Don Yacktman's Lonely Crusade Like any devout value investor, Don Yacktman has the courage to go his own way. But in this bull market, his stubborn independence wrecked returns and nearly destroyed his career.
(MONEY Magazine) – Supper at the Yacktman house starts with a prayer. As his wife and children bow their heads, Don Yacktman recites a litany of thanks. He asks for God's blessings on the food, on the Church of Jesus Christ of Latter-day Saints and on the church's elders. He asks for a blessing on his 18-year-old son Robert and his high school choir. Finally, he asks God to bless the visiting reporter sitting at the family's dinner table, "that his trip here may be fruitful." Two days later, Yacktman mentions that he is still including the reporter in his prayers.
It would be easy to dismiss this as pious glad-handing, but religious language comes naturally to Yacktman. The 57-year-old manager of the Yacktman Fund and the Yacktman Focused Fund served for five years as a bishop--that is, an unpaid clergyman--of his Arlington Heights, Ill. congregation, and he still sings in the congregation's choir. In accordance with Mormon doctrine, he tithes 10% of his pretax income to the church. He abjures alcohol, gambling, even coffee.
Yacktman says his church's teachings guide him in business too. Mormons believe that people are literally the offspring of God, he explains. "So there are two things in my mind that matter: your character and your relationships with others."
So why have people been saying such nasty things about Don Yacktman?
In a ferocious battle late last year, his funds' board of directors accused him of lying to shareholders and of violating the funds' code of ethics. They attacked his investment decisions and explored the possibility of firing him. He, in turn, fought to oust the directors and had one of them ejected from the funds' offices by the police. In the meantime, his funds have performed dismally for the past two years. His flagship Yacktman Fund returned 0.6% in 1998, while the S&P 500 index rose 29%. The deadly combination of bad press and lousy performance has scared off investors. Today he runs just $280 million in mutual fund money, down from $1.2 billion in 1997. Quite a comedown for a famed stock picker who was Morningstar's fund manager of the year in 1991.
Yacktman's woeful performance stems from his shift into small-cap stocks, which have languished while blue chips have boomed. He has wagered that this trend cannot last, and it has cost his shareholders dearly. But his problems go beyond underperformance. His independent thinking broke the rules of the fund game. Everyone--from powerful financial planners to his own board members--pressured him to stick with the large-cap investing style that had made his reputation. His refusal almost ruined him. Great investors like Sir John Templeton and Warren Buffett are revered for betting against the crowd. Yacktman's story, however, shows just how perilous it can be for a professional money manager to go his own way.
"THAT'S JUST SLEAZE"
At six feet, one inch, Yacktman might easily be intimidating, but his manner is disarmingly mild. "Boy, is that ever neat," seems to be his favorite exclamation. His firm's tiny offices in Chicago are decorated with paint-by-numberish pictures he bought at a benefit for his son's choir. There's a wall of Boy Scout plaques in his corner office.
He actually studies being nice. A child of divorce--his mother married four times--Yacktman devours books on family counseling and personal dynamics. "Looking back, I don't think my parents were diplomatic," he says. "You must have the courage of your convictions but be able to state them with diplomacy."
Yacktman has always had the courage of his convictions. At 15, he left Catholicism to become a Mormon, and he later interrupted his studies at the University of Utah to go on mission for two years, proselytizing door to door in Georgia.
In 1965 he graduated at the top of his university class, then headed to Harvard Business School. His father, a wealthy real estate developer, offered him an enticing job shortly before graduation, but Yacktman turned it down. His father wanted him to promise not to go on another mission if the church suggested it. Yacktman knew the church would not ask, but he refused to make the promise anyway. "It was a principle thing," he says. "I couldn't commit to that."
