxes an investor would pay on distributions or share redemptions. Net and Gross Expense Ratios are as of the Fund’s most recent prospectus. The Fund has entered into fee waiver and/or expense reimbursement arrangements with the Investment Advisor. The Advisor has contractually agreed to waive a portion of the Advisor’s fee and reimburse certain expenses (excluding taxes, interest, brokerage costs, acquired fund fees and expenses and extraordinary expenses) to limit the total annual fund operating expenses of the Class’s average daily net assets through 07/31/2021. The Net Expense Ratio reflects the total annual fund operating expenses of the Fund after taking into account any such fee waiver and/or expense reimbursement, if any; total returns would have been lower had there been no waivers or reimbursements.

See page 8 for additional performance disclosures. See page 81 for a description of all indices.

Contributions to Fund performance are based on actual daily holdings. Securities may have been bought or sold during the quarter. Return shown is the actual quarterly return of the security or combination of share classes.

Source (Top Performers, Bottom Performers): FactSet Analytics

20 Q3 2020 Semi-Annual Report

NEBRASKA TAX-FREE INCOME FUND

Portfolio Manager: Tom Carney, CFA

Investment Style: Municipal-State Bond

The Nebraska Tax-Free Income Fund returned +0.50% in the third quarter compared to a +1.28% return for the Bloomberg Barclays 5-Year Municipal Bond Index, the Fund’s primary benchmark. Year to date, the Nebraska Tax-Free Income Fund’s total return was +2.74% compared to a +3.49% return for the index. Our Fund’s large weighting (approximately 52%) in investments under three years is the principal reason for underperformance in the quarter.

Overview

Municipal bonds outperformed Treasuries for the quarter as yield ratios of municipal bonds relative to comparable U.S. Treasuries continued to move lower. The ratio of the 5-year AAA-rated municipal bond to the 5-year Treasury, for example, declined to 104% as of September 30 from 160% as of June 30. This ratio remains a reasonably useful tool in measuring the relative attractiveness of tax-free municipal bonds compared to U.S. Treasury bonds. All else being equal, the higher the ratio of municipal bond yields to U.S. Treasury yields, the more appealing municipal bonds become, given their tax-advantaged status. While it is historically unusual to have municipal bond yields (which are historically a reasonable predictor of forward returns) exceed Treasury yields, we are clearly living through very unusual times given the economic impact caused by responses to combat the COVID-19 pandemic. The budgetary impact to states, cities, counties and other municipal bond issuers has been dramatic, and its effects will continue to play out in the months and quarters ahead.

Nominal returns (based on coupon interest alone) for municipal bond investors continued to set lows in the quarter. The chart below depicting the yield to worst (YTW) of the Bloomberg Barclays U.S. Municipal Index, a broad index of long-term municipal bonds, illustrates the seemingly inexorable march lower of the return environment for tax-exempt municipal bonds (as measured by YTW) since 1979. Double-digit YTW starting points in the early 1980s (what some might call nostalgic) has shrunk to nearly a tenth of those levels in 2020.

Source: Bloomberg

Surging Taxable Municipal Bond Issuance

The meaningful increase in taxable municipal bond issuance has been a distinguishing development in the municipal bond market in 2020. Historically low U.S. Treasury interest rates have prompted more and more issuers to elect a taxable versus tax-exempt means to raise capital. Why has this occurred? With the passage of the Tax Cuts and Jobs Act of 2017, municipal issuers were precluded from taking advantage of lower tax-exempt municipal bond interest rates by refinancing older, higher interest rate callable bonds, often several years ahead of their call dates. This is known as an “advance refunding”. The taxable market afforded issuers the ability to take advantage of advance refunding opportunities and the ability to seek funds for working capital and new projects without the restrictions of tax-exempt debt. The percent of municipal bonds being issued as taxable has steadily increased – from 8% of total municipal bond issuance (both taxable and tax-exempt) in 2018, to 16% in 2019, to 30% as of September 30. The increased supply of taxable municipal bonds has at least partially (if not one-for-one) reduced the amount of tax-exempt municipal supply for those investors seeking both federal and state tax exemption.

For more on our views regarding the fixed-income and equity markets, please read our quarterly Fixed Income Insights and Value Matters.

Top Quarterly Contributors

Leading segments included:

•     Lease revenue bonds issued by Omaha Public Facilities Corporation (Omaha Baseball Stadium Project).

•     Hospital revenue bonds issued by Douglas County (Nebraska Medicine, Madonna Rehabilitation and Nebraska Methodist) and Madison County Nebraska (Faith Regional Health Services).

•     Higher education revenue bonds issued by Nebraska State College Facilities Corporation and University of Nebraska (Kearney Student Housing Project).

•     School district general obligation bonds issued by Sarpy County, Nebraska; Bellevue School District; Buffalo County Nebraska School District; and Cass County, Nebraska, Weeping Water Public Schools.

•     Combined utility bonds issued by Municipal Energy Agency of Nebraska and Metropolitan Utilities District of Omaha.

•     Airport revenue bonds issued by Port of Seattle, Washington, and Austin, Texas.

 

Q3 2020 Semi-Annual Report 21

Top Quarterly Detractors
• No segment detracted from results in the quarter.

Turning to portfolio metrics, the average effective duration and average effective maturity of the Fund were unchanged in the quarter at 3.5 years. Overall asset quality remains high, with approximately 84% rated A or better by one or more nationally recognized statistical rating organizations.

