The AMG Yacktman Focused Fund (Trades, Portfolio) (Service Class) returned -2.6% for the second quarter of 2015, compared with 0.3% for the benchmark, the S&P 500 Index. For the 12 months ending June 30, 2015, the Fund returned -0.1%, while the benchmark returned 7.4%.
This year, the Russell 1000® Value, which is an index representative of Large Cap Value, has lagged the Russell 1000® Growth Index by nearly 5% in the first half of the year. More than 30% of the Russell 1000 Value stocks are now greater than 20% below their 52-week high. We think the underperformance is mostly attributable to the short-term race for growth over value that often happens towards the end of an aging and expensive bull market.
Current Market Favors Promise over Profits
In recent quarters, the investment environment has favored expensive concept stocks which offer a promise of potential significant future growth over much more attractively-priced companies where there may be less momentum in the short term because of currency headwinds or short-term business challenges. “Promise” stocks include “new tech” stocks like Netflix (NFLX, Financial) and Amazon.com (AMZN, Financial), as well as companies where there may be no earnings, or even revenues, as with biotech companies.
As investors we often state that “it’s almost all about the price.” We remain focused on companies with sustainable business models that generate significant free cash flow, and sell at attractive valuations. Like it did in the late 1990s, this approach can go out of favor in the short term when high multiple stocks are popular.
Underperformance Often Sets Up Outperformance
We think our recent results have set us up for much better returns going forward. Some of our largest positions, like Procter & Gamble (PG, Financial) (“P&G”) and 21st Century Fox (FOXA, Financial) (“Fox”), which have underperformed, are much more attractively priced today than they were at the beginning of the year. The Fund is more concentrated than it was at the end of the first quarter, with the Yacktman Focused Fund (Trades, Portfolio) holding 26 positions.
Our favorite investments may lag late in expensive bull markets. The underperformance of the Fund in the late 1990s set us up to provide strong positive returns over the next three years, even as the market dropped nearly 50%. Similarly, underperformance from 2005-2007 prepared us to deliver solid results in 2008-2009 even as the market declined.
In early July, investors were reminded that stocks can be risky, as markets in China and Hong Kong posted significant losses. In the United States, we are now more than six years into a bull market. We think what has worked in the last few years may not work so well going forward. As market sentiment shifts, what has not been successful recently may significantly outperform in the future.
Contributors
During the second quarter, top contributors included Microsoft (MSFT, Financial), Stryker (SYK, Financial) and Anthem (ANTM, Financial).
Microsoft’s shares rebounded in the second quarter after declining in the first. The price movement demonstrates the short-term orientation that has overtaken many stocks recently, as we did not think either quarter produced much to be either panicked or excited about. We continue to like the long-term prospects for significant cash flow generation the company has, and believe the new management team is executing well.
Two health care companies, Stryker and Anthem (previously known as WellPoint), appreciated during the quarter. Both stocks were strong in large part because their sector has been in favor. Health care stocks, which were inexpensive in 2011 are now more fully priced and we are being more selective in our positions and weightings in the sector today.
Detractors
During the second quarter, some of the largest detractors included Fox, P&G, and Samsung, which are among our high conviction long-term investments. We think these investments all offer significant long-term value despite their recent unpopularity.
Fox remains one of our favorite holdings despite pulling back in the second quarter. Recently, Fox announced a series of management changes, appointing James Murdoch as Chief Executive Officer of the company with Rupert Murdoch and Lachlan Murdoch being named Co-Executive Chairmen. We believe James is a talented leader. He previously was Chief Executive Officer of BSkyB for several years, and has been extensively involved in Fox’s operations for nearly two decades. James takes the Chief Executive Officer title from his father, Rupert, who has been running the business and its predecessors for a remarkable 60+ years.
We believe Fox is extremely well-positioned for significant growth in earnings-per-share over the next several years. We think the company is getting little credit for several of its recent investments, including its strong market position in India, where the company has nearly 25% of the television viewing audience. The business in India is running near break-even, as costs are high in the short-term due to one-off expenses like World Cup cricket rights and the build-out of a mobile platform. Domestically, Fox is making investments to create new channels like Fox Sports 1 and to turn around the Fox Broadcasting Network, which has suffered from weak ratings recently. The expenses associated with the investments will decline over time, and we expect profit margins to rebound while the company achieves solid revenue growth and free cash flow.
