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Holly LaFon
Holly LaFon
Articles (9005)  | Author's Website |

Yacktman Fund's 1st Quarter 2018 Shareholder Letter

Discussion of holdings and markets

June 12, 2018 | About:

In the first quarter of 2018, both our Fund and the market declined modestly with the AMG Yacktman Fund (Trades, Portfolio) (Class I) down 0.96% and the S&P 500 Index down 0.76%. The S&P 500 rocketed to start the year, appreciating almost 6% in January with technology stocks and momentum/growth leading the way. Following the strength in January, the market suffered a rapid 10% decline from the highs, ultimately closing modestly lower for the quarter.

Nine years into an expensive bull market, we were beginning to feel like the knight guarding the grail in the final act of the movie Indiana Jones and the Last Crusade.

INDIANA JONES: Who are you?

KNIGHT: The last of three brothers who swore an oath to find the grail and to guard it.

INDY: That was seven hundred years ago.

KNIGHT: A long time to wait.

While some may be concerned by the return of market declines and volatility, we welcomed them back. In the last several years, the majority of market returns have been fueled by multiple expansion (people paying

higher prices for a similar level of earnings). Without the contribution of strong earnings growth, higher multiples typically lead to lower future rates of return and increased risk. We have responded to this environment by:



  • Selling or reducing holdings that became less attractive, often due to price appreciation




  • Adding select opportunities outside of the United States such as Samsung Electronics Co Ltd Preferred (Samsung)




  • Holding cash in the absence of investment opportunities meeting our strict investment criteria (We will never hold cash as a market call)


The return of market volatility could lead to much better investment opportunities. We have a list of potential additions that we are ready to purchase at the right prices.

Indexing continues to increase in popularity. Recent outperformance by passive over active no doubt helps influence this shift, as the attraction to what has worked lately is strong. However, we think the trend has set up an extremely dangerous situation for those who invest passively in the market.

Prices, which we think are the key determinant of returns over time, are high. We believe high prices lead to lots of risk and disappointing future returns. Similarly, an investor needs to choose between indexing, an approach that doesn’t consider price or risk, versus the active investment strategy we employ that is constantly evaluating valuation and risks and has achieved superior risk-adjusted returns over the long term.

The popularity of indexing is leading many to confuse the risk of underperformance with the risk of losing money. We have always believed that low-cost indexing made sense versus hiring a high-fee manager who closely tracked benchmark weightings. Contrast this with our approach which focuses on security-specific opportunities while managing the level of risk. A recent study by S&P Dow Jones reported that more than 92% of U.S. large cap active fund managers underperformed the S&P 500 Index over the last 15 years.4 Our Fund was in the 8% that outperformed. We also generated this return for our investors with less risk, outperforming in the difficult market periods such as 2001–2003 and 2008–2009.

Investors should be highly skeptical of a passive investing approach that largely ignores the price paid for an asset. Overpaying leads to high risk and low returns over time. We only have to look back to market valuations at the end of 1999, where a passive investment in the S&P 500 Index lost money over the next decade. During that same time period, the price and risk-conscious strategy of our Fund generated nearly 12% annual returns. To again quote the knight from Indiana Jones, “Choose wisely.”

Contributors included 21st Century Fox, Inc. (Fox) Cisco Systems, Inc. (Cisco) and Microsoft Corporation.

Late last year, Fox’s shares increased as the company agreed to sell nearly $70 billion of assets to Disney while retaining Fox News, the Fox Network, Fox Sports 1, and other assets as “New Fox.” To start 2018, Fox’s shares have continued to increase as investors appraised the positive attributes of transaction, especially the value of New Fox. Other parties were also interested in Fox’s businesses, and it has been reported that Comcast may still be interested in acquiring Fox assets. Stay tuned.

Cisco (NASDAQ:CSCO) and Microsoft (NASDAQ:MSFT) produced solid returns to start the year, following a strong 2017. Technology stocks have been in favor for the last few years due to strong business momentum and earnings growth. In recent years, Satya Nadella as Microsoft’s CEO has accomplished what many thought was improbable—returning Microsoft to a role of leadership in the technology space. The stock has responded nicely, more than tripling since Nadella took over the helm in February 2014.

Detractors included Procter & Gamble (P&G) PepsiCo (Pepsi) and Johnson and Johnson (J&J).

Consumer staples stocks fell out of favor in the first quarter as many of the companies are struggling to produce earnings growth, causing investors to question their valuations. For many decades, investors could purchase high-quality consumer companies and perform fairly well. The sector produced solid growth at high returns, protected by shelf space with retailers and reinforced by advertising campaigns to build strong brands.

