Yacktman Managers Interview: Answers to Fund Management, Portfolio and Investment Strategy Questions
Donald Yacktman is the firm's President and Co-Chief Investment Officer, Stephen Yacktman (his son) is Vice President, Portfolio Manager and Co-Chief Investment Officer, and Jason Subotky is Vice President, Portfolio Manager, and Co-Manager of The Yacktman Funds.
Recently they took questions from our readers. Their responses are below.
Fund Management Questions:
Question: Has the rapid size growth of the fund hampered your ability to invest? Do you ever think you might close the fund to new investors due to size?
[Yacktman Managers:] We manage approximately $9 billion in total assets today in our mutual funds and separate accounts. The current size of our asset base is having a minimal impact on our ability to invest in this market environment as most of the best opportunities are in very large and liquid securities. We feel we can manage substantially more money than we advise today. However, at some asset level, which is well above what we currently manage, we would consider closing the firm to new money. We would rather be better than bigger.
Question for Stephen Yacktman: How much of the portfolio management role do you play now? And how long of a commitment do you intend to make to running the fund after your father? Do you see managing the fund as a life's passion and a continuation of a family legacy or do you think you may want to do something else?
[Stephen Yacktman:] I was added as a co-manager at the end of 2002 for my significant contributions in the prior few years (1999-2002). I am also the Co-Chief Investment Officer of the firm. Jason Subotky was added as co-manager of The Yacktman Funds more than a year ago for his contributions in prior years. Over the last decade, my contributions have been significant. I think that people would see a bigger divergence in management style from the last decade if Jason or I left than if my father left. At this time none of us are contemplating leaving.
I enjoy managing the funds. My level of excitement varies based on the opportunities of the marketplace. I especially enjoy periods like late 2008 and early 2009 and look forward to future market declines where bargain hunting is generally best. I do not think about managing the funds for the sake of a legacy. I am a competitive person and enjoy winning for personal satisfaction rather than public notoriety. I intend to be managing the funds for a long time to come.
Question: Have you thought of starting an asset allocation fund or a world allocation fund?
[Yacktman Managers:] No. We already have the flexibility to purchase fixed income securities on a limited basis in both The Yacktman Focused Fund and The Yacktman Fund. Recently a fund we advise was launched to allow non-U.S. investors to access us. We have no plans to start any other funds.
Question: Some of your larger stakes are in beverage plays - PepsiCo (PEP) and Coca-Cola (KO). But PepsiCo is the larger of the two. Do you think that PepsiCo has a better upside and better managed than Coca-Cola? Would like to know your thoughts on the two, which has a better future?
[Yacktman Managers:] We own both stocks and think both companies have bright futures. PepsiCo is a larger position than Coca-Cola for us because it is less expensive and, in our opinion, has a similar growth profile over time. The overlap between PepsiCo and Coca-Cola’s businesses is lower than it appears on the surface, as the majority of Pepsi’s value is derived from food businesses including Frito Lay and Quaker Foods, not beverages.
Question: I have a considerable position in Apollo Group Inc. (APOL). I think the business is highly undervalued at current prices ($43) and was able to add in the deeps ($34). I think it is worth at least $60.
What is your opinion about this company? And what is your range for the intrinsic value?
[Yacktman Managers:] As of December 31, 2010, which is the latest date we released ownership information on securities we hold, we owned a position in Apollo Group. We purchased the position after the Department of Education released loan repayment data for higher education universities, giving us a better ability to appraise Apollo’s business and compare it to other schools.
Apollo is the largest of the “for profit” education companies and has significant scale advantages compared to other “for profit” companies. The quality of any university’s reputation is extremely important, and we think Apollo has established the leading brand in the “for profit” education space. We think Apollo provides a valuable service and has the ability to effectively manage through changes to government loan programs should they occur. We do not comment on prices at which we would purchase or sell securities.
Question: Any thoughts as to Pepsi losing market share on its CSD position and ceding its long-held 2nd place position to Diet Coke? Are they losing focus on CSD and concentrated too much on the food business?
