Yacktman Asset Management 1st Quarter Commentary

Discussion of markets and holdings

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May 03, 2017
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The AMG Yacktman Focused Fund (Trades, Portfolio) (Class N) returned 8.48% during the first quarter, outperforming the S&P 500 Index, which increased 6.07%. For the 12 months ended March 31, 2017, the Fund appreciated 15.64%, while the benchmark was up 17.17%.

We achieved strong results and substantial outperformance to start the year due to strong performance from our top holdings, with significant positive contributions from Samsung Electronics Preferred (Samsung) shares and 21st Century Fox (Fox).

Our start to the year is especially gratifying because value, which is our investment style, has significantly lagged growth. Excess cash in the Fund, which increased modestly during the quarter, restrained results; however, given current high market valuations, we continue to vigilantly manage risk until we find better opportunities for purchase of individual securities. Last quarter we found more to trim or sell than to buy, given the strong performance of many of our holdings. Excess cash is never a market prediction, and if we find what we believe are good individual investments, even in an expensive market, we will make purchases.

Active/Passive Debate

To paraphrase Mark Twain, “The reports of [active management’s] death have been greatly exaggerated.”

Many who report about the asset management industry would have you believe that active money management is dying. It reminds us of the late 1990s when many stories were written about the demise of value investing.

On April 13, 2017, The Wall Street Journal produced an article titled “Indexes Beat Stock Pickers Even Over 15 Years.” In a chart titled “Lagging Behind”, the data noted that 92% of large cap managers trailed the S&P 500 Index over the prior 15 years.

The AMG Yacktman Focused Fund (Trades, Portfolio) outperformed the S&P 500 Index by more than 4% per year over the 15-year period ending December 31, 2016, as measured by The Wall Street Journal. Further, we did it with significantly lower risk than the market, at times carrying excess cash even greater than today’s levels.

We believe the move toward passive investing has some merit. In the industry, many managers have never been truly active in their approach, seeking to construct their funds with sector weightings that were similar to their investment benchmark so performance would not deviate too much. These managers prized gathering assets over achieving investment returns, and the end result was underperformance.

Our approach has always been about achieving returns over a full market cycle with a strong focus on risk management. We outperformed not only the benchmark in the time period measured by The Wall Street Journal, we also did so by a sizable margin. We managed through both good and bad periods with a focus on individual securities and how they could perform over the long-term, while paying less attention to short-term noise. We continue to believe that our active style––which is characterized by significant concentration in high-conviction ideas, a strong focus on valuation and quality and flexibility to find ideas that may be out of benchmark, like fixed-income securities or Samsung––can continue to reward long-term oriented shareholders going forward.

Contributors to the quarter included Fox, Samsung and Oracle Corp (Oracle)

In the first quarter, Fox (FOX, Financial)’s shares rose more than 15%. Fox News continued to post strong ratings even though viewership typically declines substantially after a presidential election. Tucker Carlson seamlessly replaced Megyn Kelly, who left for rival NBC, and his show achieved significantly stronger ratings than that of his predecessors. Fox continued its run of luck in sports, with a strong first-ever Super Bowl that went overtime (following an exceptional seven-game, extra-inning World Series final in the fall), and its film business had successes with Logan and Hidden Figures.

More importantly, we believe Fox continues to create substantial long-term value in its underappreciated overseas businesses. In the last three years, Fox has faced nearly a $1 billion earnings headwind from foreign currency moves, masking otherwise strong results from outside the United States.

Samsung (XKRX:005930, Financial)’s stock delivered solid results in the quarter, in large part due to significantly-improving profit trends in the company’s semiconductor and display businesses. Due to strong product cycles and tight product supplies, we think these businesses could produce earnings that nearly double in 2017.

In recent months, South Korea has experienced significant political unrest, culminating in the arrest of impeached President Park Guen-Hye at quarter end. We believe the changing political landscape will bring about improved corporate behavior, which could allow Samsung’s shares to trade more in line with global peers––and substantially higher than where they are today. Although tensions with North Korea have recently increased, Samsung is a powerful global business whose stock remains, in our view, attractive, due to its well-positioned businesses, low valuation and strong balance sheet.

Oracle (ORCL)’s shares rose during the quarter along with general strength in the technology sector, which also lifted investments in Microsoft and Cisco. Oracle’s stock was also helped by solid earnings results and a continued transition to a more subscription-based revenue model and away from large one-time contracts.

Detractors included Sysco Corp, Avon Products (Avon) and Exxon Mobil Corp (Exxon)

All three of the Fund’s largest detractors for the quarter were securities that produced exceptional returns in 2016. Often, much of the short-term share price movement is just random noise for both contributors and detractors, and we think Sysco, Avon and Exxon Mobil are all well-positioned for the long run.

Sysco (SYY, Financial)’s stock was off by 6% during the quarter. The company continues to execute well, benefitting from an increased focus on profit margins and strong results in Brakes Group, a significant acquisition the company completed in 2016.

Avon (AVP, Financial)’s shares declined during the quarter, as the company faced what we think will prove to be short-term challenges in the company’s long-run turnaround plan. We own both the equity and the debt of Avon in the Fund. Owning debt is a part of the flexibility we referred to earlier in this update, and typically, when we own debt, the rate of return we expect to achieve is similar to that of a stock of which we might invest. However, due to its seniority in the capital structure of the business, we believe it may offer a lower-risk method of achieving a higher return.

Exxon (XOM, Financial) traded off during the quarter along with general declines in the energy sector. Notably, ConocoPhilips (COP, Financial) was flat for the quarter, in large part due to a sharp price increase after the company announced the sale of Canadian assets at an attractive valuation.

Conclusion

We are pleased with the solid results for the first quarter, though, as always, we like to judge performance over the long-term. We continue to work hard assessing current holdings and potential new additions to the AMG Yacktman Focused Fund (Trades, Portfolio), and we will be patient, objective and diligent in our efforts.