Long-Tenured Fund Manager Passes the Torch

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AMG Yacktman Service is fully prepared for this changing of the guard. With two experienced but still young comanagers, the fund retains its Morningstar Analyst Rating of Gold.

Don Yacktman's stepping down as comanager of this fund completed a transition that was years in the making. Although he officially left the fund on May 1, he had not been actively involved in the fund's management for several years. His son Stephen Yacktman and Jason Subotky have guided the fund during that time. Don Yacktman will remain at Yacktman Asset Management as an advisor. He is still under a 10-year employment contract the team signed with AMG when it purchased the fund in 2012. But with Don turning 75 this year, this decision has been expected.

More importantly, Stephen Yacktman and Jason Subotky are well-prepared to lead the fund. Even though both are only in their mid-40s, they have been in their current roles for years. Stephen has been a comanager on the fund since 2002 and began at the firm more than 20 years ago. Subotky has been a comanager since 2009 and has been with the firm for nearly 15 years.

Stephen Yacktman and Subotky are keeping the fund on the path that has led to its long-term success. The fund has struggled in recent years, but they are very patient investors and are comfortable with being temporarily out of step with the market.

Their belief in the portfolio's collection of high-quality companies paid off during the 2015-16 correction. Peak to trough (May 21, 2015 to Feb. 11, 2016), the fund fell 9% versus a 12.6% drop for the S&P 500. The fund's cash stake, which has been more than 15% of assets since September 2012 and hurt returns during the prior three-year rally, played a big role. Top-holdings

The fund still trails the S&P 500 in the trailing three- and five-year periods but leads by big margins during the past 10 and 15 years.

Process Pillar: Positive | Kevin McDevitt, CFA 05/17/2016 This fund sometimes gets the high-quality label, but price and valuation are what matter most here. That said, the team's preference for companies with strong free cash flows, reasonable debt, high returns on capital, and modest cyclicality tends to lead them to high-quality consumer staples and discretionary (media, in particular) companies. The team thinks of stocks as junior bonds and compares their free-cash flow yields with those of AAA rated corporates. Once a stock is in the portfolio, the team is reluctant to sell because high-quality companies tend to compound capital at attractive rates. This leads to low turnover. On the other hand, if the team cannot find new, cheap stocks to buy, it will let cash build to 20% or more of assets. This patience and discipline earn the fund a Positive Process rating.

Capacity is a concern, as assets have soared to $8.8 billion from $260 million in March 2009. It isn't an immediate issue, though, given the portfolio's low turnover and current focus on liquid large-cap stocks. However, the fund has grown too big to invest meaningfully in small- and mid-cap stocks as it did in the late 1990s. Back then, the fund loaded up on mid- and small-cap stocks given their compelling valuations versus large caps. Now, the team likely wouldn't have the flexibility to invest meaningfully in such stocks even if valuations became attractive. That's especially true if the team plans to maintain the relatively concentrated portfolio for which it's known.

In some ways, this is one of the more concentrated large-blend offerings. The fund has 50% of its assets in its top 10 holdings, nearly triple that of the S&P 500. Plus, the fund sticks to just a few sectors, given the team's preference for companies with competitive advantages that aren't very economically sensitive. This has led to big stakes in consumer-oriented and, recently, technology shares. Branded consumer staples and discretionary stocks represent about half the equity portfolio versus less than one fourth of the S&P 500.

But the fund has marshaled its defenses as valuations have risen. The portfolio's average price multiples are higher than the index's, but its holdings tend to be of higher quality, too. This shows in the shifting balance between staples and discretionary stocks. Since peaking at nearly 31% of the equity portfolio in March 2009, economically sensitive discretionary stocks dropped to 15.3% in March 2016. Meanwhile, the team has added to recession-resistant staples such as Procter & Gamble, taking the staples weighting to 36.7% of the equity portfolio from 23% in March 2009. This weighting is more than triple that of the S&P 500, but consumer staples are a relatively defensive sector. Moreover, management has kept cash high at 17%, although it added to its position in Twenty-First Century Fox in 2016's first quarter.

Performance Pillar: Positive | Kevin McDevitt, CFA 05/17/2016 This fund's long-term returns are excellent, earning it a Positive Performance Rating. Since its 1992 inception, the fund's 10.2% annualized return through April beats the S&P 500's 9.2% return by 1 percentage point.

Plus, the fund has delivered these strong returns without high risk. This is owes to management's preference for high-quality companies, its valuation consciousness, and a penchant for building big cash stakes when equity valuations get stretched. Despite maintaining a relatively concentrated portfolio, the fund's 15-year standard deviation, a measure of volatility, is below the large-blend Morningstar Category average.

Keep in mind that, as with most highly differentiated, successful funds, this one has gone through its share of dry spells. Indeed, it has been left for dead on more than one occasion, including during both the late 1990s and the mid-2000s, and again from 2012 through mid-2015. While the fund's 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. But this defensiveness led to outstanding relative returns during the 2000-02, 2008, and 2011 bear markets. Any lost gains during rallies have been made up on the downside.

People Pillar:

Positive | Kevin McDevitt, CFA 05/17/2016

This fund ensured continuity when its advisor Yacktman Asset Management sold itself to

That's encouraging considering Don Yacktman, Stephen Yacktman, and Jason Subotky's long-term investment success. Don Yacktman officially stepped down as a comanager on May but will remain as an advisor. This move reflects the fact that his son Stephen and Subotky have managed the fund day-to-day for the last several years. Those two do not have an independent record of their own, but they have ample experience. This earns the fund a Positive People rating. Stephen has worked on the fund since 1993 and has been a comanager since year-end 2002. Subotky has been a comanager since year-end 2009 and has been with the firm since 2001. Both have more than $1 million invested in the fund.

The team strengthened its bench when it hired Adam Sues in August 2013. After less than a year with the firm, Sues was named the sole manager of

Parent Pillar: Neutral | 06/25/2014 Formerly Managers Funds, AMG Funds changed its name in 2014; today all offerings in the AMG Funds lineup carry the AMG moniker. The wholly owned subsidiary of Affiliated Managers Group Inc. also hired Jeffrey Cerutti to fill a newly created CEO position. Cerutti's background is in distribution, previously having worked for Virtus Investment Partners. A rebranding effort and CEO with distribution chops, along with AMG Inc.'s routine of growing its assets through acquisition, could indicate growth is front and center at this fund family. Meanwhile, expenses here remain average overall, with a slight skew toward above-average and high fees.

AMG Funds and AMG Inc., however, also have long partnered with strong investment managers. AMG Inc. historically has contributed distribution, marketing, and servicing both through AMG Funds and when funds are offered independently, while leaving investment management to the affiliate managers. That being said, some of the AMG Funds use unaffiliated subadvisors; these funds carry both the AMG and "Managers" name.

AMG Funds' manager-ownership of fund shares has improved. The Yacktman funds have helped: They have grown and have high manager co-investment. Now 66% of firm assets are invested in funds in which at least one manager has more than $1 million invested, from 30% in early 2013.

Price Pillar: Positive | Kevin McDevitt, CFA 05/17/2016 This fund offers a talented investment team at an attractive price, earning it a Positive Price rating. Its 0.72% expense ratio is near the cheapest quartile of actively managed large-blend funds and is 19 basis points below the group median. As a result, the fund receives an overall Morningstar Fee Level of Below Average. Plus, the fund's low turnover keeps brokerage commissions, as a percentage of net assets, below those of the category average.