April 16, 2008

Dear Fellow Shareholder:

The Short-Intermediate Income Fund’s total return for the first quarter of 2008 was +2.3%, which consisted of approximately +0.9% from net interest and dividend income (after deducting fees and expenses) and +1.4% from (net realized and unrealized) appreciation of our bonds and other investments. Our first quarter return was less than the 3.0% return of the Lehman Brothers Intermediate U.S. Government/Credit Index, our Fund’s primary benchmark. For the fiscal year ended March 31, 2008, our total return was +7.0%.

The table below shows the results of the Short-Intermediate Income Fund over various time periods through March 31, 2008, along with the Lehman Brothers Intermediate U.S. Government/Credit Index and two additional Lehman Brothers Indexes with a shorter average maturity (1-3 and 1-5 year) which more closely resemble the historical average life of our Fund.

The following tables show a profile of our portfolio and asset allocation as of March 31:

Charles Dickens came to mind in trying to describe the events of the past year in the fixed-income marketplace -- "It was the best of times, it was the worst of times". The best of times were had by owning U.S. Treasury bonds, as yields fell dramatically (prices rose). The latter half of the fiscal year, particularly, was marked by rising turbulence in the financial markets. This led to increased risk aversion and a dramatic ‘flight to quality’, primarily U.S. Treasury securities.

The worst of times were also an unfortunate experience last year. The storm that began in the subprime segment of the mortgage market took on crisis-like qualities as summer turned to fall and began to have a broader effect on the economy. Business and consumer confidence fell. Transparency and liquidity, key components of healthy capital markets, were periodically unavailable as worries of large, but yet-to-be disclosed, losses pervaded the stock and bond markets. These concerns and events led to a radical, and belated, reassessment of risk by investors who had been willing to accept yields that, in retrospect, provided insufficient compensation given the risks involved.

Borrowing further from Dickens’ A Tale of Two Cities, last year may also be dubbed the "age of foolishness" as layers of leverage added to the misery for some. Declining asset prices and high leverage conspired to sink a number of large investment funds, leaving investors with little to nothing. And investors were painfully reminded that all AAA-rated bonds are not created equal. Wall Street alchemy and rating agency support succeeded in turning pyrite into gold (for a time) – transforming low investment grade (BBB-rated) mortgage securities and other assets into mostly AAA-rated instruments in the securitization market through the power of perceived diversification. As delinquencies and losses mounted for these newly created "AAA" bonds, investors may have felt like so many prospectors who mistook pyrite for the real thing.

The monetary (Federal Reserve) and fiscal (Congressional) response to the unfolding credit crisis has been dramatic and historic. Actions not used since the Great Depression, and a few new ones, have been (or will be) implemented to alleviate the stress in the financial markets. Here is a recap of some of the actions taken to date:

• The Federal Reserve has lowered the Federal Funds rate by 300 basis points (a basis point is one one-hundredth of a percent), the largest and swiftest decline in over a decade. This has resulted in a dramatic steepening of the yield curve, where yields of shorter-maturity instruments (e.g. T-Bills) are much lower than longer-maturity instruments (e.g. 10-year bonds). Changes in the Federal Funds rate tend to act with a lag in the economy, but this reduction in short-term rates may alleviate some of the rate shock for some homeowners with adjustable-rate mortgages that are set to re-price this year.


• The Federal Reserve has injected enormous amounts of liquidity into the markets, approximately $400 billion, via an alphabet soup of lending facilities (FAF, TSLF, PDCF) to depository institutions and primary dealers. One of the intended goals of these actions is to improve trading conditions and increase the willingness of market participants to provide credit to households and firms.


• With the consent of Congress and their regulator, the two largest participants in the mortgage market (Freddie Mac and Fannie Mae) have been granted permission to provide up to $200 billion of immediate liquidity to segments of the mortgage-backed securities market.


• And beginning May 2, the IRS will start mailing out rebate checks to many households as part of a $152 billion stimulus package to help boost the flagging economy.

These dramatic actions, and others, may succeed in lessening the impact of the current credit crisis. They also have the capacity to create unintended consequences, the most troubling of which could be a meaningful rise in the long-term inflation level. Since inflation is a genie best left in the bottle, we will be particularly focused on what implications this should have on the Fund’s portfolio allocations.