Following are additional details regarding the breakdown of our holdings. Our investments may be broad, but our philosophy is the same: we strive to own only those investments we believe compensate us for the incremental credit risk. Our overall goal is to invest in a portfolio of bonds of varying maturities that we believe offer attractive risk-adjusted returns, taking into consideration the general level of interest rates and the credit quality of each investment. We believe the Fund’s investments of primarily high-quality general obligation and revenue bonds from fiscally strong entities will be able to manage through the ongoing economic storm our nation faces.

Definitions: Average effective duration provides a measure of a fund’s interest-rate sensitivity. The longer a fund’s duration, the more sensitive the fund is to shifts in interest rates. Average effective maturity is the weighted average of the maturities of a fund’s underlying bonds. Yield to worst (YTW) is the lowest potential yield that can be received on a bond portfolio without the issuers actually defaulting.

 

 

 

Data quoted is past performance and current performance may be lower or higher. Past performance is no guarantee of future results.

Investment return and principal value of an investment will fluctuate, and shares, when redeemed, may be worth more or less than their original cost. All investments involve risks, including possible loss of principal. Please visit weitzinvestments.com for the most recent month-end performance.

Investment results reflect applicable fees and expenses and assume all distributions are reinvested but do not reflect the deduction of taxes an investor would pay on distributions or share redemptions. Net and Gross Expense Ratios are as of the Fund’s most recent prospectus. The Fund has entered into fee waiver and/or expense reimbursement arrangements with the Investment Advisor. The Advisor has contractually agreed to waive a portion of the Advisor’s fee and reimburse certain expenses (excluding taxes, interest, brokerage costs, acquired fund fees and expenses and extraordinary expenses) to limit the total annual fund operating expenses of the Class’s average daily net assets through 07/31/2021. The Net Expense Ratio reflects the total annual fund operating expenses of the Fund after taking into account any such fee waiver and/or expense reimbursement, if any; total returns would have been lower had there been no waivers or reimbursements.

See page 8 for additional performance disclosures. See page 81 for a description of all indices.

The Fund receives credit quality ratings on portfolio securities when available from credit rating agencies. The Fund itself has not been rated by a credit rating agency. Ratings and portfolio credit quality may change over time. A security is “investment grade” when it has received a credit quality rating of at least BBB. If a security has received different ratings from more than one rating agency, then the highest rating is used.

Source (Fixed Income Attributes, Credit Quality, and Maturity Distribution): Bloomberg Analytics

 

Q3 2020 Semi-Annual Report 23

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24 Q3 2020 Semi-Annual Report

PARTNERS III OPPORTUNITY FUND

Portfolio Manager: Wally Weitz, CFA & Drew Weitz

Investment Style: Multi-Cap Alternative

The Partners III Opportunity Fund’s Institutional Class returned +7.59% in the third calendar quarter compared to +8.93% for the S&P 500 (the Fund’s primary benchmark) and +9.21% for the Russell 3000. For the calendar year to date, the Partners III Opportunity Fund’s Institutional Class returned +0.50% compared to +5.57% for the S&P 500 and +5.41% for the Russell 3000.

Equities extended their rally during the third quarter, with some sectors (most notably large-cap software and technology) returning to, and through, their prior highs. The U.S. economy is healing from the worst of the shutdown-induced trauma, but its recovery has lagged the market – at least as measured by popular indices like the S&P 500. Our portfolio has likewise recovered from the first quarter drawdown, and we are pleased to report a return to “black ink” for the year-to-date period.

The portfolio saw broad-based gains during the quarter. As a result, our top contributors list is populated by investments that combined high-conviction, larger position sizes with strong double-digit returns. Berkshire Hathaway, the Fund’s largest holding, was the standout along with solid contributions from Liberty Broadband, Intelligent Systems and Mastercard.

The strongest quarterly performance came from Qurate Retail, a more modestly sized holding. Qurate’s home shopping offerings across pay-TV, dot-com and other digital channels were well suited for the current environment, driving a return to sales growth in the second quarter (the first in more than a year). Management also took steps to highlight the company’s resilient cash flow generation, paying a $1.50 cash dividend and distributing new 8% cumulative preferred securities to owners as part of a broader capital structure shuffle. We were encouraged by these announcements and bought additional shares of the common equity, which also allowed us to receive additional preferred shares. As trading in the preferred began, technical pressures led the shares to trade at a significant discount to par, giving us another opportunity to further build our position at attractive prices. In the days that followed, the pressure eased, and shares recovered to trade at a modest discount to par value.

Against the backdrop of the continued rally, our short positions against ETFs that track the S&P 500 and Nasdaq 100 were again the top detractors to quarterly returns. Shares of Box took a breather and gave back some of last quarter’s strong gains. The company’s recent user conference and investor meeting have bolstered our confidence in Box’s strategic direction. Liberty Global and Liberty SiriusXM’s modest negative returns qualified as top detractors, a development we view as more “noise” than “signal”.

Our top year-to-date contributors feature some of the mega-cap technology names that have led the market, including Amazon.com, Facebook and Mastercard. Liberty Broadband also enjoyed a strong year, aided in part by its investment in Charter Communications. As customers spend increasingly more time at home, the utility of Charter’s broadband service has never been greater, and management continues to execute its growth strategy. We have trimmed each of the four portfolio holdings on strength, managing their position sizes relative to the forward-looking opportunity. We also locked in gains earlier this year by covering more than one-third of our S&P 500 short position during the first quarter’s swoon.

