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PARTNERS
® FUNDS ®
Small-Cap Fund (2/21/89 IPO). . . . . 630.8 539.8 115.5 10.7 32.1 (0.8) (10.6)
Russell 2000 Index . . . . . . . . . . . . . . 431.2 380.0 34.4 1.9 21.5 (2.0) (9.9)
International Fund (10/26/98 IPO). . 153.2 NA 66.1 1.6 6.5 (9.1) (10.9)
EAFE Index . . . . . . . . . . . . . . . . . . . 35.3 NA 1.6 4.5 5.9 (13.2) (14.0)
1
Equities offer a superior opportunity for investors today, particularly compared to fixed income. The earnings yield
of the S&P 500 based on 2011 projected EPS is 9.4%. If adjusted for the approximately $100 of cash imbedded in
the S&P, the operating earnings yield increases to 10.4%. The numbers are slightly more attractive overseas. Based
on 2011 estimates, the EAFE Index earnings yield is 9.8%. If earnings grow organically from today’s depressed
levels at only 5% per year (a rate that does not require the reinvestment of earnings because of current excess
capacity), and even if the P/E ratio remains below the long-term average, an investor’s five year average annual
return will be in the mid-teens.
By contrast, corporate bonds with fixed, taxable coupons yield much less than the growing, after-tax coupon that
companies produce. The following table compares corporate earnings yields to bond yields at bear market lows
since 1932. When stocks have been at their lowest levels, earnings yields have been an average of 2.8% higher than
Aa2 bond yields. At the beginning of July earnings yields are 4.3% above debt yields or almost twice stocks’ relative
attractiveness to bonds at bear market lows. We have rarely witnessed this much disparity in the benefits of being
an owner of a growing coupon versus being a lender to a fixed one.
Median: (2.3%)
Average: (2.8%)
7/2/2010 9,686.5 930.4(2) 9.6% 5.3% (4.3%)
(1)
Source: Value Line except as noted.
(2)
First Call/Thomson Financial earnings estimate.
(3)
Long-term corporates.
In spite of the short-term market noise that the “D’s” are creating, over the long run equities will reflect the value of
the free cash flow streams that businesses produce. We are highly confident that (1) the competitive strength of our
companies makes them more certain to deliver growing free cash flow coupons than the average business; (2) our
companies have superior corporate captains; and (3) the stock prices of our holdings are much cheaper than the
S&P 500, EAFE, and the DJIA. P/Vs are in the mid-50% range for all three Funds, providing a large margin of
safety as well as tremendous upside performance opportunity which will be magnified as values grow.
2
Advocacy for long-term investors
We believe capital markets exist to facilitate the transfer of capital between long-term investors and businesses.
Securities and Exchange Commission regulations are designed to promote fair, transparent, and accessible markets.
Recent advances in technology, however, have enabled select short-term traders to gain structural advantages over
other market participants. This inequality began in the U.S. but is spreading to foreign exchanges as well. The “Flash
Crash” on May 6th highlighted some of the issues. Southeastern believes (1) our intellectual capital (i.e. investment
trading decisions) should not be sold by exchanges or used by others to interpose in transactions; (2) all market
participants should have simultaneous access to the same exchange data; and (3) submitted orders should be true
intentions to transact and remain applicable for a minimum increment of time. In response to SEC requests for
comment on U.S. equity market structure, over the last several months we have submitted a letter to the SEC
(http://www.sec.gov/comments/s7-02-10/s70210-164.pdf); met with all five of the SEC Commissioners, including
Chairman Schapiro, as well as various members of Congress (http://www.sec.gov/comments/s7-02-10/s70210-228.pdf);
and testified before the Joint CFTC-SEC Advisory Committee on Emerging Regulatory Issues (http://sec.gov/news/
openmeetings/2010/jac062210.shtml). The links provide more detail about our assessment of market structure
imperfections. We encourage you to ask your other managers their views and activities related to this important
topic for long-term investors.
We greatly appreciate your investment partnership. With analysts based in Singapore, London, and Memphis we
have the deepest and most capable research team in Southeastern’s history. This vested group is uncovering
qualifying investments that we believe will produce above average returns.
Sincerely,