In the fourth quarter, the AMG Yacktman Fund (Trades, Portfolio) (the Fund) declined -3.80% while the S&P 500® Index dropped -13.52%. For the year, the Fund was up 2.69% compared to the S&P 500, which declined by -4.38%. The Russell 1000® Value Index, which we are introducing as a secondary benchmark for the fund given our value approach, declined -11.72% for the quarter and -8.27% for the year.
While we are pleased with the short-term returns, what really matters is long-term results. In the last 20 years, the Fund has compounded at 9.6% annually compared to the S&P 500’s 5.62% return. We achieved this outperformance with a keen eye on risk, while, at times, carrying excess cash at levels that are similar to where they are today. Although many have given up active management to purchase index funds because they have been told it is nearly impossible for a manager to outperform over long periods of time, we believe our record refutes an all-passive approach.
We think protecting well in the down markets is one of the most crucial aspects to achieving superior long-term risk-adjusted returns. We are not alone. In a speech in 2015, Stanley Druckenmiller (Trades, Portfolio), one of the most successful hedge fund managers of all time, said about evaluating a potential manager, “When I look at their record, I immediately go to the bear markets and see how they did.” When the market declined nearly 20% between September 21 and December 24, the Fund declined 7.4%.
In the more prolonged declines of 2008-2009 and 2000-2002, we also delivered solid outperformance.
Consumer staples shares were generally stronger during the fourth quarter as businesses with consistency and quality were viewed as a relative safe haven during the period of market stress. Procter & Gamble (PG, Financial)’s shares were a standout in the staples group after reporting the highest quarterly organic sales growth since 2012, pointing to signs that, after many years of restructuring, a turnaround may be taking hold.
Fox (FOX, Financial)’s shares were strong during the quarter as the company moved closer to closing its transaction to sell key assets to Disney. In the fourth quarter, the transaction received key antitrust approval from China, something which had been a concern to some given the current state of trade relations. We think the transaction will close some time during the first quarter, and there remains solid value in the shares at current prices. Fox’s execution continued to be solid, helped by a turnaround in football ratings, benefiting Fox Network, which recently added Thursday night games to its schedule.
Similar to P&G, Coca-Cola (KO, Financial)’s shares outperformed and delivered positive returns during the quarter, after reporting improved business results. Over the last several years, we think Coca-Cola’s management has done an excellent job of re-orienting the company towards overall beverage consumption and reducing its exposure to carbonated soft drinks.
Detractors – Tech
Having delivered strong stock returns in the past few years, technology shares declined sharply in the fourth quarter.
Samsung (XKRX:005930, Financial)’s shares retreated due to stronger evidence of short-term weakness in the memory semiconductor businesses as well as the general declines in technology stocks. Historically, the memory business (DRAM and NAND) has been brutally cyclical even though the overall trend has been one of solid growth. While the cyclicality has not been eliminated, we think the current down cycle should be much more benign and fairly short in duration for DRAM, as today only three vendors control more than 90% of the market and all are cutting back on capacity additions. Over time, we see strong growth in the industry, as many of the advances in technology should require huge amounts of memory semiconductors.
We think Samsung’s shares have far overreacted to the down cycle and the valuation makes it an exceptional investment opportunity, and made additional purchases during the quarter on the price declines. Samsung’s preferred shares represent one of the least expensive investments in a high-quality large company we have ever seen, selling below book value and having more than half of the market cap in net cash/investments/hidden assets. While earnings will be weaker in 2019, the stock trades at less than three times our expectations for this year’s earnings after subtracting the excess assets not required to produce the profits.
Oracle (ORCL, Financial) and Microsoft (MSFT, Financial) also traded off with general weakness in the tech sector. We think Oracle remains inexpensive and is making a slow but effective transition to the cloud, something Microsoft has already done, helping Microsoft’s stock to more than triple in the last six years. Microsoft has continued to produce solid results, and despite the fourth quarter pullback in the shares, it delivered strong returns in 2018.
Other
During the quarter, we increased holdings in some of our favorite positions like Samsung Electronics Preferred (Samsung) and Bollore SA (Bollore). While we would have enjoyed deploying more cash in new bargains, after nearly a decade of a rising market, driven in recent years by multiple expansion, the sharp pullback failed to create significant new opportunities.
Johnson & Johnson (JNJ, Financial)’s (J&J) shares declined modestly during the quarter, dropping about 10% on December 14 due to a Reuters report which alleged J&J knew about asbestos risks in its baby powder for decades. The company, which is currently defending these charges in many lawsuits, disputes these claims. We are confident that J&J has the financial strength to successfully manage through the issue.
Conclusion
Our goal is to provide solid risk-adjusted returns over time. We are pleased that fourth quarter results protected fund holders far better than owning the S&P 500 Index. We will continue to work hard to deliver results over time for fund holders, and, as always, will be patient, objective, and diligent when managing the AMG Yacktman Fund (Trades, Portfolio).
The views expressed represent the opinions of the Yacktman Asset Management (Trades, Portfolio) LP, as of December 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.
A short-term redemption fee of 2% will be charged on shares held for less than 60 days. Effective March 1, 2019, the Fund will eliminate this redemption fee.
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.