Shares of Redwood Trust have rebounded over 50% in the past six months but remain the Fund’s top year-to-date detractor given the depth of its first-quarter decline. Management acted decisively to steer the business through the worst of the crisis, and the company is now on firmer footing. After recovering from clearly distressed prices, we view the risk/reward as less favorable going forward, and we elected to close our remaining position. Liberty SiriusXM remains on the laggards list predominantly due to its difficult performance in the first calendar quarter. Currently Liberty/SiriusXM shares trade at a sizeable discount to where we think they should trade, given the market price of the underlying SiriusXM shares. We believe that Liberty SiriusXM management will unlock that discount over time, but in the meantime, we have shorted a portion of our position’s underlying SiriusXM shares as to monetize some of that discount for ourselves. We continue to be long-term believers in SiriusXM’s business, and we remain net long on Liberty/SiriusXM on an economic basis. Insurance company Markel’s shares have mostly trodden water since the first quarter, but we remain confident in the company’s proven, disciplined underwriting culture as well as clients’ need for insurance products. The tech-heavy Nasdaq 100’s gains translated into negative results for our index short position. Finally, DXC Technology was sold during the second quarter but remains a top detractor so far this year.

We added a new “starter”-sized position to the portfolio with Fidelity National Information Services (FIS), a leading core bank and payment processor that our team knows well, having previously owned it in other Weitz portfolios. FIS is riding several industry tailwinds and for the next few years has the chance to power through broader economic turbulence. Portfolio activity was otherwise tilted toward trims. Our long exposure closed the quarter at 90% of net assets. We added modestly to our Nasdaq 100 short position during the quarter, and we reduced our SiriusXM short. Together with our S&P 500 ETF short, the portfolio’s short exposures represented 17% of net assets. The Fund’s effective net long position of 73% is mostly unchanged from the second quarter.

Definitions: Effective net is the effective long (the sum of the portfolio’s long positions, such as common stocks, or derivatives where the price increases when an index or position rises) minus the effective short (the sum of the portfolio’s short positions, such as derivatives where the price increases when an index or position falls).

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Data quoted is past performance and current performance may be lower or higher. Past performance is no guarantee of future results.

Investment return and principal value of an investment will fluctuate, and shares, when redeemed, may be worth more or less than their original cost. All investments involve risks, including possible loss of principal. Please visit weitzinvestments.com for the most recent month-end performance.

Investment results reflect applicable fees and expenses and assume all distributions are reinvested but do not reflect the deduction of taxes an investor would pay on distributions or share redemptions. Net and Gross Expense Ratios are as of the Fund’s most recent prospectus.

See page 8 for additional performance disclosures. See page 81 for a description of all indices.

Contributions to Fund performance are based on actual daily holdings. Securities may have been bought or sold during the quarter. Return shown is the actual quarterly return of the security or combination of share classes.

Source (Top Performers, Bottom Performers): FactSet Analytics

26 Q3 2020 Semi-Annual Report

PARTNERS VALUE FUND

Portfolio Managers: Wally Weitz, CFA, Brad Hinton, CFA & Drew Weitz

Investment Style: Multi-Cap Value

The Partners Value Fund’s Institutional Class returned +7.14% during the third quarter compared to +9.21% for the Russell 3000 and +8.93% for the S&P 500 (the Fund’s primary benchmark). Year to date, the Fund’s Institutional Class returned -6.55% compared to +5.41% for the Russell 3000 and +5.57% for the S&P 500.

It was a reasonably good quarter for Fund investors, with solid absolute returns. Yet again, large-cap stocks bested mid-cap, and mid-cap bested small-cap. The Fund’s experience followed suit. Our large-cap holdings posted double-digit returns, substantially outpacing the broader indexes. While our mid-and small-cap holdings also delivered modest gains, they meaningfully trailed the index returns.

Berkshire Hathaway paced the Fund’s quarterly contributors. After lagging in the first half, Berkshire’s stock rebounded strongly from overly depressed levels. Liberty Broadband’s stock reached all-time highs as core holding Charter Communications posted another set of strong results. Charter has been a powerful example of how good things can be when you have the right business, run by the right people, at the right time. Our thesis on the recent portfolio addition, CoStar Group, has played out nicely to date, and the stock has responded in a positive way.

Quarterly detractors include software companies Box and Guidewire Software. Box showed investors another quarter of modest progress, which we liked more than the market. The recent BoxWorks virtual meetings further bolstered our confidence in the company’s strategic direction. Guidewire’s stock took a mild breather after rebounding sharply in the second quarter. We see nothing of substantive concern for Guidewire at this time. Liberty Latin America issued a subscription rights offering to bolster its balance sheet, and we participated with enthusiasm at an attractive price.

Year to date, Liberty Broadband has been the Fund’s strongest contributor as its core holding, Charter Communications, continued to execute on its multi-year business plan. Digital advertising giants Facebook and Alphabet also have delivered strong gains. Both have extremely powerful business models, pristine balance sheets and stocks that trade at moderately discounted valuations. Both also live in the spotlight’s glare with distinct regulatory risks. With these risks in mind, we have managed our collective position sizing in these companies.

A trio of small-cap value stocks headlined year-to-date detractors. We wrote about Redwood Trust’s setbacks in the first quarter. After weathering the worst of the storm, the mortgage REIT’s business is on a firmer footing and the stock has rallied nearly 50%. We trimmed our position as the risk/reward outlook became less favorable. We think Liberty Latin America’s sturdy business and strategic moves position it to withstand near-term challenges.

Much ink has been spilled over the top-heavy nature of this market. A narrow group of mega-cap companies is dominating (and distorting perceptions of) the results of the most widely reported indexes, whose returns are weighted by size. To illuminate the point, the S&P 500 Equal Weighted Index, comprised of the largest U.S. stocks, is down nearly 5% year-to-date. The typical large company stock is not faring nearly as well as a narrow list of favorites.