In recent years, the world has changed. It is far easier to launch a brand without advertising, and products can be purchased online rather than in stores, negating some of the historical advantages of incumbents. We believe the staples space will be significantly more challenging than in the past, but select companies should continue to produce solid results. Choosing the right business has become more important than ever in this sector. A similar path has played out in the media sector over the last few years, where Fox, Time Warner, and Scripps substantially outperformed Discovery, Viacom, CBS, AMC and Disney. In the Fund, we like Pepsi for its Frito Lay business, Coca-Cola for its global beverage dominance, and P&G for its ability to produce better results due to an improved portfolio of brands and the ability to cut costs—all can perform well over time even through the industry headwinds. Our expectation is the companies will deliver strong free cash flow while producing modest unit volume and pricing growth.

We have owned consumer staples through other periods of underperformance, including the period started by Marlboro Friday in 1993. Back then, Philip Morris announced a 20% price cut to fight off generic manufacturers. Many believed this meant that consumer brands were dead, and staples declined across the board. The fears were overdone, and the declines proved to be buying opportunities for many of the top consumer staples. We believe the concerns about staples in general are becoming overblown, but have high conviction in the specific staples companies in the Fund.

J&J, which has a modest sized consumer business as well as larger pharmaceutical and medical device businesses also declined during the quarter. The stock has been a strong performer in the last few years, and we think has a solid outlook going forward.

Other

Samsung (XKRX:005930)’s shares declined modestly during the quarter even though the company generated record results. The stock continues to sell at what we feel is an incredibly low valuation. Samsung reported record preliminary operating profits of nearly $15 billion for the first quarter, in large part due to a surge in demand for memory chips used in servers and continued demand in phones and PCs.

Samsung is currently earning more than $1 billion in pre-tax profits per week, yet we are paying less than $200 billion for the shares net of excess cash and investments via the preferred shares. This valuation is incredibly low and a massive discount to most other technology companies. Samsung is the market leader in memory chips, a space where demand is expected to grow dramatically over time due to advances in artificial intelligence, virtual reality, the cloud, and autonomous driving. In the short term, the stock has stalled, substantially underperforming its memory market peers. We continue to see improvements in governance at Samsung and in Korea, and expect these positive changes could lead to higher valuations for the company over time.

New Purchases

In the last couple of quarters, we found some attractive securities, including Bollore and KT&G. Bollore is a global conglomerate with large representation in media and ports & logistics. Like many of our favorite investments, it is a bit complicated. This is compensated by an attractive price, as we think the market does not give Bollore credit for all of its assets or even the correct share count. KT&G sells tobacco and ginseng and offers a low valuation and an exceptional balance sheet. We think, like Samsung, it could benefit from positive governance changes taking place in Korea.

Like the knight from Indiana Jones, we will protect to the best of our ability for as long as we need to. We are seeing many stocks decline and move towards significantly more attractive valuations, and believe the need to protect may decline soon and the ability to purchase bargains return. As always, we will purchase new opportunities when we see them, regardless of market levels. We will continue to be patient, diligent, and hard-working when managing the Fund.

The views expressed represent the opinions of the Yacktman Asset Management L.P., as of March 31, 2018, 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 800.835.3879 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.

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 is subject to risks associated with investments in mid-capitalization companies such as greater price volatility, lower trading volume, and less liquidity than the stocks of larger, more established companies.

The Fund is subject to risks associated with investments in small-capitalization companies, such as erratic earnings patterns, competitive conditions, limited earnings history and a reliance on one or a limited number of products.

5 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.

Companies that are in similar businesses may be similarly affected by particular economic or market events; to the extent the Fund has substantial holdings within a particular sector, the risks associated with that sector increase.

The Fund invests in value stocks, which may perform differently from the market as a whole and may be undervalued by the market for a long period of time.

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.

Unlike the Fund, the S&P 500 Index is unmanaged, is not available for investment and does not incur expenses.

The S&P 500 Index is proprietary data of Standard & Poor’s, a division of McGraw-Hill Companies, Inc. All rights reserved.

Any sectors, industries, or securities discussed should not be perceived as investment recommendations. Any securities discussed may no longer be held in the Fund’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.

About the author:

Holly LaFon
I'm a financial journalist with a master of science in journalism from Medill at Northwestern University.

Visit Holly LaFon's Website


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