So he began his career as a bank loan officer. Then, in 1968, he landed a job running private investment portfolios for a Chicago firm, Stein Roe & Farnham. Yacktman remembers his 14-year stint there as a prolonged exercise in frustration. "It was a nice job and neat people, but it just wasn't me," he says. Bill Goldstein, who later wooed Yacktman away, recalls, "He was not their golden boy. They were on his back all the time because they were momentum investors and he wasn't. But he was beating the momentum portfolios."
Yacktman joined Goldstein's brokerage firm, Vincent Chesley, in 1982 to run an obscure $76 million fund called Selected American Shares. At 41, he finally had a portfolio he could call his own.
Unashamedly frugal, Yacktman drives a four-year-old Ford Taurus SHO, which he calls "my splurge." He raised his seven kids in a modest suburban tract house. As a fund manager at Selected, he applied the same cheapskate instincts to buying stocks. He hunted for cash-rich firms trading at low prices relative to what he thought a rational buyer would pay for the whole operation. He hung on to these bargains for years, until he felt he had squeezed the last bit of growth out of them. The strategy worked beautifully. By 1990, the fund had a four-star rating from Morningstar, having beaten 62% of all equity funds over five years. Assets had grown to $400 million.
It was a magnificent time for Yacktman. In 1990 he built up a 6% position in Freddie Mac, which buys home mortgages. The stock had dropped more than 40%, and Yacktman snapped it up at a split-adjusted $4 a share. In 1991 it hit $10. Such skillful bargain hunting earned the fund a stunning 46% return for 1991, outstripping the S&P 500 by 16 percentage points. That feat earned Yacktman the Morningstar award and a legion of new fans. His fund now boasted $700 million in assets.
Meanwhile, Vincent Chesley was acquired by Kemper, a financial services giant that planned to hawk Yacktman's fund more aggressively and sell him as the firm's star manager. But Yacktman had little affection for his new boss, Jerry Cole. Part of the problem was that Cole, who has since retired, wanted to cut Yacktman's share of the fund's fees. "Money doesn't drive me," says Yacktman. "It's not the important thing in my life." But he was insulted by Cole's plan. Equally galling, Cole wanted to impose controls on Yacktman's investing, hiring a chief investment officer to oversee him. Cole says that Yacktman was investing too heavily in small-caps. "In our opinion, he was not adhering to the parameters of the prospectus," he complains. "People were not getting what they expected." Still, the median market cap of the fund's stocks was a hefty $7 billion.
"That's just sleaze," Yacktman says heatedly, in response to Cole's account. He claims Cole pushed him to resign or to secretly give up running the fund but to stay on as a figurehead manager--a charge that Cole denies. Yacktman quit in 1992, and one of the country's most successful money managers was suddenly out of a job. It wouldn't be the last time that his insistence on doing things his way would damage his career.
OUT OF HIS BOX
I was in Hawaii at a conference, and Don called me and said he had been let go from Kemper and wanted to know what we could do," recalls Jon Carlson, an institutional salesman who had worked with Yacktman at Vincent Chesley. Yacktman decided to launch his own fund company, with Carlson handling the business end. "I felt like Carlson was looking at me as a meal ticket," Yacktman says brusquely. "But he was willing to work."
Carlson hired lawyers, set up the back office and, with Yacktman's approval, marketed the new Yacktman Fund to financial planners and institutional investors who could individually pump millions of dollars into a fund at once. By 1998 these middlemen had contributed 70% of the Yacktman Fund's assets, giving them huge power over Yacktman's fate. It was a fast way to build assets, but it would later backfire disastrously.
Carlson also recruited the fund's three independent directors. The boards of funds are meant to represent shareholders, but they usually function as rubber stamps. Independent directors are chosen by the fund company and paid plump fees for little work. They are often friends of management. The Yacktman Fund's directors were no exception--but Stas Maliszewski, Tom Hanson and Steve Upton were Carlson's friends, not Yacktman's. In 1998, Yacktman would say that his worst mistake was letting Carlson pick this board.