To cut to the chase, we think this backdrop spells opportunity for our multi-cap strategy. As we find so often in investing, yesterday’s challenges seed tomorrow’s upside potential. We have dissected the Fund’s performance six ways to Sunday, and the facts suggest that the mid-cap basket is our area for greatest improvement. Some of that has been the result of a tough market, and some of it has been subpar execution. In response, we are redoubling our efforts in mid-cap research and management.

We are pleased to welcome Drew Weitz to the Partners Value Fund’s portfolio management team. We believe that investing in businesses of all sizes, with a valuation-focused lens, should be an enduring advantage of a multi-cap strategy. Drew brings additional experience, aptitude and focus to the small- and mid-cap basket of the portfolio. His investing style is also well-suited to our mid-quality holdings, which often have more of a traditional value tilt. His strengths are complementary to what we have done well over time, and the three of us look forward to collaborating with the rest of the Weitz research team on behalf of investors.

This collaboration is already bearing fruit, as we bought a new position in First Republic Bank in September. First Republic is a San Francisco-based, ultra-high-touch bank and wealth management company offering personal banking, business banking, trust, and wealth management services. First Republic develops raving fan clients through exceptional service, and the company acts more like a rarified luxury services organization than a commodity bank. Earnings growth is less a function of market interest rates (although higher rates certainly would not hurt) and credit cycles and more tied to the efficient acquisition of customers with high and growing lifetime values. In our view, First Republic is a powerful unit growth story with a long reinvestment runway. Research Analyst Sean Pompa, CFA, describes our investment thesis for this terrific and unique company in our Q3 2020 Analyst Corner.

Valuation remains our North Star, and we think our stocks are attractively priced despite the mixed headlines and hazy outlook. Appraisals are more fluid than usual given the extreme nature of the COVID-19 disruption. Our current estimation is that the portfolio trades at a price-to-value in the mid-to-upper 80s. The mid-cap basket is notably cheaper than the large-cap basket, and we expect to continue tilting the Fund’s allocation in that direction. Even with some margin for error, these discounted valuation levels suggest adequate long-term return potential.

 

Data quoted is past performance and current performance may be lower or higher. Past performance is no guarantee of future results.

Investment return and principal value of an investment will fluctuate, and shares, when redeemed, may be worth more or less than their original cost. All investments involve risks, including possible loss of principal. Please visit weitzinvestments.com for the most recent month-end performance.

Investment results reflect applicable fees and expenses and assume all distributions are reinvested but do not reflect the deduction of taxes an investor would pay on distributions or share redemptions. Net and Gross Expense Ratios are as of the Fund’s most recent prospectus. The Fund has entered into fee waiver and/or expense reimbursement arrangements with the Investment Advisor. The Advisor has contractually agreed to waive a portion of the Advisor’s fee and reimburse certain expenses (excluding taxes, interest, brokerage costs, acquired fund fees and expenses and extraordinary expenses) to limit the total annual fund operating expenses of the Class’s average daily net assets through 07/31/2021. The Net Expense Ratio reflects the total annual fund operating expenses of the Fund after taking into account any such fee waiver and/or expense reimbursement, if any; total returns would have been lower had there been no waivers or reimbursements.

See page 8 for additional performance disclosures. See page 81 for a description of all indices.

Contributions to Fund performance are based on actual daily holdings. Securities may have been bought or sold during the quarter. Return shown is the actual quarterly return of the security or combination of share classes.

Source (Top Performers, Bottom Performers): FactSet Analytics

28 Q3 2020 Semi-Annual Report

SHORT DURATION INCOME FUND

Portfolio Managers: Tom Carney, CFA & Nolan Anderson

Investment Style: Short-Term Bond

The Short Duration Income Fund’s Institutional Class returned +0.93% in the third quarter compared to a +0.16% return for the Bloomberg Barclays 1-3 Year U.S. Aggregate Index (Bloomberg Barclays U.S. Agg 1-3), the Fund’s primary benchmark. Year to date, the Fund returned +2.52% compared to a +2.85% return for the benchmark.

Due to the Fund’s positive returns in the third quarter, the Fund’s overall yield to worst (YTW) declined to 2.1% on September 30 from 2.6% on June 30 and 4.2% on March 31. As a reminder, YTW has historically been a reasonable predictor of forward returns. And while favorable reinvestment opportunities are becoming more challenging to uncover, we continue to like what we own, and our YTW at quarter-end remains quite favorable to the benchmark’s yield to worst of 0.4%

Portfolio Positioning

The table below shows the change in allocation to various sectors, from the prior quarter and from a year ago. This summary provides a view over time of how we have allocated capital. Since our goal is to invest in sectors that we believe offer the best risk-adjusted returns, our allocations may change significantly over time.

 

+  High-Yield exposure (as of 9/30/2020 consists of investments in the Corporate, Corporate Convertible, ABS and CMBS sectors.

During the quarter, the Fund’s holdings of corporate bond and U.S. Treasury segments declined. The Fund’s holdings of asset-backed securities (ABS) and non-agency mortgage-back securities increased as we continue to find and source more favorable risk-reward opportunities outside of the current bond index mandates and those sectors whose prices have been and are being directly influenced by the Federal Reserve’s various policy tools. Most noteworthy was our new ABS investments in corporate collateralized loan obligations (CLOs) (see Corporate CLO section that follows).

Overall portfolio metrics as measured by average maturity and average effective duration were unchanged from the previous quarter at 1.6 and 1.3 years, respectively. These measures provide a guide to the Fund’s interest rate sensitivity. A lower average effective maturity and shorter average effective duration reduce the Fund’s price sensitivity to changes in interest rates (either up or down).

