2Q24 Small-Cap Fund Commentary

Theme and Background

This chapter is the opening section of the Longleaf Partners Small-Cap Fund’s second-quarter 2024 report. It primarily discusses the fund’s performance, portfolio strategy, and future outlook in a market environment where small-cap stocks have underperformed. The report notes that while most portfolio companies have seen operational improvements, their stock prices have not reflected this progress, with market gains largely driven by the information technology sector and large-cap stocks.

Core Viewpoint

The author’s core investment thesis is: The fund currently has over 50% of its net asset value (NAV) concentrated in at least 10 investments that have a high probability of value realization events (such as asset sales, spin-offs, or mergers and acquisitions) over the next 6-12 months, which enhances confidence in short-term returns. At the same time, the author believes that U.S. Treasury yields have stabilized at historical norms, creating a favorable environment for bottom-up stock pickers, and that long-term stock selection remains the core source of value.

Key Arguments and Data

• Performance: The fund returned -4.24% in the second quarter of 2024, underperforming the Russell 3000 (+3.22%) and the Russell 2000 (-3.28%), but remains positive year-to-date (+2.32%), ahead of the Russell 2000 (+1.73%).
• Market Structure: Over 100% of the Russell 3000’s gains were driven by the information technology sector and large-cap stocks; the Russell 2000 declined during the quarter, with only two sectors contributing positive returns; the Russell 2000 Value (more aligned with the fund’s style) fell -3.64%, with all sectors making negative contributions.
• Value Realization Events: Over 50% of NAV is concentrated in at least 10 investments that have a high probability of value realization events over the next 6-12 months.
• Cash and Holdings: Cash accounts for 12.3% of the portfolio, with 19 stocks held, and the price-to-value (P/V) ratio is in the low 60% range.
• Interest Rate Environment: U.S. Treasury yields have stabilized at historical norms, which the author believes is favorable for bottom-up stock pickers.

Companies/Assets Involved

Investment Implications

• Short-term Catalysts: Investors should focus on companies with clear value realization events (such as asset sales, spin-offs, or M&A), which may offer excess returns in small-cap stocks.
• Interest Rate Environment: With U.S. Treasury yields stabilizing, bottom-up stock selection strategies may regain an edge, and companies with improving fundamentals but lagging stock prices in small caps are worth attention.
• Sector Selection: Avoid overconcentration in the information technology sector. Under the current market structure, small-cap and value stocks are severely undervalued, particularly high-quality companies in cyclical industries such as real estate, toys, and forestry.
• Risk Warnings: Political events (e.g., the impact of presidential debates on the ACA market) and index adjustments (e.g., Anywhere’s removal from the index) may cause short-term volatility but should not affect long-term value judgments.