Brian Yacktman and Elliott Savage: the Network Effect and Stock Picking

October 16, 2020


Brian Yacktman is Chief Investment Officer, Portfolio Manager of YCG Enhanced Fund and Founding Partner of YCG, LLC. Mr. Yacktman has served as Chief Investment Officer and Portfolio Manager since the inception of the fund.

Elliott Savage is Portfolio Manager of YCG Enhanced Fund and Partner of YCG, LLC. Mr. Savage has served as Portfolio Manager since the inception of the fund. Prior to joining YCG in 2012, Mr. Savage was a senior analyst at Highside Capital Management, a multibillion-dollar long/short equity hedge fund located in Dallas, Texas.

In this 4,470 word interview, exclusively in the Wall Street Transcript, Mr. Yacktman and Mr. Savage detail their investing philosophy and explore many of their top stock picks.

“What we are really after are businesses that, in a world of competition and innovation, continually earn a high return on their tangible assets or owner’s equity over long periods of time.

Competition and innovation step in and drive down pricing. We are looking for businesses where, regardless of the competition that may come their way, there is something unique or special about them, and this allows them to maintain pricing power in the face of competition and innovation. We find that most often among businesses that exhibit some form of network economics.”

The network effect is a key component of the investing thesis:

“A lot of industries are shrinking and becoming smaller portions of GDP over time. That is going to create a headwind to your pricing power.

In contrast, take the advertising industry. If your competitor’s advertising a lot, you need to advertise a lot. Therefore, what you see is, advertising has maintained its share of GDP at about, let’s just say, 1% of GDP over time.

Then, if you can find businesses that maintain pricing power, like Google (NASDAQ:GOOG) or Facebook (NASDAQ:FB), due to their network effects, that allows them to essentially become a toll taker on global advertising.

Another example would be insurance brokerages where the insurance industry has maintained its share of GDP over time, more or less. It almost looks like a sine or cosine wave, as insurance premiums harden and soften over time, but it has maintained its share more or less over time.

And then, these insurance brokerages, due to their strong networks and sticky relationships, maintain their pricing power on global insurance activity. It is almost like these businesses have built-in growth that’s indexed to GDP plus.”

One drag on the portfolio has been their banking bets, although this may mean an opportunity for new investors:

“Our concern has been, should you have interest rate or inflation surprises to the upside, then those valuation multiples are going to compress pretty rapidly, and we wanted to have something that could act as a hedge in the portfolio against that, and what’s beautiful about the banking industry — so we’re speaking of the three largest U.S. depositors: JPMorgan Chase (NYSE:JPM), Bank of America (NYSE:BAC), Wells Fargo (NYSE:WFC), with Wells Fargo being sort of the contrarian piece, as well as Charles Schwab (NYSE:SCHW), the largest discount brokerage — is these businesses are leveraged to rising interest rates.

In contrast to almost all of the other businesses, their earning power would actually increase because we are so close to the zero-bound that it is squeezing their profits. As their profitability increases, likely what would happen is, the multiples that investors are willing to pay for those businesses would also expand, again, in contrast to almost all of the other businesses. So you could get a double benefit to help hedge against the compression you are experiencing in other businesses.

But unfortunately, as anyone can tell, due to coronavirus, interest rates have dropped to zero and may actually go into negative territory, which is an extra negative to them, as well as the fear of bad loans and how this will all shake out.

It has been a real drag on the portfolio, and had we exited that portion of the portfolio, we would have looked like geniuses, but we recognize that part of having a hedge in your portfolio means that it won’t always work and sometimes can actually be a detractor, and that’s what’s happened in this instance.”

Get the full detail on all the portfolio hits and misses from this 4,470 word interview with Mr. Yacktman and Mr. Savage exclusively in the Wall Street Transcript.

Brian Yacktman, Chief Investment Officer, Portfolio Manager & Founding Partner

Elliott Savage, Portfolio Manager & Partner