Top Quarterly Contributors

Sector allocation and security selection were the key drivers of performance in the third quarter.

•     Asset-Backed Securities (ABS): Our ABS investments generated nearly three-fourths of the Fund’s total return in the quarter as capital appreciation enhanced solid coupon income. Across all categories (e.g. auto, consumer, equipment, fleet lease), credit performance continued to be benign to strong considering the economic environment. Credit ratings never take the place of our due diligence process, but it is reinforcing to have the Fund experience meaningfully more upgrades (28) than downgrades (1) among Fund holdings so far in 2020.

•     Commercial Mortgage-Backed Securities (CMBS): Our CMBS segment contributed strong price appreciation in the quarter as business plans continued to progress among our various commercial real-estate collateralized loan obligations (CRE CLOs), such as ReadyCap, Granite Point, VMC Finance, and Xantas, and our single asset single borrower (SASB) holdings from Hilton and Retail Value.

•     Corporate and Convertible Bonds: A large majority of our corporate bond segment contributed positively to returns during the third quarter as credit spreads continued to decline. Leisure holding SilverSea Cruise Finance (a subsidiary of Royal Caribbean), retail holdings L Brands and QVC, and Redwood Trust convertible bonds were the standout credits.

Top Quarterly Detractors

•     While no sector materially detracted from performance, the bonds of NGL Energy Partners gave back some of what they recovered in the second quarter. The energy sector is suffering from multiple headwinds, most important of which is the current low-price environment. Low oil prices have negatively impacted the near-term production volumes of NGL’s producer customers, which use NGL’s midstream infrastructure located in the Permian Basin in Texas and the DJ Basin in Colorado. Recently, NGL’s largest counterparty in Colorado filed for bankruptcy and there is significant uncertainty as to the value of the midstream contract going forward. These risks caused NGL’s bonds to be downgraded by Moody’s from B2 to B3. We have spoken to NGL’s management and believe the company is responding to these challenges, including a potential renegotiation of its midstream contract. A reasonable solution should also help NGL negotiate an extension of its credit facility that matures in October 2021. Given the quality of the assets and the long-term cash flow potential, we like the risk/reward at current bond prices.

Corporate Collateralized Loan Obligations (Corporate CLOs)

Our Short Duration Income Fund made its first corporate CLO investments in the second quarter. While this represents new territory for Weitz, we believe it is a natural progression and builds on the securitized products work we have done over the past decade. As with all securitized products, the investment process for corporate CLO investing is focused on the underlying collateral characteristics, the quality of the sponsor, and the securitization’s structural features and investor protections. There are two distinct corporate CLO markets: the larger broadly syndicated loan (BSL) market and the smaller middle market (MM). While there are pros and cons for each, we believe CLOs backed by middle market loans offer particularly attractive risk/reward characteristics for us at this time.

In terms of the underlying collateral, typical MM CLOs are backed by first-lien, senior secured loans issued to private companies who do not have publicly rated debt. To help offset

 

Q3 2020 Semi-Annual Report 29

the investor risks associated with smaller size and scale, we have seen that MM loans generally have wider spreads, exhibit lower leverage, and have better loan structures and covenant protections than BSL loans. Unlike BSLs, MM loans are more idiosyncratic in nature whereby the sponsor is more directly involved in negotiating lending terms with each borrower. Financial covenants and control language in the event of a workout or event of default are specifically tailored for borrowers within each credit agreement. The individualized characteristics of MM loans tends to lead to a lack of liquidity in the underlying loans.

Given the unique risks involved in middle market lending, sponsor skill is critical to strong credit performance. To that end, we came away from our months of due diligence very impressed with the size, scale, and sophistication of many of the top-tier middle market sponsors. Many of these sponsors have proven track records through multiple credit cycles. Another distinguishing factor in the middle market is the alignment of interest between MM CLO investors and sponsors. Middle market sponsors tend to retain the bottom 15-25% of their securitizations, representing significant “skin-in-game.” In the BSL market, sponsors typically retain only the legally required minimum of 5.0%.

For the MM CLOs we have purchased, credit enhancement is provided through overcollateralization, the subordination of cash flows and excess spread (similar to the credit enhancement structures for other ABS). We believe these particular MM CLOs have demonstrated resiliency through multiple credit cycles, and we like their risk/reward profiles (especially their coupon payments) in today’s challenging fixed income environment.

Taking the Market’s Temperature – excerpt from Q3 2020 Fixed Income Insights.

“Chaos and volatility are what “value” investors live for, and if we can muster the right combination of common sense and courage, we might just thrive.” – Wally Weitz August 2020

While we refrain from making bold (if any) market predictions/ prognostications, we do fully subscribe to Howard Mark’s wise advice of taking stock of the marketplace’s proverbial temperature. Speaking of temperature, 2020 has witnessed temperature swings like few, if any, others in history. Thanks to the patient, value-oriented investment approach instilled by our founder, whose recent but timeless quote began this section, our investment approach has always been to take advantage of the opportunities the market provides – by gradually expanding our circle of competence and patiently searching for pockets of favorable risk/reward investments. The ‘chaos and volatility’ (high temperature) of 2020’s first quarter has given way to a much calmer environment (mild temperature). Entering the home stretch of a historically challenging year, this is what we see:

•     A ‘pedal to the metal’ monetary policy that will keep short-term interest rates lower for longer, and a stated intention to allow inflation (when it returns) to run hotter (higher) than the Fed’s previous 2% target, in order to aid in the labor market recovery. The result, absent yield curve control by the Fed (a potential topic for another time), may be a steeper yield curve that should have less negative impact on lower duration portfolios.

