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Fund Spy: Morningstar Medalist Edition

Yacktman Focused's Markup Is Needless

A higher-than-necessary expense ratio holds this Silver-rated fund back.

Similar funds from the same manager often receive the same Morningstar Analyst Rating. But that's not written in stone. Some readers may be surprised to see that two similar funds from the same management team can receive different ratings. That's the case with Silver-rated  Yacktman Focused (YAFFX) and Gold-rated  Yacktman (YACKX), in which the former's unnecessarily high expenses dim its appeal relative to its cheaper sibling.

It's difficult to see why Focused's 1.26% expense ratio is half a percentage point higher than sibling Yacktman's. The older Yacktman fund's asset base is about $1.3 billion greater than Focused's $9.3 billion, but that difference is immaterial given the economies of scale in asset management. In fact, of the 13 actively managed no-load large-blend funds with more than $5 billion in assets, none has a higher expense ratio than this one.

Family Resemblance
Indeed, the differences between Focused and Yacktman are too modest to justify the former fund's higher levy. They share the same management team and low-turnover philosophy, and, for the most part, the funds own the same companies, too. With 59% of assets in just 10 names as of March 2013 versus 52% for Yacktman, Focused is just a more concentrated version of the larger fund. Focused currently has only one distinct holding,  Northern Trust (NTRS), and that accounts for just 0.3% of assets. Yacktman is slightly more diversified with eight additional holdings, but collectively these are only 4.1% of assets.

Both funds stick to stocks in just a few sectors, given the team's preference for companies with strong competitive advantages. Management also loves companies with relatively low capital expenditures, reasonable debt, high returns on capital, and modest cyclicality. This typically has led to hefty stakes in consumer-oriented companies and health-care names. Branded consumer staples and discretionary (which includes media) stocks represent nearly half the portfolio versus less than a quarter of the S&P 500 Index.

It's worth noting that both funds have grown more cautious as equity valuations have risen. This shows in the shifting balance between consumer staples and discretionary stocks. Since peaking at more than 25% of assets in 2009, economically sensitive discretionary stocks dropped to 14% of the Focused portfolio in March 2013 with management trimming  News Corp and other names during the quarter. Meanwhile, the team recently has added to recession-resilient staples such as  Coca-Cola (KO) and  Sysco (SYY), taking the staples weighting to 33% of assets from 16% in mid-2008. Granted, this weighting is triple that of the S&P 500, but consumer staples is a relatively cautious sector, albeit with expanding price multiples these days. Perhaps with this in mind, and wary of overpaying as the bull market enters a fifth year, management has been accumulating cash. At nearly 17% of assets, cash is at its highest level since 2008.

Too Much to Overcome?
But given the extensive overlap in holdings between the two funds, there may not be sufficient dispersion for Focused to overcome its expense handicap versus Yacktman in the long run. Since its 1997 inception, Focused has an R-squared, a measure of correlation, of 95.2 relative to Yacktman. Granted, Focused's gross return since its 1997 inception edges Yacktman's, an encouraging sign that management's greater conviction has led to better results. But any incremental outperformance gross of fees has been more than absorbed by the fund's higher expenses. Focused's 9.65% annualized return net of fees during that same stretch trails Yacktman's 9.87%. Based on how they're investing their own money, though, the management team of Don Yacktman, Stephen Yacktman, and Jason Subotky believes Focused will ultimately trump Yacktman. None of them invests a dime in the Yacktman fund, but all three maintain positions of more than $1 million in Focused.

A Strong Offering Nonetheless
Regardless, both funds trounce the S&P 500 Index's 6.3% gain since 1997. Even more impressively, Focused has delivered its high returns without egregious volatility. This owes to management's preference for high-quality companies, its valuation consciousness, and its penchant for building big cash stakes when equity valuations get stretched. Therefore, despite maintaining a concentrated portfolio, the fund's 15-year standard deviation, a measure of volatility, is just slightly above the category average.

Keep in mind, though, that as with most highly successful funds, this one has gone through its share of dry spells. Indeed, it has been left for dead by investors and the media on more than one occasion, including during both the late-1990s and the mid-2000s, and more recently in 2012. While the managers are not deep contrarians, their value leanings and the fund's concentrated portfolio can leave it out of step with the broader market, especially in the latter stages of bull markets when the team often gets defensive, as is arguably the case these days. But this defensiveness led to outstanding relative returns during the bear markets of 2000-02 and late-2007 to early-2009 and also during 2011's downturn. Any lost gains during rallies have been more than made up for by good protection on the downside.

But until the Focused fund's expenses fall more in line with its sibling's, Yacktman is arguably the surer bet.

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