The Short-Intermediate Income Fund had a total return of 7.0% in fiscal 2008, compared to 8.9% for the Lehman Brothers Intermediate U.S. Government/Credit Index (LBIGC), our Fund’s primary benchmark. Most of this difference can be attributed to unrealized price declines in the Fund’s corporate bond and common and preferred stock segments. It’s also worth noting that, over the years, our portfolio has almost always been constructed with a shorter average life (i.e. duration) and of higher quality than the LBIGC. We chose this benchmark to highlight that we could periodically invest longer term and/or lower quality when conditions warranted. The effect over time of our portfolio construction (typically shorter average life) has been a penalty in bull markets for Treasury bonds (like now), but a boost to performance when interest rates rise.

Compared to a year ago, the average maturity of our Fund was unchanged at 3.0 years. The duration declined to 1.7 from 2.6 years, and the average coupon decreased to 4.2% from 4.4%. The overall credit quality of our portfolio remains very high with approximately 89% of the portfolio invested in AAA rated securities (not BBB-rated bonds masquerading as AAA, but true AAA) or U.S. Treasury, U.S. government agency-guaranteed Mortgage-Backed Securities (MBS) and cash.

U.S. Treasury bonds account for approximately 6% of our Fund, down from 34% a year ago. This segment added materially to our performance last year. Given the rapid decline in yields that U.S. Treasury bonds have experienced, the risk/reward now appears particularly unfavorable. The 5-year Treasury yield at March 31 was 2.4%. Inflation would have to fall materially from its current pace of 4% (as measured by the Consumer Price Index) to leave any purchasing power (or ‘real’) return for investors buying Treasuries with today’s low yields.

MBS exposure increased the most in the past year, to approximately 49% of our Fund from 37% a year ago. The risk aversion that has gripped the marketplace in the past year has even affected the high-quality, agency-guaranteed mortgage-backed securities market. At one point, yield spreads for Fannie Mae and Freddie Mac MBS increased to over 300 basis points to the Treasury curve versus a more normal 100-150 basis point spread. Much of this spread widening occurred as leveraged investors were forced to liquidate assets to meet margin calls from their lenders. This disruption gave us the opportunity to redeploy some of the proceeds from Treasury bond sales into much higher yielding instruments while assuming minimal incremental risk. In addition, we have been monitoring and studying the developments in the subprime and Alt-A (loans made to borrowers above subprime) segments of the mortgage market, but have yet to commit any Fund capital to this area.

Corporate bond, convertible bond and preferred or common stock exposure remains a small segment of our Fund (less than 10%). We have written in the past that our rationale for this low weighting, particularly in corporate bonds, was a lack of compensation (i.e. incremental yield over U.S. Treasury bonds) for taking on the added credit risk. The past year’s blowout of credit spreads (rise in yields and price declines of lower quality bonds compared to higher quality) certainly affirms this decision. Sometimes the best investments are those not made. However, our small exposure still detracted from our results as Newcastle Investment Corp. and Redwood Trust common shares, Six Flags convertible preferred stock and Harrah’s bonds all declined.

The rise in credit spreads has allowed us to invest on more favorable terms than have been available in some time. An example is our investment in the USG Corporation 6.30% senior unsecured bonds maturing in 2016. USG is a leading manufacturer and distributor of building materials, maybe best known for its SHEETROCK® Brand gypsum wallboard panels. We were able to purchase these bonds at a meaningful (20 point) discount to where they were issued in May of last year. While the housing contraction has impacted USG’s near-term business prospects, we believe the market has mispriced the company’s modest leverage, strong management and attractive long-term outlook. Our near-10% yield at cost should generate attractive interest income for our Fund with possible appreciation potential as economic conditions improve.

Our investment approach consists primarily of investing in a portfolio of high quality, short-to-intermediate-term bonds where we believe we can capture most of the "coupon" returns of long-term bonds with materially less interest-rate risk. Overall, we strive to maximize our investment (or reinvestment) yield while avoiding making interest rate "bets", particularly ones that depend on interest rates going down. We are willing to trade some upside in a rapidly falling interest-rate environment in exchange for enhanced capital preservation.

