Growth of Passive Management No Problem for Active Yacktman

Gregg Warren: This is Gregg Warren, senior stock analyst with Morningstar's institutional equity research division. I'm here at the Morningstar Investment Conference with Stephen Yacktman, of Yacktman Asset Management, who has been kind enough to join us for a panel discussion involving our Ultimate Stock-Pickers.

Stephen, thank you for coming.

Stephen Yacktman: Thank you for having me.

Warren: My first question for you today is a little bit more broad. Looking at sort of the state of active management out there, when we look at sort of the growth of passive over the last, say, 10 to 15 years, it's been pretty dramatic and it's making it harder and harder for active managers to pick up flows who actually compete against sort of the attention that's been drawn toward passive. What do you feel is important for an active manager to do here and how do you feel the market for active managers is going to pan out over next, say, five to 10 years?

Yacktman: When I look at, kind of, active managers and where people are, it doesn't really concern--for instance, when we look at what we do, we just focus on picking stocks and actually, we look at the fact that people are moving to passive is that our competition is going away and that we're having people passively invest, it's nothing--when I look as an active manager and I pick stocks, I'd rather compete against a passive management style than other active managers. So, it only is going to help our returns, I think, on a forward basis. So, it doesn't really bother me where it's going. I think what it has done is it's taken managers who hug an index and try to like sector allocate and things like that and it's exposed those managers for what they are and those managers are having a hard time competing.

Warren: Now, when we look at your 10-year performance, it's been fairly stellar. I mean, your three- and five-year numbers have been a little bit more challenged, but since the start of the year you guys have really sort of taken off. I think you've beaten the benchmark by a couple of hundred basis points at this point. Do you feel like your fund is basically built up more for kind of volatile markets we're going through right now, maybe explaining some of the difficulty that was going on in the three- and five-years numbers, and what kind of markets do you sort of look for as you look to invest down the road?

Yacktman: I think when we look at the markets we invest in and when we really perform well, is first, we tend to protect on the downside. So, you've had a little volatility; the market peaked about 18 months ago; it's not going straight up. So, at the end of a bull market heading into a down market or flat market we're going to do really well, which is, I think, what's kind of played out in the returns.

The other areas that we do well is going in a down market because we're always focused on risk and looking at something else and looking at other things in the index and going, this is much riskier; I don't want to own that. So, on the way down we perform well. Then on the bottom, when there's a lot of volatility and there's opportunity, we're not shell-shocked like a lot of other managers can be if they've been more aggressive. So, we ourselves can be aggressive and kind of catch the upswing.

Where we have difficulty is--and I wouldn't necessarily say it's a difficulty, but investors could perceive it that way is, after a market's come off the bottom and run for a while, we step away, where that's risk management 101 and at that point investors see a little bit of a lag. But to us, that's a warning signal that things are getting overheated.

Warren: And you guys have traditionally been willing to hold, I think, what, up to 7% of your portfolio in cash. How did that help you during the first quarter? Were there opportunities there to put that money to work?

Yacktman: So, actually, if you look back historically, we went back to 2000 and our average cash position has actually been 17%.

Warren: OK. I'm sorry, 17%.

Yacktman: Yes. So, that's been the average over multiple cycles. And so, we're in that area right now. I don't think in a flat market, it doesn't hurt, it doesn't help you. But what I think it does show is, when you're lagging a little bit and holding cash or if you're holding up and holding cash, it shows that you have a lot of--that's what helps protect you in a down market when everything gets overheated. There's other ways to protect. I mean, you can buy--you can find stocks that are cheap, but eventually you're going to end up with cash if there's nothing to buy. It's not that we ever want to hold cash. In fact, if you look back at our record, in 2000, we had, what I'd consider, an all-time peak in terms of multiples, we had no cash and the reason was, we were able to find things to invest in. So, it's not a function of where the market is. It's a function of what we are able to find.