While Carlson built the business, Yacktman assembled a skeletal investment staff. He hired Greg Jackson, a recent college graduate whom he knew from church, as a stock analyst. A year later, Yacktman brought in a second analyst: his son Steve, then 23. An intense M.B.A. from Brigham Young University, Steve brags, "Ever since high school, I've been ahead of the curve." Yacktman could have found more seasoned talent, but he remarks, "There's no sense bringing in someone you have to sit and argue with."
Yacktman's fledgling fund was greeted with great enthusiasm. Fortune heralded it as one of 10 funds that would "shine," and U.S. News & World Report called it one of five funds that "should stand out."
Instead, Yacktman came out stumbling. He bet a fifth of the fund's assets on large-cap drug stocks, which got slammed in a panic over health-care reform. The fund lost 6.6% in 1993 as the S&P 500 rose 10%. Yacktman's board didn't flinch, and influential investors kept their faith. "I saw a CNBC interview with him, and they asked him what happened," says Harold Evensky, arguably the nation's best-known financial planner. "He said, 'I'm doing what I've always done and I'm not going to change.' I said, 'Whoa! I like that kind of thinking.' And that's when we started investing." Another early buyer known for his savvy: Don Phillips, now president of Morningstar.
Their confidence in Yacktman was quickly rewarded. In 1994 his drug picks, including Pfizer and Warner-Lambert, rose sharply, and the fund beat the S&P 500 by seven percentage points. The fund lagged again in 1995, pulled ahead of the index in 1996, then trailed it by 15 percentage points in 1997. Still, his overall performance was strong enough to attract $1 billion into the fund by late 1997 and to earn it a spot on the 1998 MONEY 100 list of recommended funds.
But in 1998 all hell broke loose. In the first half of the year, the fund gained a paltry 3.7%, vs. the S&P 500's 17.7%. Major investors began to bail out. Evensky pulled out in June; Robert Markman, another prominent planner, yanked out $8 million. Suddenly, independent members of Yacktman's board--particularly Maliszewski and Hanson--began to confront Yacktman about his investments.
The fund's biggest problem then was its 10% stake in Philip Morris, which was getting mauled over pending tobacco litigation. But the board was more concerned about Yacktman's dramatic shift into small-cap stocks. Until 1997 he had always preferred companies with market values of at least $1 billion. By 1998, however, the fund had 40% of its assets in small-caps, which were badly lagging blue chips.
It's easy to see why Yacktman was plunging into small companies. They seemed like incredible bargains. By late 1997, stocks on the small-cap Russell 2000 index had trailed the S&P 500 by an average of nine percentage points annually for three years. Yacktman's small-caps fit his old valuation rules. Take Department 56, which makes porcelain collectibles. Yacktman keeps a display of its products--a diorama of a town, complete with shops and a church--in his conference room. He first bought the stock at $20 in 1996, shortly after it took a 55% one-day hit. Today it trades at $30, still only 12 times last year's earnings.
But for many financial planners, Yacktman's move into small-caps was unacceptable. Planners often choose funds to play specific roles in a larger, diversified portfolio, so they like fund managers to stay neatly within boxes, such as large-cap growth or small-cap value. Yacktman was out of his box. "We got to where we couldn't figure out what he was doing," says Evensky. "For us, that's a fatal flaw." Others see it differently. Yacktman's "argument makes a lot of sense to me," says Morningstar's Phillips, "that, if relative value matters, small-caps are the stocks to buy."
Maliszewski and Hanson raised this "style drift" issue in a special board meeting. But Yacktman and the board squabbled about how to define style. Yacktman said his style was about finding value, so he had not changed. Maliszewski countered that style should also refer to the size of stocks in Yacktman's funds, since that was how financial planners and institutional investors define it. "If you define it that way," conceded Yacktman, "you're right."
"WHAT ARE YOU GOING TO DO ABOUT IT?"