•     An economic recovery that progresses in fits and starts (not V-shaped) where the handoff from a massive fiscal and monetary stimulus will be tricky and likely volatile.

•     We may still be in the economic ‘eye’ of the Category 5 hurricane caused by the response to limit the spread of COVID-19; that is, it may be calm at present, but we continue to expect turbulence as we navigate to the other side of the storm’s ‘eyewall.’

•     The Fed’s direct buying of assets (Treasuries, mortgages, corporate bonds, ETFs) has reduced the value and forward return opportunities in many areas of the marketplace, and we believe active managers can add value by seeking out the most promising market sectors.

Our fixed-income funds have broad, flexible mandates that, we believe, allow us to navigate the increasingly lower return environment by identifying investment opportunities away from price-insensitive index investors and less influenced by Fed intervention (such as structured products).

Our goals remain the same. Namely, to (a) preserve capital, (b) maintain a strong liquidity position, (c) understand evolving risks and opportunities, (d) selectively take advantage of favorable risk/reward opportunities, and (e) conduct consistent/thorough credit surveillance. We remain ready to take advantage of valuation disparities that may develop, and we hope to continue to earn your trust.

Definitions: Average effective duration provides a measure of a fund’s interest-rate sensitivity. The longer a fund’s duration, the more sensitive the fund is to shifts in interest rates. Average effective maturity is the weighted average of the maturities of a fund’s underlying bonds. Investment grade bonds are those securities rated at least BBB- by one or more credit rating agencies. Non-investment grade bonds are those securities (commonly referred to as “high yield” or “junk” bonds) rated below BBB- by two or more credit rating agencies. Yield to worst (YTW) is the lowest potential yield that can be received on a bond portfolio without the issuers actually defaulting.

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30 Q3 2020 Semi-Annual Report

 

 

Data quoted is past performance and current performance may be lower or higher. Past performance is no guarantee of future results.

Investment return and principal value of an investment will fluctuate, and shares, when redeemed, may be worth more or less than their original cost. All investments involve risks, including possible loss of principal. Please visit weitzinvestments.com for the most recent month-end performance.

Investment results reflect applicable fees and expenses and assume all distributions are reinvested but do not reflect the deduction of taxes an investor would pay on distributions or share redemptions. Net and Gross Expense Ratios are as of the Fund’s most recent prospectus. The Fund has entered into fee waiver and/or expense reimbursement arrangements with the Investment Advisor. The Advisor has contractually agreed to waive a portion of the Advisor’s fee and reimburse certain expenses (excluding taxes, interest, brokerage costs, acquired fund fees and expenses and extraordinary expenses) to limit the total annual fund operating expenses of the Class’s average daily net assets through 07/31/2021. The Net Expense Ratio reflects the total annual fund operating expenses of the Fund after taking into account any such fee waiver and/or expense reimbursement, if any; total returns would have been lower had there been no waivers or reimbursements.

See page 8 for additional performance disclosures. See page 81 for a description of all indices.

The Fund receives credit quality ratings on portfolio securities when available from credit rating agencies. The Fund itself has not been rated by a credit rating agency. Ratings and portfolio credit quality may change over time. A security is “investment grade” when it has received a credit quality rating of at least BBB. If a security has received different ratings from more than one rating agency, then the highest rating is used. Mortgage related securities issued and guaranteed by government sponsored agencies such as Fannie Mae and Freddie Mac are generally not rated by rating agencies. Securities which are not rated do not necessarily indicate low quality. Fannie Mae’s and Freddie Mac’s senior long-term debt are currently rating Aaa and AAA by Moody’s and Fitch, respectively.

Source (Fixed Income Attributes, Credit Quality, and Maturity Distribution): Bloomberg Analytics

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32 Q3 2020 Semi-Annual Report

ULTRA SHORT GOVERNMENT FUND

Portfolio Managers: Tom Carney, CFA & Nolan Anderson

Investment Style: Ultra-Short-Term Bond

The Ultra Short Government Fund returned +0.06% in the third quarter compared to a +0.07% return for the ICE BofA US 6-Month Treasury Bill Index (6-Month Treasury), the Fund’s primary benchmark. Year to date, the Fund returned +1.01% compared to a +1.00% return for the benchmark.

Overview

The Federal Reserve (Fed) made no changes in short-term monetary policy during the quarter (leaving rates at/near zero), but in August the Fed unanimously adopted a new monetary policy framework that, while incremental to the agency’s long-term policy goals of promoting maximum employment and stable prices, may result in a lower for a lot longer short-term interest rate environment.

The Fed’s new policy framework establishes an average inflation targeting regime as well as a rather remarkable combination of factors to wait for before moving short-term interest rates off zero. Namely, the Fed expects to maintain the current Federal Funds rate (between zero and 25 basis points) until the labor market reaches full employment and inflation has consistently averaged 2% over a one-, three-, or five-year time period. In other words, the Fed appears willing to allow inflation to overshoot 2% for some amount of time to allow the labor market to reach the Fed’s view of full employment. Using the Fed’s long-standing measure of 4.1% unemployment as the measure of full employment and the Fed’s favored inflation gauge of PCE (personal consumption expenditures), these conditions have been an extreme historical anomaly, rarely occurring together at the same time. The Fed’s new inflation targeting regime has something in common with Samuel Beckett’s tragic comedy “Waiting for Godot” – they’re both waiting for something that may never happen. As one macro strategist suggests by analogy, the Fed is attempting to cast itself as a sort of monetary Peter Pan who wants the economy to come visit Never-Never Land.

