AMG Yacktman Focused Fund commentary for the second quarter ended June 30, 2016.
The AMG Yacktman Focused Fund ( the Fund) (Service Class) returned 2.23% for the second quarter of 2016, compared with 2.46% for the benchmark, the S&P 500 Index. For the 12 months ending June 30, 2016, the Fund returned 7.05%, versus the benchmark return of 3.99%. Results this year have been strong, as high-quality franchises have been popular due to a global flight to quality stocks spurred on by low interest rates and market volatility due to global macro concerns.
Charlie Munger: Invert And Use “Disconfirming Evidence”
We like how the Fund is positioned, with holdings in what we think are significantly undervalued/underappreciated stocks like 21st Century Fox (Fox) and Samsung Electronics Preferred (Samsung), along with Procter & Gamble (P&G), PepsiCo (Pepsi), Sysco Corp (Sysco, and Coca-Cola, which have businesses that generate solid, consistent free cash flow and management teams that are highly focused on reducing expenses and improving margins over time.
For the last several years, stock market appreciation has been driven by multiple expansions—people paying higher prices and, in many cases, much higher prices—for a similar level of earnings. This has been a result of declining interest rates, and has increased the valuation of equities, as many see virtually no place to generate returns outside of stocks. This environment has also, in our opinion, significantly increased risk and reduced forward rates of return potential for those who have chosen to invest via index funds. As Charlie Munger stated near the market peak in 2000, “I think one should recognize reality even when one doesn’t like it.”
For our investment approach, the returns of the S&P 500 Index are not as important as our ability to select individual securities that meet our goal of achieving risk-adjusted returns over time. Our approach is to thread the needle, carefully choosing each security and weighting in the fund, and waiting patiently when we are not finding sufficient investment opportunities. We are especially proud that we have delivered some of our strongest outperformance in periods like 2000-2002 and 2007-2009, when market valuations began at historically expensive levels. The market is again at a valuation level that we believe is high, though we are confident that we have the Fund well-positioned for the long-term.
AMG Yacktman Focused Fund – Contributors
Top contributors in the second quarter included Samsung, Johnson & Johnson (JNJ) and Procter & Gamble (P&G).
We feel the best way to navigate an expensive market is to find securities that have been left behind and are significantly undervalued. We think Samsung is a solid example of this type of bargain in the current environment. In recent years, we built a large position in Samsung because its shares are incredibly inexpensive, its balance sheet is exceptional and the company possesses strong market leadership in a wide range of businesses that include semiconductors, mobile phones, display and consumer electronics.
During the second quarter, Samsung produced strong operating results, helped by solid sales of the Galaxy S7 phone and strength in the flash memory market. Even after solid stock price performance, Samsung’s shares still sell at more than a 70% discount to globally-established technology peers.
JNJ performed well in the second quarter after delivering solid results. Few companies have the financial strength and product diversity of JNJ, which is why it is one of only two companies in the United States (Microsoft is the other) that commands a triple-A credit rating. We think JNJ can deliver solid growth and strong free cash flow over time.
P&G’s shares were stronger in the quarter, with the general rise in consumer brand stocks. During the last few years, P&G has been refocusing the company and is now nearing the completion of a series of divestitures that, in total, eliminate more than 100 of the companies’ brands that represented roughly 6% of total profits. With a better focus going forward, fewer brands and product categories and a significant emphasis on driving down costs, we think P&G is well-positioned to deliver solid results over the next several years.
During the quarter, we sold our positions in CH Robinson and C.R. Bard, due to their strong performance.
Detractors for the quarter included Microsoft, Fox and Avon.
Microsoft’s shares were weaker during the quarter due to a modest earnings disappointment. We think CEO Satya Nadella is doing an excellent job of repositioning the company for solid long-term growth and we believe the stock is attractively priced.
Fox’s shares underperformed during the quarter as the company continued to face several challenges, including currency headwinds, underperformance in its movie business, general concerns over changes in the media industry and weakness in its stockholding in SKY, Plc after the Brexit vote. We think Fox’s shares are significantly undervalued at current prices.
In the last two years, Fox’s earnings have stalled as management invested for growth, both in the United States, through the launch of Fox Sports 1, and in India, where Fox is already the market leader with nearly 25% of television viewing through its Star business. As the costs of these longterm investments moderate, we think Fox can produce a significant rise in earnings over the next few years. When the growth returns, we expect the stock will respond positively.
Avon’s shares were weaker during the quarter, although the negative impact was somewhat offset by the appreciation in Avon’s debt, which we also own. We think the company continues to execute a solid turnaround of its business and the shares remain undervalued.
We are pleased with the strong results and feel the Fund is well positioned for the current environment. We are especially excited by our largest positions, Fox and Samsung, which we think are exceptionally well-priced and can demonstrate significantly improved business fundamentals in the next few years. As always, we will continue to be patient, diligent and objective while managing the AMG Yacktman Focused Fund.
The views expressed represent the opinions of Yacktman Asset Management LP as of June 30, 2016, are not intended as a forecast or guarantee of future results, and are subject to change without notice.
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