In the spring of 1998, Yacktman's skirmishes with the board escalated into open combat, with the directors questioning his ethics. At issue: Don and Steve Yacktman's involvement with a mail-order firm, 1-800 Contacts, which Steve's college roommate had founded. The Yacktmans personally invested $300,000 in the company and sat on its board.
The Yacktman Funds' ethics code obliged the Yacktmans to seek approval from the funds' directors before serving on the board of any public company. This rule, common in the industry, guards against conflicts of interest. A fund manager might, say, learn inside information about a stock as a director that would be illegal to act upon as an investor. Since 1-800 Contacts was a private firm, it was fine for the Yacktmans to sit on its board--until the company went public in February 1998.
When the independent directors learned of this seemingly technical violation, their hackles went up. The Yacktmans appeared not to take the board's concern seriously. Maliszewski and Hanson took Steve to lunch and asked him to leave the 1-800 Contacts board. Maliszewski recalls: "[Steve] said that he didn't care about the code of ethics, that he wasn't going to resign from the board.... And so what are you going to do about it?" (Steve denies saying that he didn't care about the ethics code.)
Yacktman says he was "not surprised" by Steve's combative stance: "I know my son....I'm not sure from a diplomacy standpoint that he did what he should have. But they had him in a corner. Stas is like a bull in a china shop." The funds' directors then offered a compromise: Don Yacktman would leave 1-800 Contacts' board immediately, and Steve would follow if the firm's market cap hit $500 million or if it got on Yacktman's buy list. No problem, said Don Yacktman.
"I'M GOING TO GET YOU"
By now, Yacktman was also feuding with Jon Carlson. Yacktman's funds sold briskly until early 1998, but he had begun to complain that Carlson was not selling enough "separate accounts"--customized funds for institutional clients. He blames Carlson's personality. "He talks too much," Yacktman gripes.
Intensifying the pressure, the Securities and Exchange Commission was examining Yacktman's separate account business. According to Carlson, the problem involved some insufficiently documented performance numbers. Carlson says the imperfect data were a minor concern and not his fault but that Yacktman "used [this] thing to make my life miserable." Yacktman is circumspect in discussing the SEC examination but claims, "Either Jon was not on top of things or he's not totally honest. [The numbers] were not accurate. That was Jon's responsibility."
Carlson says Yacktman tried to use the SEC problem as a weapon to get the funds' board off his back. "When the board would raise tough questions," recalls Carlson, "he would lean on me to get me to call the dogs off." But the board refused to let up. In May the three outside directors proposed a vote that would allow them to form a committee of independent directors. The committee would be able to hire lawyers and consultants to appraise Yacktman's investment approach and compare his performance with that of other fund managers. Carlson had a seat on the board. And with his vote, the independent directors would have the majority needed to form the committee. Carlson says he told Yacktman he would vote with the independents. "Two weeks later," says Carlson, "he fired me."
The day after he was fired, Carlson--still a director of the funds--returned to the office to clear out his desk. It was June 19, 1998. Yacktman was out of town but had left Steve instructions to keep Carlson away. When Carlson appeared at 11 a.m., Steve called a security guard, who told him to get the police if he wanted Carlson thrown out. Ten minutes later, two Chicago police officers arrived to escort Carlson out of the building. Steve and two other Yacktman employees say Carlson pointed at Steve before he exited and vowed, "I'm going to get you for this." Carlson denies this, adding, "Steve made a fool of himself that day."
"THEY WERE SHOOTING HOWITZER SHELLS"
Yacktman's war with the independent directors raged on. The directors set up their committee and hired a New York consulting firm to evaluate Yacktman's work as a fund manager. Yacktman saw this as a prelude to being fired. "Their intent was to change the management," he says. Either he could strike back or, as he puts it, "stand like Bambi's mother in the clearing and wait for them to come along with their rifles." So on Sept. 15, Yacktman asked Carlson, Maliszewki, Hanson and Upton to resign from the board. They refused. Yacktman filed for a shareholder proxy vote to remove them--probably the first time in history that a fund manager had tried to quash a dissident board.