While this new policy framework by the Fed may be more evolutionary than revolutionary, it does appear to have important implications for fixed-income investors. The acronym ZIRP (Zero Interest Rate Policy) that came into being after the Great Recession of 2008, and that resulted in short-term interest rates remaining at zero for six years could easily be eclipsed by the Fed’s new average inflation targeting and full employment directive.

Our Fund’s yield and return will invariably follow the path dictated by the Fed’s monetary policy, as we frequently reinvest maturities with holdings that mature in a short period of time. But lower (short-term interest rates) for longer (maybe much longer) appears to be the Fed’s new marching orders.

As of September 30, 81.1% of our portfolio was invested in U.S. Treasury notes, 13.5% in investment-grade asset-backed securities, 1.6% in investment-grade corporate bonds, and 3.8% in a high-quality money market fund and cash equivalents. The average effective duration on September 30 was 0.3 years, down from 0.4 years as of June 30. The Fund’s 30-day yield decreased approximately four basis points in the quarter to 0.27% as of September 30. Given the Fed is likely to hold short-term interest rates at or near zero for the foreseeable future, the Fund’s 30-day yield will likely continue to decline in the months and quarters to follow.

Under normal market conditions, the Fund will invest at least 80% of its net assets in obligations issued or guaranteed by the U.S. government and its government-related entities. The balance of Fund assets may be invested in U.S. investment-grade debt securities. Additionally, the Fund will maintain an average effective duration of one year or less. Duration is a measure of how sensitive the portfolio may be to changes in interest rates. All else equal, a lower-duration bond portfolio is less sensitive to changes in interest rates than a bond portfolio with a higher duration. Over time, this shorter-term focus (duration of less than one year) is intended to generate higher total returns than cash or money market funds, while also taking less interest rate risk than a bond portfolio with a higher duration.

The Fund’s principal investment strategies and objectives of providing current income, protecting principal and providing liquidity remain our primary goals. While the Fund’s current income will likely remain pressured (i.e. drift lower) by the current ultra-low nominal reinvestment environment, we believe we can continue to add value via security selection in the U.S. investment-grade debt segment. Protecting principal and providing liquidity will always come first in managing the Ultra Short Government Fund on behalf of shareholders. Thank you for your investment and continued confidence in our firm.

Definitions: 30-Day SEC Yield represents net investment income earned by a fund over a 30-day period, expressed as an annual percentage rate based on the Fund’s share price at the end of the 30-day period. Subsidized yield reflects fee waivers and/or expense reimbursements during the period. Without such fee waivers and/ or expense reimbursements, if any; yields would have been lower. Unsubsidized yield does not adjust for any fee waivers and/or expense reimbursement in effect. Average effective duration provides a measure of a fund’s interest-rate sensitivity. The longer a fund’s duration, the more sensitive the fund is to shifts in interest rates. Investment grade bonds are those securities rated at least BBB- by one or more credit rating agencies. Non-investment grade bonds are those securities (commonly referred to as “high yield” or “junk” bonds) rated below BBB-by two or more credit rating agencies.

 

 

 

 

 

Data quoted is past performance and current performance may be lower or higher. Past performance is no guarantee of future results.

Investment return and principal value of an investment will fluctuate, and shares, when redeemed, may be worth more or less than their original cost. All investments involve risks, including possible loss of principal. Please visit weitzinvestments.com for the most recent month-end performance.

Investment results reflect applicable fees and expenses and assume all distributions are reinvested but do not reflect the deduction of taxes an investor would pay on distributions or share redemptions. Net and Gross Expense Ratios are as of the Fund’s most recent prospectus. The Fund has entered into fee waiver and/or expense reimbursement arrangements with the Investment Advisor. The Advisor has contractually agreed to waive a portion of the Advisor’s fee and reimburse certain expenses (excluding taxes, interest, brokerage costs, acquired fund fees and expenses and extraordinary expenses) to limit the total annual fund operating expenses of the Class’s average daily net assets through 07/31/2021. The Net Expense Ratio reflects the total annual fund operating expenses of the Fund after taking into account any such fee waiver and/or expense reimbursement, if any; total returns would have been lower had there been no waivers or reimbursements.

Effective 12/16/2016, the Ultra Short Government Fund revised its principal investment strategies. Prior to that date, the Fund operated as a “government money market fund” and maintained a stable net asset value of $1.00 per share. Performance prior to 12/16/2016 reflects the Fund’s prior principal investment strategies and may not be indicative of future performance results.

See page 8 for additional performance disclosures. See page 81 for a description of all indices.

The Fund receives credit quality ratings on portfolio securities when available from credit rating agencies. The Fund itself has not been rated by a credit rating agency. Ratings and portfolio credit quality may change over time. A security is “investment grade” when it has received a credit quality rating of at least BBB. If a security has received different ratings from more than one rating agency, then the highest rating is used.

Source (Fixed Income Attributes, Credit Quality, and Maturity Distribution): Bloomberg Analytics

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34 Q3 2020 Semi-Annual Report

VALUE FUND

Portfolio Manager: Brad Hinton, CFA

Investment Style: Large-Cap Value

The Value Fund’s Institutional Class returned +11.50% for the third quarter compared to +9.47% for the Russell 1000 and +8.93% for the S&P 500 (the Fund’s primary benchmark). Year to date, the Fund’s Institutional Class returned +7.70% compared to +6.40% for the Russell 1000 and +5.57% for the S&P 500. So far, so good, in a turbulent year.

