The AMG Yacktman Fund (Trades, Portfolio) (Class I) returned 1.09% during the second quarter, trailing the S&P 500® Index, which returned 3.09%. For the 12 months ended June 30, 2017, the Fund returned 12.79%, while the benchmark returned 17.90%.
Market Prices Are Up
Performance has moderated in recent years by our rising need to control risk in an environment that has become increasingly expensive and uncertain. In the last five years, most of the market rise has been due to investors paying higher and higher multiples for stocks while earnings growth has been fairly anemic. Today, market valuations are historically expensive, which makes it more difficult to find bargains, and during times like these, we patiently hold cash until we find investments that meet our risk-adjusted return hurdles. We never make market calls in the Fund. When we find investments that meet our parameters, we invest.
We are still able to find opportunities, and in the last quarter we established two new positions. However, due to large price increases in many of our current positions, we have also been trimming and selling.
We also sold one position, C.R. Bard, after an acquisition proposal, and we have a small position in Staples that agreed to be taken private at quarter end.
Market Quality is Down
We believe technology advances have made the marketplace more difficult for many established businesses. This cuts across a wide range of sectors, from media to retail to energy to financial services, and means a prudent investor should pay a lower multiple in a world in which earnings power has become more uncertain. The investment case for most emerging disruptive companies is often weak due to high valuation or because the company is private. Also, disrupters can themselves be disrupted. Remember a few years ago when iTunes was going to dominate digital music via downloads? How about MySpace, AltaVista and AOL?
We have strong confidence that the Fund’s portfolio holdings can deliver attractive risk-adjusted returns over the long term and believe we have some standout bargains, such as 21st Century Fox (Fox) and Samsung Electronics Preferred (Samsung), which may help generate outperformance versus the market over time.
Contributors included Samsung, Oracle Corp. (Oracle), and Johnson & Johnson (J&J)
Samsung (HKSE:005930, Financial)’s shares appreciated solidly in the second quarter as the company produced strong earnings growth in memory and display products. We believe the shares remain inexpensive due to higher level of profits. We expect Samsung’s 2017 earnings per share to be more than double their level just two years ago.
Although Samsung’s stock has appreciated significantly recently, we feel it remains inexpensive, trading at a P/E of five after adjusting for net cash and investments. Samsung is currently earning more pretax than the entire FANG group combined (Facebook, Amazon, Netflix and Google— now known as Alphabet), yet it trades at about one-tenth the price.
Oracle (ORCL, Financial)’s stock rose during the quarter after the company reported solid earnings results that demonstrated a return to growth after several years of challenges. The company is executing a solid transition to the cloud, and the shares continue to trade at a significant discount to peers.
J&J (JNJ, Financial)’s stock appreciated during the quarter, along with the general strength of the health care sector. We believe J&J continues to be one of the finest and best-positioned health care companies in the world.
Detractors included Fox, Cisco Systems (Cisco), and Procter & Gamble (P&G)
After a strong first quarter, Fox (FOX, Financial)’s shares retreated as the media sector fell out of favor due to renewed concerns over the declining number of pay-television subscribers. Over the last few years, Fox has struggled to handle industry challenges, currency issues, and less-than-stellar results at its network and film businesses. Due to the lack of recent business momentum, Fox’s shares have suffered from multiple contraction, while the market overall has seen significant multiple expansion. This leaves these shares very inexpensive in a world in which it remains difficult to find high quality at a low price.
We believe a significant part of Fox’s low valuation is due to the fact that it is managed for the long term by the Murdoch family, and the company is willing to make significant investments in the business, even though that might mean depressing short-term earnings. This approach has led to significant value creation over decades, but a low valuation today.
Many of our most successful investments over time are in companies like Fox, where significant assets are ignored when earnings are depressed. Over the next few years, we expect Fox’s sizable investments in India to produce substantial growth, which we think will help investors recognize some of the substantial value that we think is being overlooked today.
Cisco (CSCO, Financial) fell after reporting solid earnings results but providing weaker-than-expected earnings guidance for the coming quarter. Cisco is transforming its business, moving toward subscription services and away from larger one-time sales, and if successful, we think the shares will be awarded a significantly higher valuation, similar to what has occurred with Microsoft and Oracle more recently.
P&G (PG, Financial)’s stock sold off modestly during the quarter, as the company struggled to generate acceptable unit volume growth. In recent years, P&G has significantly sharpened its focus by selling off non-core assets and cutting costs; however, we think the company can go much further in its efforts to revitalize the remaining businesses.
Note on Indexing
In recent years, there has been a major shift away from active fund managers to index funds and ETFs. We think there is some merit to this trend, as many managers built portfolios that were not very differently constructed than their benchmark(s).
The Fund has always been managed to achieve risk-adjusted returns over a full market cycle and not to mimic a benchmark in the short-term. We think being different has been a large contributor to our success over time. The Fund has always been about flexibility and individual security selection. We believe an index-based investment approach simply does not manage risk, has likely been a powerful contributor to the multiple expansion over the last five years, and could be creating significant market risk today. In a period of uncertainty, when investors redeem index funds, who will be on the other side of the trade? Who will be the willing buyers, and at what valuation?
Conclusion
In the first week of July, the AMG Yacktman Fund (Trades, Portfolio) celebrated its 25th anniversary. We are proud that the Fund has outperformed the S&P 500 Index since inception and done so while staying risk averse.
We want to express our sincere appreciation to our shareholders as we move into our second quarter century. Successful management of a fund emphasizing risk-adjusted returns over time requires a patient and thoughtful investor base, which we have been able to attract over the years. We are also fortunate to have an excellent business partner in Affiliated Managers Group, adviser to the Fund, and an amazing team at Yacktman Asset Management. We will continue to work hard to assess current holdings and potential new additions to the AMG Yacktman Fund (Trades, Portfolio), and, as always, we will be patient, objective and diligent in our efforts.
1 Returns for periods greater than one year are annualized.
2 The performance information shown for periods prior to June 29, 2012 is that of the predecessor to the Fund, The Yacktman 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 predecessor Fund.
3 Prior to October 1, 2016, the Fund’s I shares were known as Service shares.
4 Since the inception of the Fund on July 6, 1992.
Disclosure
Investors should carefully consider the fund’s investment objectives, risks, charges and expenses before investing. For this and other information, please call 800.835.3879 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.