Shareholders were deluged with letters from the board (paid for with fund assets) and from Yacktman (paid for by him) trading explosive charges. Yacktman railed that the board was loaded with Carlson's friends, who were acting out of loyalty to Carlson, not in shareholders' best interests. The directors alleged that Yacktman had deceived shareholders by marketing his funds as large-cap investments and had shown "a rebellious disregard for the funds' rules and investment mandate." In fact, the Yacktman Fund's prospectus--like most such documents--had intentionally given the manager wide latitude: "Although there is no specific requirement to do so, the Fund usually focuses on the securities of companies with large capitalization."
Startled investors kept cashing out of the funds. "They were shooting howitzer shells at each other, over the heads of my clients," says Gary Bowyer, a financial planner who pulled out $1 million. "I decided we just didn't need this."
The proxy ballots were counted in December, and 90% of the funds' remaining shareholders voted in favor of Yacktman. Carlson, Maliszewski, Hanson and Upton were booted out and replaced by new directors. The natural order of the fund industry was restored: Friends of Carlson were supplanted by friends of Yacktman. Two of the new directors knew Yacktman from church, and one had been in his study group at Harvard.
Maliszewski says Yacktman's victory sends a chilling message to the independent directors of all mutual funds. "Independence means you make decisions and get information independent of the group you're supposed to be independent from," he says, "which I doubt will happen now." If boards are truly to serve as watchdogs, he adds, they should be granted the power to fire fund managers without shareholder approval. But Morningstar's Phillips thinks the ousted directors overreached. "I bought the Yacktman Fund to get Don Yacktman," he argues--not to secure the talents of the fund's directors.
In any case, Yacktman had prevailed. But what about the board's attack on his ethics? A troubling fact had emerged during the proxy fight: Yacktman didn't quit the board of 1-800 Contacts until October, months after he had promised to do so. Yacktman says he simply wanted to give the company time to find a replacement because it had just gone public and was growing quickly.
It's hard to see that lapse as much more than a traffic violation. Yacktman was not engaged in insider trading or anything else that might have made him richer at the expense of shareholders. But for a man whom friends and family members describe as obsessively organized--"I've seen him fold garbage," says Steve--he was certainly sloppy about his funds' regulations.
It's also fair to ask whether all this rancor might have been avoided had Yacktman shown the board just a little more deference. Perhaps. But that's not Yacktman. "The people whom Don Yacktman didn't get along with are the people who didn't understand Don Yacktman," says Faris Chesley, former president of Vincent Chesley. "You think you're going to go in and tell Don Yacktman how to do his job? Not going to happen."
AFTER THE STORM
Finally, after 30 years of managing money, Yacktman has the independence he always sought. His new, friend-filled board is unlikely to give him grief. And with no one to challenge his investment decisions, he's betting more aggressively than ever on the small-cap stocks that nearly wrecked his career. The Yacktman Fund now has 45% of its assets in small companies such as Department 56 and Franklin Covey. "With great companies like these," Yacktman declares, "you may only have one chance in 10 years to buy them." If he's right and small-caps recover, his loyal investors will reap handsome gains.
So far, however, his contrarian boldness has brought him nothing but disaster. Last year, the Yacktman Fund trailed the S&P 500 by 28 percentage points. This year, both of his funds had lost 7% by mid-February. Impatient investors continue to abandon him: Assets in the funds have plunged 75% below their $1.2 billion peak.
Yet through it all, says his wife Carolyn, Don Yacktman has never shown a trace of self-doubt. "When you live your life clean, the accusations don't matter," she says. "He never wavered. He may have taken a few more naps. That's also what he does whenever the market goes crazy."
Yacktman says his faith in his judgment remains unshaken. "I think I'm a much better investor now than I was 10 years ago at Selected," he confides. "Ironically, the performance doesn't show that."