The Day Hagan Logix Tactical Dividend (DHLTD) strategy had a strong March, more than doubling the performance of the benchmark Russell 1000 Value index (+1.31%* vs. +0.64%) for the month. Performance was led by our food/beverage processing and specialized REIT industry holdings. Year to date with Q1 now complete, DHLTD is +9.75%* while maintaining a defensive cash position, albeit at lower cash levels than the month prior. All performance numbers are total return and gross of fees.
It is worth reflecting on the trades we made in March within the context of the strategy’s approach to holding cash. During the month, we purchased EOG Resources (EOG) in the Oil & Gas industry, as well as Franklin Resources (BEN) in the Asset Management industry. We also trimmed the position size of TJX Companies (TJX) due to the stock’s significant appreciation since purchase. Net of the new purchases and the TJX trim, our cash position decreased by 2.5%. As we’ve discussed previously, we always seek to be fully invested. However, based on our disciplined, methodical approach, we do not purchase new positions unless they meet our stringent valuation criteria. Therefore, if we don’t have enough attractively valued names to buy, we will hold cash instead. This has been historically demonstrated to improve our risk-adjusted returns.
It is sometimes perceived that the direction of the broader U.S. markets dictates the cash levels in our portfolio (e.g. we raise cash levels as the overall market goes up and gets more expensive, we put cash to work as the overall market goes down and valuations improve). Yes, we do raise cash when valuations are expensive and put it back to work when valuations improve, but our views of valuation are focused on individual industries and companies, not the overall broad market.
Our March trades provide a good illustration. Even though the overall market was higher, attractive valuation opportunities arose in the Oil & Gas and Asset Management industries. This allowed us to get more fully invested.
It is also historically true that a significant shift in the overall domestic equity markets will change our opportunity set and, correspondingly, our cash position. This happened in mid-2009, when we went from a large, defensive cash position in 2008 to becoming nearly fully invested by June 2009. While the overall market clearly became much cheaper by March 2009, we evaluated our opportunities on an industry-by-industry and stock-by-stock basis. Of course, at that time there were many more opportunities, and therefore we were able to deploy all of our cash.
In terms of the specific stocks purchased during the month, EOG is one of the largest exploration & production (E&P) energy players in the U.S., second only to Chevron as a domestic onshore producer. The company was an early mover in shale, providing it with the history and experience to drive above-industry averages in production rates and below-industry averages in cost. At West Texas Intermediate (WTI) crude prices of $40/barrel, well below current prices in the $60 range, the company has close to 10,000 “premium” wells that can generate internal rates of return of 30%+. The company at this point has modest debt levels, which it continues to retire in the name of reduced leverage, as well as significant balance sheet cash. Its 20-year annualized dividend growth rate is close to 20%, while it maintains a low free cash flow dividend payout ratio. EOG is up nearly 9% since our purchase in mid-March.
Our other March purchase, within our Asset Management industry grouping, is BEN, a global investment management firm with over $700B in AUM. BEN is well diversified product-wise, both in terms of asset class exposure and geographic focus. For example, AUM is evenly split between equities and fixed income with a growing focus on alternative strategies. From a balance sheet perspective, BEN has a whopping $6.7B cash and $1.4B in investments. $8.1B in total cash and investments for a company with a current market capitalization of about $17B provides management significant ability to be flexible and opportunistic. The large cash position is related to 2017 tax reform and the ability of the company to repatriate cash from overseas offices. In 2018, BEN authorized an 80 million share buyback and has had a dividend increase every year since 1981, most recently with a 13% increase in December 2018. We’ve successfully bought and sold BEN in the DHLTD portfolio previously, buying in February 2016 at about $34/share* and selling at about $45/share* in January 2018 (total return on the position would include dividends paid out). We purchased it again a few weeks ago at a share price of about $33, and it is up modestly since.
We continue to take an industry-first approach to portfolio construction, meaning we buy attractively valued equities in attractively valued industries. It is important to note that our view of industry classifications (i.e., to which industry an individual stock belongs) is based on the macro factors that most impact a company’s actual revenue streams. For example, all companies with a significant portion of their cash flows impacted by energy price trends would be viewed as being in the same industry.
Lastly, UBS recently published a report that showed Warren Buffett’s Berkshire Hathaway often underperformed the broad U.S. equity market over short and even multi-year timeframes. The head of UBS investment strategy, Michael Crook, posed the following question in his research (paraphrased): If investors would have had the patience to continue holding their investment with Buffett during periods of extended underperformance, would they have been rewarded for that patience? The answer is that, over a roughly 30-year period, a patient investor would have been rewarded with significantly better performance than the broad market (as defined by the S&P 500). It’s an interesting question as the lengthy bull market run continues and risk tolerance seems to be less of a focus. In any case, we are confident our unique approach to finding undervalued equities, as well as a consistent risk management philosophy over the last 17 years, will continue to serve our clients well on an absolute and relative basis.
As always, we welcome your questions and feedback.
Robert Herman, MBA
Donald L. Hagan, CFA
Jeffrey Palmer, CIPM
Arthur S. Day
Steve Zimmerman, MBA
Print Copy of Article: Day Hagan Logix Tactical Dividend Strategy Update April 2019 (PDF)
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The Russell 1000 Value Index measures the performance of the large-cap value segment of the U.S. equity universe. It includes those Russell 1000 companies with lower price-to-book ratios and lower expected growth values. Indexes are unmanaged, fully invested, and cannot be invested in directly. The S&P 500® Index is a broad-based unmanaged index of 500 stocks, which is widely recognized as representative of the equity market in general.
Disclosure: *Note that individuals’ percentage gains relative to those mentioned in this report may differ slightly due to portfolio size and other factors. The data and analysis contained herein are provided "as is" and without warranty of any kind, either express or implied. Day Hagan Logix (DH Logix), any of its affiliates or employees, or any third-party data provider, shall not have any liability for any loss sustained by anyone who has relied on the information contained in any DH Logix literature or marketing materials. All opinions expressed herein are subject to change without notice, and you should always obtain current information and perform due diligence before investing. DH Logix, accounts that DH Logix or its affiliated companies manage, or their respective shareholders, directors, officers and/or employees, may have long or short positions in the securities discussed herein and may purchase or sell such securities without notice. DH Logix uses and has historically used various methods to evaluate investments which, at times, produce contradictory recommendations with respect to the same securities. The performance of DH Logix’s past recommendations and model results are not a guarantee of future results. The securities mentioned in this document may not be eligible for sale in some states or countries, nor be suitable for all types of investors; their value and income they produce may fluctuate and/or be adversely affected by exchange rates, interest rates or other factors.
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