[Yacktman Managers:]The domestic carbonated soft drink (CSD) business is not an especially important component of the value of PepsiCo. Frito Lay, Quaker Foods, Gatorade, and many other brands are far more important than domestic CSD’s. We would not be excited about the future of either Coca-Cola or PepsiCo if we were only looking at the North American CSD businesses. Both companies have strong global franchises and a wide variety of brands which we expect will provide solid growth over time.
Question: With the dollar more likely to lose its value over time with the current fiscal and monetary path, especially compared to Asian currencies (with some at multi-year or even all-time highs, like the Sing Dollar, Malaysian Ringgit, New Taiwan Dollar, etc.), would it be a better choice to allocate money in well-managed Asian companies (with operations focused in their home countries) than say, for example, Coca Cola or Johnson & Johnson, which generate more from international market than from the United States?
[Yacktman Managers:] We prefer to own U.S.-based companies where we have a better understanding of the accounting and business conventions. We feel confident that many of our top holdings will benefit in a weaker dollar environment should one occur.
Question: What do you consider the safest and cheapest company in your portfolio?
[Yacktman Managers:] PepsiCo is probably the best combination of predictability and valuation, which is why it is our second largest position in each fund. We feel extremely confident that PepsiCo’s products will continue to be enjoyed and consumed for years to come. We think consumer brand companies generally offer a higher degree of predictability into the future than other businesses.
Question: What company is considered the highest risk reward in your portfolio?
[Yacktman Managers:] We think News Corp (NWS) offers the best risk/reward currently and it is the largest position in each fund as of December 31, 2010. News Corp has a diverse collection of media assets that generate significant free cash flow and offer solid growth, yet the stock trades at a low multiple to free cash flow.
The pay television content division is the crown jewel. Top channels include Fox News, Fox Sports, FX, and a significant platform of international properties. This segment produced more than 30% operating income growth in fiscal 2010 which ended September 30. Between 2007 and 2010, despite a major recession, the operating income of the cable content business more than doubled, and since 2000, pre‐tax profits have increased nearly 30‐fold.
We think News Corp has transformed from a cyclical, advertising-driven business model to one which is more based on recurring revenues like those they receive from pay television content. In our opinion, News Corp is well positioned to generate substantial free cash flow and growth in years ahead.
Question: I'm interested in the intricacies of your portfolio construction:
1. In the Yacktman Fund, do you consciously aim to have around 60% of the portfolio in the top 10 positions most of the time?
2. Once you've worked out risk-adjusted rates of return for each stock and ranked them, how exactly do you size positions? For example, just looking at say the top five ranked stocks, would you put 10%, 9%, 8%, 7% and 6% into them, or would you be more likely to bunch them bit more tightly say 9.0%, 8.5%, 8.0%, 7.5%, 7.0%? And if so why?
[Yacktman Managers:] We do not have pre-determined formulas for managing funds. Positions are sized based on a variety of considerations. Generally, for a holding to become greater than 5% of fund assets it has to dramatically stand out from other opportunities. We concentrate in ideas because we think we can manage risk and reward best that way. If, in an unusual scenario we found 50 positions that offered nearly identical risk/reward, we might take 50 2% positions. Since that has not happened, we position-weight based on a variety of factors, favoring low valuation, good downside protection, predictable business model, and business diversification, among other things.
10. Question: What is the most important indicator you look at—free cash flow, ROIC, etc.?
[Yacktman Managers:] We believe investing is about trying to obtain the highest risk adjusted forward rate of return over a long period of time. In order to reach that goal, we focus on what we are buying and what we pay for it. The most important decision is the purchase price relative to the value of the investment. The value of an investment is a function of the future cash flows generated from the current assets and the reinvestment of those cash flows by either the investor (reinvesting the dividends) or the management.
The quality of the cash flows is a function of their degree of predictability. We believe it is better to analyze a business model by looking at the asset side of the balance sheet and determining how much cash is being generated by the assets necessary to run the business.