Fox is in the “penalty box” because the company is trading potentially higher current profits for far greater value in the future. This is exactly the way we like to see our businesses managed. However, the stock market currently favors companies that are maximizing profits today and penalizing those willing to invest for the future. We think this will set Fox up for strong outperformance over time and believe our patience will be richly rewarded.
P&G was out of favor during the quarter as the company continued to sell its non-core businesses. Now that the divestitures are nearly complete, we think P&G will grow faster and manage costs more effectively than they have in recent years.
Samsung (XKRX:000830, Financial)’s shares declined in the second quarter due to weaker-than-expected mobile phone sales. The shares are inexpensive and offer good downside protection due to the fortress balance sheet. Net of the excess cash and investments the stock sells for 3-4 times earnings, which we think is remarkably cheap, especially given the strong market position of its semiconductor business.
“It’s waiting that helps you as an investor, and a lot of people just can’t stand to wait.” Charlie Munger (Trades, Portfolio) in 2014.
Some investors have expressed frustration with the Fund’s recent soft performance. At times, and especially late in a bull market, our patient, objective approach may be challenging to some because it looks like we are not doing enough to change things. We want to assure investors that we are constantly working on investment ideas, both current and potential new Fund holdings. We are not simply waiting; we are waiting for the right price before acting. Today, as many stocks have declined significantly from their highs, we have a longer list of potential new investments than we have had in years. Recent market activity has created many stocks that are “in the ballpark” from a valuation standpoint, but are not cheap enough to be “on the field.” At the right prices, we will act quickly.
Conclusion
We remain extremely confident in our investment approach and its ability to outperform while managing risk over the long-term. We are more excited about the Fund’s positioning and valuation than when we started the year, and will continue to execute our long-term strategy which has historically served investors exceptionally well.
The views expressed represent the opinions of Yacktman Asset Management LP as of July 17, 2015, are not intended as a forecast or guarantee of future results, and are subject to change without notice.
Disclosure
Investors should carefully consider the fund’s investment objectives, risks, charges and expenses before investing. For this and other information, please call 800.457.6033 or download a free prospectus. Read it carefully before investing or sending money.
Past performance is no guarantee of future results.
The Fund is subject to the risks associated with investments in debt securities, such as default risk and fluctuations in the perception of the debtor’s ability to pay its creditors. Changing interest rates may adversely affect the value of an investment. An increase in interest rates typically causes the value of bonds and other fixed income securities to fall.
High-yield bonds (also known as “junk bonds”) are subject to additional risks such as the risk of default.
Investments in international securities are subject to certain risks of overseas investing, including currency fluctuations and changes in political and economic conditions, which could result in significant market fluctuations. These risks are magnified in emerging markets.
The Fund can invest in securities of different market capitalizations (small, mid and large capitalizations) and styles (growth vs. value), each of which will react differently to various market movements.
A greater percentage of the Fund’s holdings may be focused in a smaller number of securities which may place the Fund at greater risk than a more diversified fund.
The Fund may invest in derivatives such as options and futures; the complexity and rapidly changing structure of derivatives markets may increase the possibility of market losses.
A short-term redemption fee of 2% will be charged on redemptions of fund shares within 60 days of purchase.
The S&P 500 Index is capitalization-weighted index of 500 stocks. The S&P 500 Index is designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.
The S&P 500 Index is proprietary data of Standard & Poor’s, a division of McGraw-Hill Companies, Inc. All rights reserved.
The Russell 1000® Value Index is a large-cap value index measuring the performance of the largest 1,000 U.S. incorporated companies with lower price-to-book ratios and lower forecasted growth values.
The Russell 1000® Growth Index is a market capitalization weighted index that measures the performance of those Russell 1000® companies with higher price-to-book ratios and higher forecasted growth values.
Unlike the Fund, the indices are unmanaged, are not available for investment and do not incur expenses.
Any sectors, industries, or securities discussed should not be perceived as investment recommendations. Any securities discussed may no longer be held in an account’s portfolio. It should not be assumed that any of the securities transactions discussed were or will prove to be profitable, or that the investment recommendations we make in the future will be profitable.
Funds are distributed by AMG Distributors, Inc., member FINRA/SIPC.
- Returns for periods greater than one year are annualized.
- The performance information shown is that of the predecessor to the Fund, The Yacktman Focused Fund (Trades, Portfolio), which was reorganized into the Fund on June 29, 2012, and was managed by Yacktman Asset Management LP with the same investment objective and substantially similar investment policies as those of the Fund.
- Since the inception of the Fund’s Institutional Class shares on July 24, 2012.
- Annual expense ratio as of May 1, 2015.