Warren: Now, as far as your overall investment process, you guys have tended to historically sort of have heavier weightings in consumer staples, consumer discretionary, and just more recently, it's been technology names. Now, when we look at sort of the consumer staples names right now, they've had a pretty good run, I'd say, since the end of August of last year. I mean three of your top holdings--PepsiCo, Procter & Gamble, Coke--are all up more than 13% during that time frame relative to 9% gain for the S&P 500. When we look at the multiples on the stocks right now, they're sitting in the low 20s, which, I covered consumer stocks for a very long time, normally 18 is about the norm. Does it make you nervous right now with those evaluation sitting that high, is there a time that which you would consider trimming back positions? Because over time that will sort of revert to the mean.

Yacktman: Right. I think when you look at consumer staples and you look at the overall market again, the market is not cheap right now. And so margins in other areas, the way we look at things, are overextended, and so when you look at consumer staple relative to other things, they are not as expensive. But on an absolute basis, I would agree with that statement that consumer staples are expensive. They've been more expensive if you go back to the '98 period, '97-'98.  They were much more extended, and like look at Coke, the stock's basically back to its high that it was at '98 and there has been some growth there over the last almost two decades.

So, are they expensive? Yes. But on the upside in a down market, they provide comfort. You don't have to worry about margins, you don't have to worry about a lot of things. I think as people have gotten into this market environment where again we've been flat for around 18 months, people are nervous about a lot of different factors, they provide protection. So when we look at the portfolio, that's how we end up with cash, is we'll end up looking at and going, OK, we're going to trim them, we have no other place to put the money, then it ends up in cash.

So are consumer staples a place to be? I think on a relative basis, yes. On an absolute basis, there is very few places to hide right now.

Warren: Now when we think about sort of the--another part of the portfolio, somewhat riskier names than say staples, typically are in technology sector. That said, you have some of the more older technology names the portfolio: Oracle, Microsoft, Cisco. I just look back at your portfolio historically, at some point you started elevating your positions in technology. What did it take for you guys get comfortable with some these technology names? And is there a certain type of name you prefer to invest in, say a dividend payer, something that has a more steady stream of revenue or are you willing to take sort of gambles on riskier names that might have better growth longer term?

Yacktman: I think it really boils down to price. I mean you look back at the portfolio in 2000, we had zero tech. I mean it was kind of like for a while we had zero energy. We are willing to do. We're not trying to hug again. We're not trying to hug a benchmark and we'll just go where the value is. I think in the tech, one of the big areas that you've listed a whole bunch of stocks, one of the big areas in tech that we have right now is Samsung.

We have Samsung Preferred, and if you've looked out over the entire universe, I don't think you could find a cheaper stock that's global than Samsung Preferred on a price to EBITDA when you take out the cash that they have, it trades at around 2 times that number. And this is a company that's been heavily investing in CapEx and R&D.

And so unlike a lot of companies in the U.S. where they've tried to maximize their margins, maximize their profits and have forgone, I think, investing in the future, Samsung has gone the opposite direction, so those numbers are actually understated when compared. And so you end up with something that cheap, it doesn't really matter what exactly happens to the business and you could have a complete failure in one area and still be OK.

A lot of people think of Samsung as just phones, but really it's on memory chips. They have got logic chips as an up-and-coming business. They have got display. They have got consumer electronics. They have got--I think on and on, they have got a big position in Samsung BioLogics. They have great businesses that can fill that gap and it's such a low price that it's hard to miss.

Warren: Just again along those lines then, for far as the cheap stock and sort of that sector, IBM has been relatively cheap the last few years. I know it's a larger position within Warren Buffett's portfolio, Berkshire Hathaway, but the stock has been pretty much a laggard during the entire time that he picked it up. Not necessarily to put you on the spot here, but what do you think we are missing or what do you think he might be missing in the name? If you have looked at it, what is sort of taking you from making a stake in that firm?

Yacktman: I think when you look at the different tech companies, again, I think by far I think, especially if you look at the Yacktman Focused Fund, Samsung Preferred, it's a double-digit position for us. We have taken a huge--the price is just--it's not even close to anything else. IBM, I think, how much do they invest in their future, you see the revenue line. There's a lot of things to worry about there. There is just other things that are cheaper in our mind that have a little less risk and in Samsung's case, it is not even close. So why bother.

Warren: Thanks again, Steven, for all the insight there on Samsung and some of the other holdings within your portfolio. And thanks again for joining us.

Yacktman: Thank you for having me.