In the second quarter, the AMG Yacktman Fund (Trades, Portfolio) (the Fund) appreciated 2.83% during the second quarter of 2019, lagging the S&P 500 Index, which appreciated 4.30%, and the Russell 1000(R) Value Index, which increased 3.84%. For the twelve months ending June 30, 2019, the Fund returned 10.60% compared to the S&P 500 Index, which returned 10.42% and the Russell 1000(R) Value Index, which returned 8.46%.
In the U.S. markets, prices are high even though business disruption, driven by innovation and technological advancement, is faster than ever before, something, which should cause lower valuations. Additionally, debt levels, both at the corporate and country level are at record highs. The combination of inflated valuations, significant debt, and the presence of rapid disruption should give investors concerns aplenty. However, many have now moved to an index or exchange traded fund (ETF) approach, which purchases what the rest of the crowd is buying at the current price with no thought to risk.
The expectation of lower interest rates has mainly driven recent market rallies, and the market seemed to rise every time weak economic data appeared due to the increased odds of an accommodative U.S. Federal Reserve (the Fed). We have seen typical signs of froth, including the issuance and strong performance of initial public offerings (IPOs) of companies with suspect business models producing significant losses.
Recently we have heard a return of the expression "there is no alternative," meaning some are willing to pay almost any price for equities because they see little ability to generate the returns they require in other asset classes, especially now that rates have declined. The "no alternative" philosophy, like indexing, doesn't care about price or risk. However, at current valuations we believe the good case for the S&P 500 Index over the long term is likely a modest return, and the bad case could produce extreme losses.
There is an alternative...
We believe there is an alternative in how you invest with price and risk management as the central features. The price you pay helps determine your return, and paying a low valuation can protect from turmoil or unexpected outcomes. We actively manage the holdings in the Fund and make adjustments when prices are high or better opportunities arise.
During the first half of 2019, we made many new purchases and reduced or eliminated several holdings due to valuation or changes in fundamental outlook. New positions include Disney and Fox Corporation (Fox), a result of the completion of the merger between Walt Disney Company (Disney) and 21st Century Fox, as well as Booking Holdings, Alphabet Inc. (formerly Google), Brenntag, Macy's, News Corporation, Rennai Corp, and Weatherford International debt. We sold our position in Avon equity after the company received a buyout offer, and also eliminated Infosys and KT&G Corp. Additionally, we reduced our weightings in Procter & Gamble and PepsiCo due to price appreciation and increased our weightings in Samsung Electronics Preferred (Samsung) and Bollore.
Disney (NYSE:DIS) provided strong performance in the second quarter as the company continued to dominate the movie box office and investors became more confident in Disney's ability to compete with Netflix and emerging technology companies. During the quarter, the company entered into an agreement with Comcast, which will allow Disney to take full control of Hulu over time.
Samsung (XKRX:005930) appreciated during the first half of 2019 even though its earnings fell sharply due to a down cycle in its semiconductor business and a maturing mobile market. We think earnings will improve, as supply growth for memory chips is being reduced by key industry players, which should lead to better pricing over time. Samsung's low valuation and strong balance sheet enabled the shares to navigate the down cycle and remain inexpensive.
Recently, trade relations between Korea and Japan have become more strained, and Japan has implemented export changes, which could disrupt Samsung's ability to acquire key chemicals for manufacturing semiconductor and display products. We believe the political issues will get sorted out over time, and Samsung has the balance sheet strength and business diversity to manage through any near-term challenges that may arise from these issues. Eventually, we expect Korea and Samsung to become less dependent on Japanese companies for key supplies.
Coca-Cola (NYSE:KO)'s shares delivered strong returns in the first half of 2019 as consumer stocks were stronger and both companies reported solid results. We think new management is doing an excellent job of improving results and expect the company to deliver solid growth going forward.
State Street (NYSE:STT) fell during the quarter as expectations for renewed Fed rate cuts increased. Earnings in trust banks like State Street and Bank of New York are pressured in a lower rate environment; however, State Street's valuation is low, with the bank selling at about ten times earnings.
Alphabet (NASDAQ:GOOGL), a new position this year, detracted from results after our purchase due to the potential for increased regulatory pressures. We think that Alphabet's shares are inexpensive, especially considering that assets, like Waymo and YouTube, could earn significantly more in the future. Alphabet has a strong balance sheet and produces significant free cash flow.
During the first half of the year, Avon (NYSE:AVP) agreed to be purchased by Natura, a Brazilian cosmetics company. As a result, we sold our small position in the stock and have reduced our ownership of the debt. Although the stock investment was disappointing over the years, we did exceptionally well owning Avon's debt, demonstrating that our flexible mandate which allows us to purchase fixed income from time-to-time can be critical to producing results. The debt offered and achieved an equity-like rate of return over the time we owned it with significantly less risk than the stock.
Hakuna matata, which translates as "no worries," is a popular song from The Lion King, the Disney blockbuster movie and Broadway show. A new version of The Lion King was just released, and will be one of the top-grossing movies of 2019, which makes us happy as new Disney shareholders.
The philosophy of "no worries" in The Lion King is one that seems to prevail among many market participants today. However, we believe when people tell you not to worry, you probably should worry. Hakuna matata did not work in The Lion King and certainly is not an intelligent investment approach.
We believe we are well positioned today and will continue to navigate with a focus on risk-adjusted returns over time. High market multiples will not always stay elevated; business disruption matters significantly, which should reduce the price you are willing to pay for many established companies; and the Fed will not always be able to save the day or extend the rally. We believe it is important to have a manager like us who worries for you about such things as valuation and risk amidst a market driven by a mantra of there is no alternative and approaches risk by thinking "no worries." We have been through these environments before, and, as always, we will navigate by focusing on individual securities we think can produce solid results while maintaining a keen focus on risks.
- Returns for periods less than one year are not annualized.
- 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 AMG Yacktman Fund (Trades, Portfolio) on June 29, 2012, and was managed by Yacktman Asset Management (Trades, Portfolio) LP with the same investment policies as those of the predecessor Fund.
- Since the inception of the Fund on July 6, 1992.
- Effective on October 1, 2018, the Fund added the Russell 1000(R) Value Index as a secondary benchmark.
- 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.
The views expressed represent the opinions of the Yacktman Asset Management (Trades, Portfolio) LP, as of June 30, 2019, are not intended as a forecast or guarantee of future results, and are subject to change without notice.
This article first appeared on GuruFocus.
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