Yacktman Focused Fund 2Q15 Commentary for the second quarter ended June 30, 2015.
The AMG Yacktman Focused Fund (Service Class) returned -2.6% for the second quarter of 2015, compared with 0.3% for the benchmark, the S&P 500 Index. For the 12 months ending June 30, 2015, the Fund returned -0.1%, while the benchmark returned 7.4%.
This year, the Russell 1000® Value, which is an index representative of Large Cap Value, has lagged the Russell 1000® Growth Index by nearly 5% in the first half of the year. More than 30% of the Russell 1000 Value stocks are now greater than 20% below their 52-week high. We think the underperformance is mostly attributable to the short-term race for growth over value that often happens towards the end of an aging and expensive bull market.
Yacktman Focused Fund – Current Market Favors Promise over Profits
In recent quarters, the investment environment has favored expensive concept stocks which offer a promise of potential significant future growth over much more attractively-priced companies where there may be less momentum in the short term because of currency headwinds or short-term business challenges. “Promise” stocks include “new tech” stocks like Netflix and Amazon.com, as well as companies where there may be no earnings, or even revenues, as with biotech companies.
As investors we often state that “it’s almost all about the price.” We remain focused on companies with sustainable business models that generate significant free cash flow, and sell at attractive valuations. Like it did in the late 1990s, this approach can go out of favor in the short term when high multiple stocks are popular.
Yacktman Focused Fund – Underperformance Often Sets Up Outperformance
We think our recent results have set us up for much better returns going forward. Some of our largest positions, like Procter & Gamble (“P&G”) and 21st Century Fox (“Fox”), which have underperformed, are much more attractively priced today than they were at the beginning of the year. The Fund is more concentrated than it was at the end of the first quarter, with the Yacktman Focused Fund holding 26 positions.
Our favorite investments may lag late in expensive bull markets. The underperformance of the Fund in the late 1990s set us up to provide strong positive returns over the next three years, even as the market dropped nearly 50%. Similarly, underperformance from 2005-2007 prepared us to deliver solid results in 2008-2009 even as the market declined.
In early July, investors were reminded that stocks can be risky, as markets in China and Hong Kong posted significant losses. In the United States, we are now more than six years into a bull market. We think what has worked in the last few years may not work so well going forward. As market sentiment shifts, what has not been successful recently may significantly outperform in the future.
Yacktman Focused Fund – Contributors
During the second quarter, top contributors included Microsoft, Stryker and Anthem.
Microsoft’s shares rebounded in the second quarter after declining in the first. The price movement demonstrates the short-term orientation that has overtaken many stocks recently, as we did not think either quarter produced much to be either panicked or excited about. We continue to like the long-term prospects for significant cash flow generation the company has, and believe the new management team is executing well.
Two health care companies, Stryker and Anthem (previously known as WellPoint), appreciated during the quarter. Both stocks were strong in large part because their sector has been in favor. Health care stocks, which were inexpensive in 2011 are now more fully priced and we are being more selective in our positions and weightings in the sector today.
Yacktman Focused Fund – Detractors
During the second quarter, some of the largest detractors included Fox, P&G, and Samsung, which are among our high conviction long-term investments. We think these investments all offer significant long-term value despite their recent unpopularity.
Fox remains one of our favorite holdings despite pulling back in the second quarter. Recently, Fox announced a series of management changes, appointing James Murdoch as Chief Executive Officer of the company with Rupert Murdoch and Lachlan Murdoch being named Co-Executive Chairmen. We believe James is a talented leader. He previously was Chief Executive Officer of BSkyB for several years, and has been extensively involved in Fox’s operations for nearly two decades. James takes the Chief Executive Officer title from his father, Rupert, who has been running the business and its predecessors for a remarkable 60+ years.
We believe Fox is extremely well-positioned for significant growth in earnings-per-share over the next several years. We think the company is getting little credit for several of its recent investments, including its strong market position in India, where the company has nearly 25% of the television viewing audience. The business in India is running near break-even, as costs are high in the short-term due to one-off expenses like World Cup cricket rights and the build-out of a mobile platform. Domestically, Fox is making investments to create new channels like Fox Sports 1 and to turn around the Fox Broadcasting Network, which has suffered from weak ratings recently. The expenses associated with the investments will decline over time, and we expect profit margins to rebound while the company achieves solid revenue growth and free cash flow.
Fox is in the “penalty box” because the company is trading potentially higher current profits for far greater value in the future. This is exactly the way we like to see our businesses managed. However, the stock market currently favors companies that are maximizing profits today and penalizing those willing to invest for the future. We think this will set Fox up for strong outperformance over time and believe our patience will be richly rewarded.
P&G was out of favor during the quarter as the company continued to sell its non-core businesses. Now that the divestitures are nearly complete, we think P&G will grow faster and manage costs more effectively than they have in recent years.
Samsung’s shares declined in the second quarter due to weaker-than-expected mobile phone sales. The shares are inexpensive and offer good downside protection due to the fortress balance sheet. Net of the excess cash and investments the stock sells for 3-4 times earnings, which we think is remarkably cheap, especially given the strong market position of its semiconductor business.
“It’s waiting that helps you as an investor, and a lot of people just can’t stand to wait.” Charlie Munger in 2014.
Some investors have expressed frustration with the Fund’s recent soft performance. At times, and especially late in a bull market, our patient, objective approach may be challenging to some because it looks like we are not doing enough to change things. We want to assure investors that we are constantly working on investment ideas, both current and potential new Fund holdings. We are not simply waiting; we are waiting for the right price before acting. Today, as many stocks have declined significantly from their highs, we have a longer list of potential new investments than we have had in years. Recent market activity has created many stocks that are “in the ballpark” from a valuation standpoint, but are not cheap enough to be “on the field.” At the right prices, we will act quickly.
Conclusion
We remain extremely confident in our investment approach and its ability to outperform while managing risk over the long-term. We are more excited about the Fund’s positioning and valuation than when we started the year, and will continue to execute our long-term strategy which has historically served investors exceptionally well. The views expressed represent the opinions of Yacktman Asset Management LP as of July 17, 2015, are not intended as a forecast or guarantee of future results, and are subject to change without notice.
