An Options-Enhanced Value Strategy
Brian Yacktman is chief investment officer, portfolio manager and a principal of YCG Investments. He has been managing money for over a decade. Prior to founding YCG, he was an associate at Yacktman Asset Management, the adviser to The Yacktman Funds. He joined them in June 2004 from Brigham Young University where he graduated cum laude with a B.S. in economics and an M.B.A with an emphasis in finance.
I spoke with Brian on May 16.
You are the son of the legendary investor Don Yacktman, with whom you’ve previously worked. How did you become involved in investment management and what was it like working alongside your dad?
It goes all the way back as early as I can remember. My dad would tell me why he bought Ralston Purina or Johnson & Johnson and over the years I started to get a hang of what he was talking about. He always incentivized us to invest at a young age; if we would save $100 and invest it, he would double it and put it in the stock market. When I graduated from high school and I saw the portfolio that I had accumulated, I immediately garnered the bug for investing. In hindsight, part of that was the fact that it was the bull market in the 1990s. But the desire to invest started at the dinner table.
I never thought of my dad as a legendary investor. He was just my dad. But he is a hero to me, someone that I look up to. I learned from him a lot about how to think about businesses conceptually. He’s a very giving man. He’s a loving man with impeccable integrity. What a lot of people probably don’t know about him as a man is his character. So working alongside him was great and such a blessing because he was always open to just be there as a mentor.
What led you to split off and create your own firm?
In 2007, I mentioned to my dad that his account minimums were too high. I said there must be people who can’t meet your minimums who would be very interested in a separate account. He said, “It sounds like a great idea, but just don’t do it here.” Basically the five largest accounts at his firm made up more than 90% of their assets and they weren’t looking to have tons of smaller accounts. So he gave me his blessing and said I could even put our last name on the door, which I thought was very important to help cut through the noise, so people could find me.
I started what was then called Yacktman Capital Group. Later, Affiliated Managers Group (AMG) wanted to purchase the exclusive rights to the Yacktman name. My father asked me one week before Father’s Day if I would be willing to change the name of my firm. I realized for years I had been writing in my Father’s Day cards, “What could I ever do to repay you?” I realized this was it. We changed the name from Yacktman Capital Group to YCG.
How does your investment style differ from your dad’s?
Being mentored by him, there’s going to be similarities in the way that I pick stocks. Where there is a difference is the use of what I call “option enhancement,” using options as a way to get exposure to the businesses. It’s a strategic way to indirectly access a security when we believe that doing so through the option provides a better risk-adjusted return than owning the stock outright.
But as far as selecting individual securities, while there are not a lot of differences in methodology, we still have our own unique personal preferences, which lead to some overlap and also to some very different holdings.
Another obvious difference is that we’re much smaller and nimbler. It’s advantageous for us to only be managing $400 million as opposed to billions. It’s no surprise, and empirical evidence supports the assertion, that the more assets you manage, the more difficult and cumbersome it becomes.
You have described your investment philosophy as based on price, product and people. Let’s start with price. Can you elaborate on that?
No matter how wonderful a business is, if you overpay, it’ll end up being a terrible investment. That is why we analyze the price. But we view valuation a little differently. We flip the equation around. Rather than trying to solve for what we believe the value of a stock should be, we ask, “If we already know what the price is, then what is the forward rate of return that can be expected if you buy the stock at this price?” Through that method, we are able to create a table of forward rates of return that are expected on different securities. I view those as probability distributions around the expected returns. We look to see if, based on the expected return and whether there is a narrow probability distribution, we want to own something that has a wider probability of distribution if it gives us a high enough spread above the narrow distribution.
Price is about developing the forward rate of return that we can expect and then figuring out the best place to allocate capital based on risk-adjusted returns.
When we analyze the cash flows of a business, we make some adjustments to reflect, for example, if a pension appears to be over or underfunded, the impact of stock options, leases or other accounting things that may come up. But generally we are looking for the true cash-generative power of the business. Another thing that is often overlooked is that sometimes acquisitions are maintenance capital expenditures in disguise.
After we make all of these adjustments, we know what percentage of the earnings that a company generates truly are free, and then we take what we call the shareholder yield and add to it the growth rate. Essentially, we want to understand if something is growing faster or slower than GDP, or faster or slower than other things in the portfolio.