For the month of July 2017, the Day Hagan Logix Tactical Dividend strategy returned +1.00%* gross (+0.97% net*) compared to the Russell 1000 Value at +1.33% and the S&P 500 at +2.06%. All numbers are total return. Value's underperformance vs. growth continued in July, extending the significant year-to-date gap between the two. For the year to date, Day Hagan Logix is +3.68% gross*, +3.39% net*.
As a deep value strategy utilizing complex dividend yield modeling to find trough valuations, we certainly feel the headwinds of "risk on," growth-oriented market performance in 2017. However, while we use a fundamental overlay to ensure we aren't missing anything transformational for a name or industry, in general we view our established process as a strategic way to achieve our risk-return goals over a multiyear period. This does not mean we ignore volatility (positive or negative) related to quarterly earnings calls or daily news flow. But ultimately, most of what we see on a day-to-day basis is short-term noise that does not impact our underlying valuation foundation. We have been using the same valuation approach since 2002 inception, which has led to 70%+ upside market capture and 50% downside market capture. Since inception, this translates into meaningful outperformance vs. both the S&P 500 and the Russell 1000 Value with a beta of around 0.6.
Today's market environment has led many into a sense of complacency. As the S&P 500 continues to perform, many ignore a macro backdrop and valuation picture that is far from certain. As well-known investor Howard Marks of Oaktree Capital recently wrote, "The key strategic decision for anyone shaping investment strategy is whether to apply aggressiveness or defensiveness at a given point in time." Or more directly from Warren Buffet, "What the wise do in the beginning, fools do in the end." We are not by any means calling anyone a fool, but the sentiment is well taken. We are defensively positioned, based on our current level of cash holdings, and regardless of the near-term volatility in our names and industry groupings, we believe strongly in the existing portfolio based on our process. Mr. Marks goes on to make additional points of interest in his letter. Among them is that strategies that seek lower risk and rational returns (such as ours) may sometimes encounter relative underperformance during the phase of the bull market when trends reach "irrational extremes and prices go from fair to excessive." He further opines that a lower-risk approach is also a "prerequisite for investment successes."
To take this perspective a step further on the current value-investing underperformance, research shows that value outperformed growth by 4.8% annually between 1926 and 2005 (source: Fama and French) while growth has outperformed value by less than 1% annually over the last twelve years. Excepting the dotcom bubble era of the late 1990s and early 2000s, value is cheaper than growth by the widest gap in the last 60 years. Leadership inevitably will change again, and we believe we are uniquely positioned to take advantage of the shift given our valuation methodology related to deep value. This, of course, does not mean that all or even most value stocks are worth buying. Our approach goes significantly deeper in avoiding "cheap" names that are that way for good reason.
Generally, what we own from an industry and individual equity perspective is somewhat contrarian. In other words, frequently we are buying at or around trough valuations because the broader markets do not "like" the industry or name. Often it means we are early, something we are comfortable with as long as our entry points fit our criteria. A good case study is our continued ownership of the Asset Management industry. We originally purchased the industry in February of 2016 amid very negative sentiment. Today we hold only two of the same names from the industry entry point, Franklin Resources and T. Rowe Price (BEN, TROW), but have done very well overall with the industry, buying and selling names within the grouping along the way. We purchased SEI Investments (SEIC) later that February as it came into a buy range, subsequently selling it four short months later with an approximate 32% gain*. One of our original holdings, Northern Trust (NTRS), was also sold in June with about a 19% gain*. To replace NTRS and SEIC, we purchased two attractively valued names, Invesco (IVZ) and Waddell & Reed Financial (WDR), both of which we continue to own today. One of our other original holdings, Janus (JNS), was sold in October of last year with a low-teens gain after its merger with U.K.-based Henderson Group was announced. Eaton Vance (EV) was added in October but sold at the end of last year after a rapid gain of about 16%.
Despite attractive performance for our asset management industry holdings to date (~+27% since February 2016 purchase), broader sentiment around these names continues to be mixed. A common viewpoint, flowing back to our earlier discussion around the "risk-on" markets, is that passive has somewhat permanently taken over as the approach of choice for investors. We believe, however, with history as our consistent guide, the pendulum will swing back in favor of active or at least a mix of the two. In fact, we would suggest that long-term survivors in the asset management space will embrace a diverse mix of active and passive, along with diversity in terms of geography, asset classes and risk management. Active managers should also ultimately benefit from the opportunity presented by the massive indexing movement, as fund flows related to passive indexes can lead to a disconnect between an underlying company's fundamentals and stock price, generating active management opportunities.
Finally, a quick note on energy. Towards the end of July, oil prices were at two-month highs and, in the final full week of the month, showing the strongest weekly gain of the year based on signs of more balanced supply and demand. The well-regarded energy team at Raymond James published a report in mid-July indicating their expectation that oil prices will need to move to $65 to avoid massive inventory reductions in 2018. We do agree that underlying and improving oil fundamentals will again, inevitably, link back to an increase in oil prices. Regardless, we view our holdings in the energy space as having sufficiently right sized and refocused to effectively weather the storm and ultimately thrive, regardless of near-term price movement. Chevron (CVX) is a good example of this, seeking to improve efficiencies, reducing their 2017 capital expenditures, while simultaneously achieving better-than-expected production in the Permian basin (West Texas/Southeastern New Mexico). Most importantly, all of our energy holdings have passed our evaluation criteria and methodology based on absolute and relative yield (and inversely, price) cycles along with sustainable fundamentals.
We look forward to the months ahead and, as always, keeping you apprised of our progress.
- Robert Herman
- Donald L. Hagan, CFA
- Jeffrey Palmer
- Arthur S. Day
PDF COPY OF ARTICLE: Day Hagan Logix Tactical Dividend Strategy Update, August 4, 2017 (pdf)
Note: The S&P 500 Index is based on the market capitalizations of 500 large U.S. companies having common stock listed on the NYSE or NASDAQ. 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.
Disclosure: *Note that individual's 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 expressed 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. When evaluating the results of prior DH Logix recommendations or DH Logix performance rankings, one should also consider that DH Logix may modify the methods it uses to evaluate investment opportunities from time to time, that model results do not impute or show the compounded adverse effect of transactions costs or management fees or reflect actual investment results, that some model results do not reflect actual historical recommendations, and that investment models are necessarily constructed with the benefit of hindsight. For this and for many other reasons, 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.