October 12, 2008

Dear Fellow Shareholder:

The credit crisis that has been unfolding over the past year and a half turned very ugly in the 3rd quarter. Then it got worse in October. The "unthinkable" has happened so many times recently that many investors are in a state of shock. As this is written, world leaders are meeting to discuss the global financial crisis and rumors are flying about various major financial institutions. Making meaningful predictions about what will happen in the near-term is a bit like trying to assess storm damage from deep in a shelter while the storm is still raging. Nevertheless, we believe that the economy will eventually recover and that it is possible for patient and disciplined investors to navigate through this treacherous stock market. We will elaborate later on our reasons for guarded optimism, but in a nutshell:

1. Credit losses on mortgages and other loans are enormous and real. They have/will cause permanent damage to many financial institutions and their shareholders, but the financial system will survive and eventually restore liquidity and credit availability to companies and individuals;
2. During the liquidity crisis, marginal companies will fail and unemployment will undoubtedly rise (exacerbating credit losses), so we are likely to have a recession that is deeper and lasts longer than usual. However, the U.S. and other major governments have shown their willingness to go to great lengths (and expense) to restore capital and confidence to the global financial system. The U.S. has already done one tax rebate and will undoubtedly spend freely on tax cuts and public works to pull the country out of recession;
3. Given the destruction of capital and the likelihood of a severe recession (and the attendant decline in corporate earnings) the stock market might be expected to go down sharply. In the 1973-74 recession and bear market, the market declined roughly 40%. Given that the S&P 500, the Nasdaq Composite and the Russell 2000 are each down about 40% in the last 12 months (as of this writing), stocks have already discounted a great deal of bad news;
4. Fear, confusion and financial stress cause markets to be very volatile. With patience and discipline, we believe that a market that moves erratically sideways, even for an extended period, can be profitable for value investors. Then, when confidence returns, new bull markets have a way of starting explosively. So, although we plan to be cautious in this treacherous environment, we do not believe that retreating completely to the sidelines is in the best interests of our shareholders’ long-term investment results.

Now, returning to what seems like ancient history, our Funds showed strong relative performance during the 3rd quarter. They have declined less than the S&P 500 so far in October, too, but the absolute numbers are awful. Over the past few years, we have acknowledged the possibility that the market could suffer a decline comparable to the bear market of 1973-74, and over the past 12 months it has. The table below shows investment results through September 30 for our stock Funds (after deducting fees and expenses) and for the S&P 500 (larger companies), the Russell 2000 (smaller companies) and the Nasdaq Composite (a proxy for technology companies).

The credit crisis deepened during the 3rd quarter and financial stocks were generally weak. During the first half of 2008, we had reduced our positions in Fannie Mae, Freddie Mac and AIG as we became more concerned that they might lose control of their financial destinies. As the 3rd quarter began, we eliminated the balance of our holdings in each. We were late in making these decisions, but sales prices in the teens for the last of the Fannie and Freddie and $20 for AIG allowed us to avoid further substantial losses as all three were, in effect, taken over by the U.S. government.

Another feature of the 3^rd quarter market decline was weakness in energy and other commodity company stocks. Fears of a global slowdown prompted selling of both commodity futures and the stocks of commodity producers. Some of the selling was voluntary; some was done in response to margin calls. Our relative results suffered over the past few years as we missed the "global energy/commodity/emerging markets infrastructure play" but as those stocks corrected sharply in the 3^rd quarter, their absence worked in our favor. We have been doing research on several energy and commodity companies over the years, and it is possible that some will meet our investment criteria if their weakness continues.

Several of our companies’ stocks performed quite well during the quarter and we were able to redeploy capital to other more attractively-priced investments. Apollo and TD Ameritrade reached their price targets and we sold them but they would be welcomed back at lower price levels. Others like Omnicare, Comcast, WellPoint, UnitedHealth and some of our retail and aggregates (rocks and gravel) companies staged temporary rallies that allowed for some trimming of positions.

The cash that was raised through these sales was reinvested in new or existing positions that offered better value. In addition to price/value considerations, we also considered balance sheet strength and each company’s ability to generate ample cash internally to conduct its business without external financing.

In the Funds' Semi-Annual Report, following this letter there are several pages of information on each Fund—a Management Discussion and Analysis, a Schedule of Investments and a series of tables of portfolio and performance data. Our Funds have a March 31 fiscal year, so this is technically our "Semi-Annual" report and thus also contains financial statements for the Funds as well as expense ratio and portfolio turnover data.

The financial world has changed so much in the past several months that it would be silly for us to make detailed predictions or for shareholders to believe them, but we can make a few guesses. Credit will probably be harder to come by for a long time and capital will be more highly valued. Deleveraging of corporate and individual balance sheets (selling assets to pay off debt) should dampen spending and the liquidation of collateral (e.g. houses) should be deflationary. On the other hand, hundreds of billions (trillions?) of dollars of government spending to stabilize financial markets and stimulate the economy could eventually be inflationary. Many other major countries have financial problems at least as severe as ours and both world trade and geopolitics will probably be affected in unexpected ways.

"Uncertainty" is a grossly over-used term in investment discussions—few things are ever "certain." However, even the smartest and most experienced investors seem quite uncertain about how the next few years will unfold. As we wrote at the beginning of this letter, we are willing to believe that the current liquidity crisis will be solved and that the recession, however painful, will end. We believe that real businesses and real people will find ways to produce and consume. We believe that certain companies are financially strong enough and well-managed enough to survive and even thrive over the next few years. From today’s price levels, we believe that patient and disciplined investors (with strong stomachs) have a very reasonable prospect of earning excellent returns over the next several years.

Sincerely,

Wallace R. Weitz	Bradley P. Hinton
Co-manager Value and Partners Value	Co-manager Value and Partners Value
Portfolio Manager Hickory and Partners III	brad@weitzfunds.com
wally@weitzfunds.com