The AMG Yacktman Fund (Trades, Portfolio) (Class I) appreciated 7.48% in the fourth quarter compared to the 6.64% increase in the S&P 500 Index. We achieved strong results in the fourth quarter through outstanding security selection. 21st Century Fox (Fox) delivered exceptional returns for the Fund due to the announcement of a transaction with The Walt Disney Company (Disney) which we think could create substantially more shareholder value over time.
We recently celebrated the 25th anniversary of the AMG Yacktman Fund (Trades, Portfolio). For the 25-year period ending December 31, 2017, the Fund appreciated 10.5% annually compared to 9.7% for the S&P 500 Index. This annual outperformance of nearly 1% over 25 years means that $10,000 invested in the Fund compounded to $111,250 versus $100,988 for an investment in the Index.4 The Fund’s outperformance was particularly impactful during the down markets of 2000–2002 and 2008–2009. The Fund was never constructed to look like a benchmark, and in most years it performed differently than the general market. Our outperformance versus the general market over the 25-year period was especially notable because 1) most managers have underperformed over that time, leading to many investors deciding to purchase index funds in recent years, 2) we achieved our results largely by owning higher quality securities and holding excess cash to manage risk when it was difficult to find bargains and 3) much of our best outperformance came during the down markets of 2000–2002, when the Fund appreciated each year, and 2008–2009.
Today’s market environment reminds us of other periods during which investors ignored risks, chased growth and paid little attention to valuations. The combination of these factors can be dangerous, with more potential downside scenarios than long-term upside cases. Investing in an expensive market is especially challenging for fund managers like us who are focused on protecting capital, and we are pleased to have navigated the fourth quarter of 2017 and the entire year so successfully.
For some historical perspective, the last momentum-oriented growth chasing market like this was in 1999, a year when the Fund declined - 16.9% compared to a 21.0% rise in the S&P 500 Index. The insanity of that investment environment set up a remarkable decade for the Fund where it delivered 11.9% annualized returns compared to the S&P 500 Index which declined by 1.0% annually over the same period.5 Translated to Dollars, this return differential means an investor in the Fund ended the decade with $30,816 for each $10,000 invested, compared to only $9,090 for an investment in the S&P 500 Index.6
Contributors included Fox, Cisco Systems (Cisco) and Microsoft
Toward the end of 2017, Fox (FOX, Financial) and The Walt Disney Company (Disney) (DIS, Financial) entered into a transformative transaction in which Fox will merge the majority of its assets in exchange for Disney stock in a deal we expect to receive approval from regulatory agencies. In addition to Disney shares, Fox shareholders will receive shares in “New Fox” which will retain valuable businesses including Fox News, Fox Sports, Fox Network, television stations, real estate and investments. New Fox and Disney will both benefit significantly from the lower corporate tax rate which was passed in the U.S. in late December.
For several years, we have been puzzled as others looked past the significant value we observed at Fox. We felt the market was largely ignoring Fox’s global businesses that were underearning because management was investing for future growth. Competitors in the industry better understood the value and importance of Fox’s businesses, which was demonstrated by press reports of significant interest in ownership of Star and investment stakes in Sky and Hulu by not only Disney but also Comcast, Sony and Verizon. We believe the proposed transaction with Disney, resulting in a large ownership stake in Disney’s stock, represents an exciting long-term opportunity for Fox investors, and we applaud the Murdoch family and board of directors of Fox for being fantastic stewards for shareholders and always thinking and investing for the long term.
The recent result of our Fox investment should reinforce for the Fund’s shareholders that a combination of patience and a significant discount to fair value has worked well over time. Another key takeaway is that we dynamically adjust our position size in response to valuation as a core part of our process. In mid-2014, the Fox position was 7% of assets. Today the weighting has more than doubled because Fox’s business value grew substantially in the ensuing years. In addition to an inexpensive absolute valuation, we believe Fox is a far better deal compared to alternative investment opportunities which have gotten more expensive through multiple expansion (people paying a higher price for a given level of earnings).