Question: I am managing accounts for several friends. Here are some questions I would like to ask: The company is trading at negative enterprise value sounds great opportunities for investment? Any risk buying in negative or very low enterprise value?
[Yacktman Managers:] There are risks in all types of equity investing. While investing in low or negative enterprise value businesses can work from time to time, there are many risks associated with the strategy. Is the enterprise consuming capital? Are there hidden liabilities? Will management do something dumb with the capital? Generally we find it better to invest in higher quality businesses that generate substantial free cash flow and have future growth ahead. However, good investing is largely about the right purchase price and if you can buy an enterprise cheap enough and understand the potential risks you might have a successful investment.
Question: Where do you often look for your investment ideas?
[Yacktman Managers:] We have a wide universe of securities we follow and also run proprietary screens to find ideas. Many of the best investments involve short term negative news about the company, industry, or the economy. If negative news sends a stock or group of stocks lower, we individually examine each idea, and, if the price is right, make a purchase. Our team is very experienced so there is a basic knowledge of many companies and work can be done rather quickly.
Question: In the absence of "absolute" value with an acceptable "margin of safety," some managers opt to hold higher levels of cash. Could you share your thoughts about this? And what were your flagship fund's cash allocation at previous market peaks 1999 & 2007?
[Yacktman Managers:] The Yacktman Fund is the older of the two funds, however we do not consider it our flagship fund. In fact, the co-portfolio managers of the funds have the personal assets that they have invested in The Yacktman Funds exclusively invested in The Yacktman Focused Fund due to the greater flexibility we have in managing that fund. That said, I presume you were asking about cash levels in The Yacktman Fund. At the market peaks in March of 2000 and October of 2007 we had approximately 5% and 20% of assets in The Yacktman Fund in cash.
In the absence of sufficient bottom-up ideas, we are willing to let cash build. It is all about the quality of the individual investment ideas and is not a market call. At the market peak in 2000, The Yacktman Fund had less than 5% of assets in cash because we found compelling bargains we felt could generate solid returns even though most companies seemed overvalued at the time.
Question: Other than company fundamentals or macro economics, do you pay any attention to a stock´s technicals, relative strength, momentum or chart patterns?
[Yacktman Managers:] No.
Question: Do you agree that M&A activity is driven primarily by fundamentals? In other words, inasmuch as fundamentals to not appear in the current environment to drive momentum (in my view, that is driven by price), do you feel that fundamental research, if done properly, can still lead an investor to excellent acquisition targets?
[Yacktman Managers:] M&A activity occurs for a variety of reasons. In our opinion, one of the major reasons for mergers and acquisitions is the ego of the management team of the acquirer. We think time is better spent looking for companies where solid returns can be achieved based on the operations of the business rather than looking for businesses that might be acquired.
Question: How do you calculate forward rate of return?
[Yacktman Managers:] The forward rate of return is the rate we would expect if we hold a security indefinitely and the multiple we pay for the business does not change much. We look at the cash being generated and the growth rates of the business, and by adding those components together, get a forward rate of return.
A simplified example is Coca-Cola. The free cash flow is a high percentage of net income and the stock trades at a free-cash-flow yield on our normalized numbers of about 5.25%. Inflation adds another 3% and we assume another 2% in organic growth, so that gives us an estimated compound annual return above 10% per year.
Question: Please what is the best way to invest in Africa? Is it through and ETF or a Fund?
[Yacktman Managers:] We are strong believers in active investing if you can find great managers. We have no special expertise when it comes to investing in Africa.
Question: Has technology made you better or more efficient investors in any particular ways and to what extent do you rely on excel modeling in your investment process?
[Yacktman Managers:] Technology has dramatically made company data more accessible. We do not rely on excel modeling to the degree others do as we are not trying to predict the next few quarter’s earnings to the penny. We would rather be generally right than wrong to the fourth decimal.