“Market commentators and investment managers who glibly refer to “growth” and “value” styles as contrasting approaches to investment are displaying their ignorance, not their sophistication. Growth is simply a component – usually a plus, sometimes a minus – in the value equation.”

- Warren Buffett, 2000 Berkshire Hathaway letter to shareholders

Mr. Buffett certainly has a way with words. We understand the intense interest in the growth versus value discussion. The return differences have been stark. Growth stocks have been like the Harlem Globetrotters, brimming with assured attitude and trick shots. Value stocks have played the part of the hapless Washington Generals. It is great theater. We can speak the value and growth dialect, partly out of professional necessity. At a fundamental level, though, the great debate does not resonate.

Our investment philosophy is to buy high-quality businesses at a discount to what we think they are worth. This Quality at a Discount (QuaD) investing approach is timeless, and it transcends traditional growth and value labels. We own some companies that others label as value (Comcast, Oracle, JPMorgan), and we own some companies that others label as growth (Alphabet, Salesforce.com, Visa). We also own many companies that fall somewhere in between (Analog Devices, Aon, Diageo, LabCorp).

The common thread is that we own a collection of what we think are very good businesses with enduring competitive advantages and durable cash flows. We apply a valuation-focused process to buy their stocks when the odds are stacked in our favor. We do not need market trends to continue or change to earn acceptable returns. We are not waiting on a value stock renaissance that may or may not come. Nor are we overly reliant on mega-cap, aggressive growth companies staying in favor. Our goal is to build a resilient large-cap portfolio. And while we like what we own, we are continuously looking for ways to improve our process and holdings.

Berkshire Hathaway led the Fund’s quarterly contributors. After lagging in the first half, Berkshire’s stock rebounded strongly from overly depressed levels. Salesforce.com posted the highest percentage gain, reporting exceptional quarterly results as customers accelerate rather than delay digital transformations. Thermo Fisher Scientific and Danaher experienced revenue tailwinds from helping society deal with the COVID-19 pandemic, and their core businesses showed resilience. Analog Devices and Liberty SiriusXM were the only detractors for the quarter, with single-digit price declines that were not noteworthy.

Year to date, Amazon.com, Danaher, Salesforce.com and Thermo Fisher Scientific were the strongest contributors. All are so-called COVID “beneficiaries” with strong business tailwinds. Detractors included Liberty Sirius XM which trades at a healthy discount to the current market value of its SIRI stock and other assets. After a fresh underwriting, we think SIRI itself also trades at a discount to underlying value. With John Malone involved, this kind of “double discount” tends to eventually get resolved to our benefit. Also among the year’s detractors were a trio of financials – JPMorgan Chase, Charles Schwab and Berkshire Hathaway. We remain resolute on the multi-year outlooks at Charles Schwab and JPMorgan Chase. While both face current headwinds, they offer contrarian exposure to a potentially steeper yield curve (someday).

We added one “meat and potatoes” stock during the quarter, Fidelity National Information Services (FIS). We owned this leading core bank and payment processor in the mid-2010s, so our team knows the company and industry well. FIS acquired Worldpay last year, adding to the company’s capabilities, strengthening its moat, and enhancing its profit growth story. FIS is riding several industry tailwinds, and for the next few years has the chance to power through any broader economic turbulence. While the risk/reward skew is favorable, the stock is more likely to be a role-playing grinder than a superstar.

Even with most of our team working remotely, research productivity remained high. Our equity team analyzed and debated another half dozen companies that are potentially actionable for the large-cap strategy. The eclectic group spans industries and sectors. The bar for portfolio entry is tougher than ever to clear, and competition for capital is increasingly robust. Credit again to our talented and experienced analyst team for their hard work on behalf of our investors.

The portfolio is focused and well-aligned with our vision for successful large-cap investing. We have ownership stakes in 26 companies, with the top ten representing roughly 45% of the portfolio. Each position is significant enough to matter, yet none can individually make or break our results. Valuation appraisals are more fluid than usual given the extreme nature of the COVID-19 disruption. Our current estimation is that the portfolio trades at a price-to-value in the mid to upper 90s. Several core holdings still have a chance for outsized gains over a multi-year period. Most, however, are priced for adequate return potential primarily from expected growth in per-share business value.

 

 

Data quoted is past performance and current performance may be lower or higher. Past performance is no guarantee of future results.

Investment return and principal value of an investment will fluctuate, and shares, when redeemed, may be worth more or less than their original cost. All investments involve risks, including possible loss of principal. Please visit weitzinvestments.com for the most recent month-end performance.

Investment results reflect applicable fees and expenses and assume all distributions are reinvested but do not reflect the deduction of taxes an investor would pay on distributions or share redemptions. Net and Gross Expense Ratios are as of the Fund’s most recent prospectus. The Fund has entered into fee waiver and/or expense reimbursement arrangements with the Investment Advisor. The Advisor has contractually agreed to waive a portion of the Advisor’s fee and reimburse certain expenses (excluding taxes, interest, brokerage costs, acquired fund fees and expenses and extraordinary expenses) to limit the total annual fund operating expenses of the Class’s average daily net assets through 07/31/2021. The Net Expense Ratio reflects the total annual fund operating expenses of the Fund after taking into account any such fee waiver and/or expense reimbursement, if any; total returns would have been lower had there been no waivers or reimbursements.

See page 8 for additional performance disclosures. See page 81 for a description of all indices.

Contributions to Fund performance are based on actual daily holdings. Securities may have been bought or sold during the quarter. Return shown is the actual quarterly return of the security or combination of share classes.

Source (Top Performers, Bottom Performers): FactSet Analytics