What follows is the written summary of that analysis.
I have reviewed 4 funds in the Large Cap (3 Value, 1 Blend) category, and have selected the Yacktman Service Fund (YACKX) as the lead choice.
Yacktman Fund is classified as "Large Blend" by Morningstar, and yet it performs similar to a Large Cap Value Fund, with a much lower beta of .76 than the category average of 1.04. The defensive nature combined with lower risk metrics of its holdings, makes it an appropriate core holding in any portfolio. When examining the history and future prospects of this fund, there's not much to dislike about it. This fund, to use a baseball analogy, knocks it out of the park on so many levels. For me, as an analyst, one of the primary things that jumps out is the downside capture ratio, which beats the 3 other funds on a 1, 3, 5, and 10 year timeframe. While the fund may not capture all the upside movement in a bull market (as is typically a characteristic of a Value fund), its clear that not capturing 100% of the downside move is more important. To use a behavioral finance term, Prospect theory, states that investors give much more value to what they lose than what they gain. As shown by the bear market decile rank of 3, Yacktman clearly understands this and manages the fund accordingly.
As shown by the relative underweighting in financials and volatile energy sectors, Yacktman is invested defensively, while at the same time, not terribly conservative, as shown by the 16% allocation to technology (roughly in line with the S&P, but slightly underweighted on a relative basis), something I would agree with. The tech names in the fund are solid names such as Microsoft, Cisco, and Hewlett Packard, a company selling at book value, and a potential turn around story that investors are getting paid a nice 2.6% dividend to wait for. It should also be noted that it is only in recent years that Yacktman began investing in technology. Does this sound like another famous investor we know? In doing so, one can surmise that Yacktman views certain companies in the technology sector have greatly reduced technology risk (no pun intended) and are trading at depressed multiples with good consistent cash flows.
The number of holdings in this fund is 43, so not over or under diversified, in my view. While the top 10 holdings do represent 54% of the portfolio, four of them are defensive (Coke, Pepsi, Sysco, Proctor and Gamble). But Yacktman is not afraid to get aggressive, as shown by the blistering 59% return in 2009. Don Yacktman has mentioned in several interviews that he usually prefers high quality, as current portfolio reflects, but in 2009 it made more sense to buy lower quality because it was so ridiculously cheap. This shows how innovative and flexible management is.
Lastly, Yacktman has averaged 15% in cash over the last 10 years, indicating they don't feel the need to always be fully invested, which again speaks to flexibility. This likely is in large part why they are only capturing 75% of the S&P 500 downside moves, on average. For these reasons, Yacktman Service is my top pick.
The table below will show the weightings in various sectors in each fund, which I will discuss in more detail.
|Sector Weightings||Yacktman||Dodge & Cox|
|T. Rowe Price |
|American Funds |
As of 3/31/12
As for the other funds, here's where they may be better choices under different assumptions. American Funds Washington Mutual is a solid 5 star rated and Gold rated (a new rating system designed to predict future prospects) fund by Morningstar. The fund buys stable, high quality franchises that pay dividends. This fund, by its very nature, performs well in down markets, as shown by its top 10% ranking over the past year while its competitors lost 5.5%. From Morningstar" At least 95% of the portfolio must be invested in dividend payers, and those companies, at a minimum, must have paid their dividends for the past five years and earned them for eight out of the past 10 years." Currently, the fund is underweight financials and overweight materials and industrials relative to its category. This would imply that the fund manager still believes the U.S. economy is in early recovery and sees a stronger economy ahead. If we're in for another "lost decade", then these are the types of companies that should be able to eke out a nominal return and pay a dividend. The fund manager believes the companies its invested in can absorb economic setbacks and therefore has taken larger bets on companies providing goods and services that people want and need. These companies are able to raise dividends, and therefore well positioned going forward. Of note, all of the managers have at least $100k or more of personal money invested in the fund. If, as a company, we want to select a pure value fund, my second choice would be American Funds Washington Mutual, with its below average risk and above average return characteristics and similar profile to Yacktman on the same measures.
Dodge and Cox had its worst year ever in 2008, likely affecting its Morningstar Rating of 3 stars (a historical-based rating). Staying true to its value style, the fund buys out of favor companies. However, in doing so, the fund has an above average risk profile, as indicated by the relatively high standard deviation, as well as the highest downside capture ratio of these 4 funds (i.e.: a negative). With nervous investors, this is not something one likes to see. Additionally, it owns up to 20% in foreign stocks, and area an investor can get access to in other ways. As stated in their annual report, Dodge and Cox thinks foreign equities are compelling at 10-12 times projected next year's earnings. The top 2 holdings are Wells Fargo and Capital one, representing approximately 8.5% of the portfolio. Specifically, Charles Pohl, the fund manager, sees higher capital ratios, better liquidity, declining credit losses, low valuations, and consolidation in the industry.
Of particular note is Dodge and Cox 20% allocation to technology, showing that it likes companies with strong balance sheets and arguably stronger fundamentals vs. other sectors. Last year the Fund added to Hewlett Packard and is taking a bet that the bulk of HPs revenues coming from overseas will be a positive for future growth. HP is the funds 4th largest holding, and proof that it is as contrarian as ever. The typical time horizon is 3-5 years. Many of the managers have significant investments in the funds they manage, always good to see.
T. Rowe Price Equity Income Fund is rated 3 stars by Morningstar, but also has a Gold rating. Dividends are not the primary driver in this fund. With a trailing 12 month yield of 1.95%, it lags the S&P Index and its peers in this measure. Due to its cyclical nature of investments, this fund may underperform in the short term, but has been in the top third of its category over a 10 year period. While not making a sector bet on Financials, it is betting on cyclicals. I would rather see an overweight in Morningstar rated "Sensitive" sectors, meaning sectors that will fluctuate with the overall economy, but not severely so. This would include communication services, energy, industrials, and technology. This fund also has over 100 holdings and typically has a low cash position of 3-5%. Again, the fund manager here has his own money invested in the fund, more than $1 million.
All of these fund managers are bottom up managers, meaning they are more concerned about the individual company strength and ability to weather economic downturns, but without taking a view on the economy per say.
In an up market, I would expect American Funds Washington Mutual and Yacktman Services to lag the S&P 500 (although Yacktman crushed the S&P 500 return in 2009) and in a down market both of these funds should perform better than the S&P 500. The idea being that both of these funds make up their underperformance in up markets with the outperformance in down markets.
Dodge and Cox Stock fund has severely lagged in recent years in both up and down markets, with the exception of 2009. In its defense, many of the contrarian picks take longer to work out, so one truly needs a longer term view with this fund. Time smooths out the bumps in performance. Lastly, T.Rowe Price Equity Income Fund will likely lag in racier markets, but should perform better in down markets. However, history shows that this fund performs about in line with its peers over the short to intermediate term, only doing much better over a 15 year time period by only capturing 79% of the downside vs. 91% for the category.
While all four of these funds have a very sound process for value investing, again, my top pick is Yacktman Service Fund.