Question: Your funds invested heavily in small caps in 2009 during the crash. Coming out of the crash the small caps performed best. How did you know to invest in the small caps during that period? Was it from looking at past crashes, e.g., 1974 or was it because they were the cheapest?
[Yacktman Managers:] Will Rogers said, “Good judgment comes from experience and a lot of that comes from bad judgment.” We think investing, like many things in life, is about getting the important concepts right. It’s what you buy and what you pay for it and it’s a marathon not a sprint, so understand business models, competitive dynamics and valuation, and think long term. You may have us confused with another manager. We owned many very large companies in 2009. Our largest 10 holdings at year end 2009 were News Corp, PepsiCo, Coca-Cola, Viacom (VIA.B), Microsoft (MSFT), Pfizer (PFE), Conoco (COP), Comcast (CMCSA), and Clorox (CLX); hardly small cap companies.
We also purchased or owned several smaller market cap companies because we thought the deals were exceptional. For example, AmeriCredit’s (ACF) market cap went under $1 billion at its low in 2009 because it was trading at approximately 20% of book value. In 2010 it was acquired by GM for more than seven times that price. We believe in being objective and flexible, and when we saw great deals like AmeriCredit, we made purchases. We are focused on managing risk and reward and generating positive returns over time for our shareholders, not being slaves to a style box. That said, we have a strong preference for larger cap companies.
Question: How and when did you find your system for managing money, and has it changed over the years? Who do you read to stay grounded?
[Yacktman Managers:] I find the best way to stay grounded in this business is to read what rational, intelligent and seasoned veterans write: Warren Buffett, Bill Gross, Jeremy Grantham, Seth Klarman, John Hussman, David Rosenberg, Steve Romick and Robert Rodriguez of FPA, Bill Miller and of course Don Yacktman. It can be overwhelming and confusing at times to read such a diverse range of views on managing money, but they all seem to have a common core belief—design a system that you believe in, and stick to it We believe a good investor has to stand on his or her own two feet. We read extensively about great businesspeople and what other investors are doing, however we rely on our own experience and judgment when making investment decisions. We continually look to increase our understanding of great businesses and believe it is important to be open-minded while holding firmly to our investment process.
Question: Congratulations on a stellar performance for the extremely difficult "double zero" decade. I recently sorted through the 10-year results of all 116 of the gurus listed here. You ended up in my top ten, so that's why I recognized your name.
My questions: Is there any merit to the idea of using Put options instead of actually buying stocks? I am not talking about "get rich schemes" using options. But for serious long-term investments, as a sort of "insured" or "minimal risk" method of investing, as suggested in several books. I suspect this eliminates qualifying for the long-term tax rate... but other than that... can it work?
[Yacktman Managers:] We think selling puts makes sense from time to time rather than as an overall strategy. Many of the best investments we find do not have significant volatility, which makes selling options fairly unattractive. We would also rather participate in the upside of stocks rather than sell puts in the hopes of harvesting the premium. In The Yacktman Focused Fund we have the ability to use options, and last year we sold put options on BP (BP) at the height of the oil spill. Our put sale with a $20 strike allowed us to establish a price where we were willing to own the stock at a far lower level than it was trading for at the time. We ended up collecting the premium.
Question: Most of the stocks Yacktman funds (YACKX) and (YAFFX) own are companies listed in the U.S. While many of those companies have good foreign exposure, are you not worried about a fall in the stock markets (listed in U.S.) for various macro reasons (like loss in reserve currency status or a slow loss in confidence on U.S. as a capitalist leader or long deleveraging cycle, etc.)?
Japan is a great example of loss in their stock markets for two decades after a financial and housing crisis and a gradual deleveraging cycle. How do you protect your portfolio from being another Japan?
[Yacktman Managers:] We focus on purchasing securities we think we can generate solid returns regardless of the market movement over time. Over the “lost decade” in the U.S. market between 2000-2010 we generated solid absolute returns by selecting and owning individual securities rather than owning the market.
We appreciate your questions and interest in Yacktman Asset Management. [/i]