Many investors seek a catalyst that they think will help move shares higher in the short term. Most of the time, our investments lack such a well-defined trigger to unlock value in the near term as we are more interested in a quality business selling at a substantial discount to what we think it is worth. We are willing to wait as long as we need to if we see significantly more value than the current trading price. We see our patience as a huge competitive advantage, one that exists because Yacktman is a boutique firm. The Fund’s portfolio managers control the day-to-day decisions in the Fund and at the firm, and we only answer to ourselves, our Fund board and our investors about long-term results.
Cisco (CSCO, Financial) shares appreciated in the fourth quarter along with strength in the information technology sector. Cisco continues to migrate its business from larger one-time sales toward subscription services, which we believe makes the company significantly more stable, predictable and valuable. We feel the shares remain attractively priced and the company possesses a strong balance sheet.
Microsoft (MSFT, Financial)’s stock performed solidly for the fourth quarter and for all of 2017. The company has continued to execute well, delivering solid growth, especially in its cloud-based businesses. It is remarkable how successfully Microsoft has transformed its results under the strong leadership of CEO Satya Nadella.
Detractors included Avon Products (Avon), Aggreko, and Oracle
In 2017, there were only a handful of securities which produced negative returns. Cash was the biggest negative drag for the Fund, but one which we felt was necessary given current valuations and risks.
Avon (AVP, Financial)’s ongoing business struggles led to a price decline in its debt in the fourth quarter. We continue to think Avon has significant brand value and believe a new CEO can significantly improve the business results and restore investor confidence.
Aggreko (LSE:AGK, Financial)’s stock declined modestly as the company struggled with disappointing orders for its utility business. Revenue growth at Aggreko has also been impacted as its energy-related customers faced challenges and competition increased due to industry softness. The recent increase in oil prices may lead to a better environment for Aggreko’s customers in North America.
Oracle (ORCL, Financial)’s shares pulled back slightly during the quarter due to modestly disappointing results in its cloud business. Even after the pullback, the shares remain strong performers for the year. We continue to believe that Oracle will successfully transform its business, much like Microsoft did, into a more robust subscription-based business. In the meantime, in our view the stock remains inexpensive.
Other
After a long proxy battle, Procter & Gamble (PG, Financial) announced it would add Nelson Peltz of Trian Partners to the board of directors in 2018. We think Mr. Peltz, a significant shareholder and important voice for all owners, will improve PG’s focus. Several of our other highly successful investments— such as Sysco Corporation (where Trian Partners has two board seats), Microsoft and Fox—have benefited greatly from having a shareholder advocate in the boardroom.
Conclusion
Despite high market valuations and an investment environment that has fewer true bargains than we would like, we believe we can produce solid returns over time while managing risk, even if it takes time to deploy the cash we hold. As always, as we find individual investment opportunities, we make investments regardless of general market valuations.
We are pleased with the strong absolute returns that the Fund delivered in the fourth quarter and all of 2017. A market driven by growth-oriented shares in an already expensive investment climate is not one we would have expected to largely keep up with given our strong focus on quality, attractive valuations and risk management. Security selection allowed us to achieve good results and we believe this ability will allow us to thrive going forward. As always, we will continue to be diligent, disciplined and patient in managing the Fund.
The views expressed represent the opinions of the Yacktman Asset Management L.P., as of December 31, 2017, are not intended as a forecast or guarantee of future results, and are subject to change without notice.
Top Ten Holdings (%)7 (as of 12/31/17)
1 Returns for periods less than one year are not 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 Since the inception of the Fund on July 6, 1992.
4 Dollar figure for the S&P 500 Index does not include potential costs such as fees and transaction costs.
5 Annualized returns for the period 2000–2009.
6 Dollar figure for the S&P 500 Index does not include potential costs such as fees and transaction costs
7 Mention of a specific security should not be considered a recommendation to buy or a solicitation to sell that security. Holdings are subject to change.
