Does Longleaf Partners' Closing Signal a Market Top?

Karen Wallace: From Morningstar, I'm Karen Wallace. Large blend Longleaf Partners fund announced that it was going to close because the managers were having trouble finding investment opportunities that met their criteria. Here to discuss what that might mean for valuations in general is Russ Kinnel. He's editor of Morningstar FundInvestor.

Russ, thanks so much for being here.

Russ Kinnel: Good to be here.

Wallace: So, first of all the circumstances surrounding Longleaf Partners fund closing is different than why some other funds might close. Can we talk a little bit about why funds might close and why this is different?

Kinnel: Sure. Usually funds close because they hit a certain capacity limit or because fund flows are coming in at such rapid clip that it's starting to cause some problems. That's a typical reason. It's not really what's going on here. In this case Longleaf is closing because they can't find enough stocks they like. They are kind of old school investors. They look for really big discounts to their estimates of intrinsic value. When they can't find that they let cash build. At a certain point if cash builds past say 20% they decide to close the fund. So it's fairly different from a fund hitting certain flow driven or overall capacity limits. In fact, this fund is not getting inflows.

Wallace: So, what investment style do they use at Longleaf Partners fund?

Kinnel: Though it's technically a blend fund, they look for companies trading at steep discounts to their intrinsic value. So I think of them really as a focused value fund, even though technically they are in large blend.

Wallace: And already they are holding a lot of cash.

Kinnel: So, they say that cash is already north of 20%. So, they are going to close the fund in early June.

Wallace: OK. Would you take Longleaf's closing as a signal that the market has gotten overheated?

Kinnel: Kind of. So, I think it's one more input, but I don't know of any indicators that are great predictors of a market top. And looking back, this is the fourth time they have closed, and in the past, they really weren't great predictors. So, the first time they closed which is 1995--market had a nice run after that. So that wasn't a great indicator. Next time they closed was June of 1999, that was a great indicator, would have been a great time to sell. Then the next time was June 2004--again a bad indicator; the market had another four years of run before it started to crater. So, kind of a mixed record, I think partly because they are very--looking for specific kinds of companies. I think it tells you about the kind of value companies they like, but it's obviously not perfect predictor of market tops.

Wallace: How has Longleaf's record been on reopening the fund?

Kinnel: Really as a timing signal it's even worse. Because the first time they reopened was October 1998--that would have been closer to a time to sell than to buy. Then you had February 2000--that would have been a time to sell. And then they actually reopened January 2008--that would have been much better time to sell. So just the way they invest, they are often early, and I guess you could say the way they reopen the fund they are often little early, too.

Wallace: So, what should a current investor in Longleaf think about this decision?

Kinnel: I think if I was a shareholder I would be encouraged. I think this is really their MO they are consistently applying this discipline of building cash and then closing when they can't find enough good investments. So, I would be encouraged but obviously as the record shows it's not like this necessarily tells you we're at the market top, or you should sell.

Wallace: OK, great. Thanks so much for being here to discuss this.

Kinnel: You are welcome.

Wallace: From Morningstar I'm Karen Wallace. Thanks for watching.