For a small portion of our portfolio, we also search for other fixed-income related investments that have favorable risk/reward characteristics (such as high-yield and convertible bonds, preferred and convertible preferred stock, or high dividend paying common stock). Despite the disappointing results of the past year, these types of investments (like the USG bonds) have enhanced our Fund’s historical returns.

The divergence in inflation and interest rates over the past year is reason for caution, we believe. Inflation measures (both consumer and producer) have risen meaningfully while interest rates (U.S. Treasury) have fallen even more. The Consumer Price Index, for example, has risen 4% in the past year, up from a 2.8% rise a year ago. Five-year Treasury bond yields, on the other hand, have declined by nearly half to 2.4% at March 31. High inflation is not the friend of the bond investor as it erodes the purchasing power of interest returns. While it’s plausible that a recession (if one occurs in the U.S.) could lower inflationary pressures in the economy, we believe U.S. Treasury rates are still abnormally low. The tremendous ‘flight to quality’ by investors fearful of further cataclysmic events certainly explains much of this decline in Treasury rates. Therefore, we expect to maintain our shorter portfolio duration compared to that of our Fund’s primary benchmark (1.7 years versus 3.8 years for the LBIGC at fiscal year end) while we continue searching for qualifying investments with more favorable terms for investors.

Government Money Market Fund Overview

The Government Money Market Fund closed the first quarter with a 7-day effective yield of 2.14%. (An investment in the Fund is neither insured nor guaranteed by the U.S. Government. There can be no assurance that the Fund will be able to maintain a stable net asset value. Although the Fund seeks to preserve the value of your investment at $1.00 per share, it is possible to lose money by investing in the Fund.)

In the past year the Fund’s 7-day effective yield has declined meaningfully (by 3.05%), coinciding almost exactly with the 3% year-over-year decline in the Fed Funds rate (the overnight lending rate between banks controlled by the Federal Reserve). Most of this decline, nearly two thirds, has occurred in 2008 as the Fed has acted in historic fashion in response to a growing credit crisis.

As we have mentioned in previous letters, the Fed Funds rate exerts an effect similar to a gravitational pull on the investment universe for our Fund. The past year has been no exception. Since we invest in ultra high-quality short-term investments (e.g. U.S. Treasury bills and government agency discount notes) that have a weighted average maturity of less than ninety days, our yield has invariably followed the path dictated by the Federal Reserve’s monetary policy as we frequently reinvest maturing bills and notes in these short-term instruments.

As we proceed through the balance of 2008, it seems increasingly plausible that our yield will continue to drift lower. The Fed seems poised to continue lowering the Fed Funds rate as a tool to address the ongoing turmoil in the financial markets. In anticipation of this possibility, and in reaction to the overall ‘flight to quality’, investors have already pushed Treasury bill yields meaningfully below the current Fed Funds rate. While we have limited control over the longer term direction of our Fund’s yield, which will rise and fall with changes in the Fed Funds rate, credit quality will remain high.

If you have any questions about the mechanics of either Fund or our investment strategy, please call or email. As always, we welcome your comments and questions.

Please plan to join us at the Scott Conference Center in Omaha at 4:30 p.m. on May 27. The center is located at 6450 Pine Street on the Aksarben campus. There will be no formal business to conduct, so we can devote the entire meeting to answering your questions. Maps and driving directions are available from our client service representatives. Thanks for your continued support, and we look forward to seeing you there.

Best Regards,

Thomas D. Carney
Portfolio Manager
tom@weitzfunds.com

Investors should consider carefully the investment objectives, risks, and charges and expenses of the Funds before investing. The Funds’ Prospectus contains this and other information about the Funds. The Prospectus should be read carefully before investing. Portfolio composition is subject to change at any time and references to specific securities, industries, and sectors referenced in this letter are not recommendations to purchase or sell any particular security. See the Schedules of Investments in Securities included in the Funds’ quarterly report for the percent of assets of each Fund invested in particular industries or sectors.

Weitz Securities, Inc. is the distributor of the Weitz Funds.