Greetings and best wishes for a happy, healthy and lucrative new year. In what is no surprise to anyone reading this letter, it was a difficult month for the markets, with the S&P 500 and Dow recording their worst December since the Great Depression. This led to 2018 showing the biggest losses for the markets since the financial crisis of 2008. The S&P ended the year with a loss after being in positive territory for the first three quarters, the first time this has happened. While the Day Hagan Logix Tactical Dividend strategy outperformed its benchmark in December and for the year, it was not immune from the highly unusual market activity. For the year, the strategy was -7.31%, ahead of the Russell 1000 Value Total Return benchmark at -8.27%. We also fared far better than some of our peers. As a few examples, the AIG Focused Dividend Fund was -11.10% and the Fidelity Value Fund was -17.34% for the full year.
Since 2002 inception, Day Hagan Logix is now +8.81% on an annualized basis vs. the Russell 1000 Value at +6.62%, marking meaningful outperformance while maintaining a modest beta of 0.63. As an additional comparison, Day Hagan Logix is also outperforming the S&P 500 over the same timeframe, by 188 basis points annually. The strategy continues to generate positive alpha across recent and longer-term timeframes.
We expect any downside capture over the next several months to be more consistent with historical measures. It is hard to draw any real conclusions from one month of performance (December still showed outperformance versus the benchmark). What we did see was that the way we measure value, using our complex, objective dividend yield-based modeling and fundamental screens inclusive of healthy balance sheets and free cash flow generation, didn’t matter in December. However, if there’s anything that 17 years of managing the portfolio with a consistent and disciplined approach has taught us, it is that our “smart value” strategy works over time on both an absolute and relative (to our benchmark) basis. That includes history like the internet meltdown in 2002 and the financial crisis in 2008.
For example, the four largest down quarters in our strategy’s history were all followed by meaningfully positive performance (see below; green shows positive performance after respective drawdowns). In other words, we have been here before and have a high degree of confidence and optimism in our strategy moving forward.
Previous Quarterly Declines and Subsequent Positive Returns
(Please view disclosures at the end of this letter.)
In fact, as our portfolio stands now at the end of Q4, we see average potential price-only upside of 64%, with our 30 current holdings ranging from price targets at +22% to +135% above current values. In addition, inclusive of our defensive cash position (just over 18% of the portfolio), our portfolio yield is an attractive 3.2%.
The fourth quarter was very active in terms of portfolio trading, particularly in December. Based on our objective methodology, in the midst of the market sell-off we were able to opportunistically add new positions and increase existing positions. Despite some holdings hitting our stop-loss levels—an expected part of our process, particularly during broader market weakness—we actually reduced our cash position a fair bit over the last weeks of the year. In December, we added three new positions and increased position sizes for six others. Most recently, on December 26, we added to existing holdings across the financials, consumer staples, REITs and retail sectors.
Energy was the worst-performing S&P sector for the month, quarter and year. It’s been quite a reversal from just a few months ago in early October, with the price of crude from peak to trough down over 40%. While, alongside market forecasters, we can discuss reasons for the decline and all of the potential positives for a coming rebound in oil, we also feel it’s important to talk about energy in the context of our current holdings and our strategy more broadly.
We added Suncor Energy (SU) to the portfolio in December. SU is a Canadian-based integrated energy company that operates both upstream (Canadian Oil Sands, exploration and production) and downstream (refining and marketing). Downstream is the largest contributor to revenue, nearly 60%. In the midst of lower oil prices, the refining part of the business is effective in providing cash flow stability. In other words, refining can still be very profitable in a low crude oil price environment. Fundamentally, SU is the kind of stock that screens well with our strategy, with modest leverage and significant balance sheet flexibility. The company has sixteen consecutive years of dividend increases, low dividend free cash flow (FCF) payout ratios and a FCF yield approaching double digits. Management states that even in a lower oil price environment, they expect a significant dividend increase ahead. It’s interesting to note that in the oil sands, the company has shown meaningful reduction in operating costs per barrel over the last several years. Current operating costs are about C$25.50/barrel, and in their non-oil sands exploration & production it is under C$10/barrel.
Another integrated energy holding in the Day Hagan Logix portfolio, ExxonMobil (XOM), shows that at $40 oil, it can increase its cash flow by 50% by 2025 (the increase in cash flow goes to 105% at $60 oil). Occidental Petroleum (OXY) indicates that at $40 (West Texas) oil, it can maintain production and comfortably pay its dividend. OXY also has sixteen straight years of dividend growth and has returned over $30 billion to shareholders since 2006. We mention management’s expectations in modest price scenarios because nearly every (greatly reduced) forecast for 2019 we’ve seen shows Brent Crude oil in the $60s and $70s per barrel and West Texas Intermediate in the $50s and $60s (with differentials versus Brent reducing). Our average price target upside for our energy holdings is about +80%.
In our approach as a “smart value” manager, we typically and frequently buy industries and stocks that are out of favor with significant negative sentiment accompanying them. It can, at times, mean we are too early even if we have conviction around our valuation work and thesis. Being early also means we often face negative volatility (and the occasional stop loss in a given industry) before upside potential plays out. We view that as what has happened recently as it relates to our energy exposure.
Note that Day Hagan Logix Tactical Dividend is not offering an opinion on the macro direction of the energy market. We do not portray ourselves as having or attempting to have an information edge or a deeper subjective take on, for example, energy supply and demand impacting future oil prices. All of the narrative or “story” around our holdings more broadly matters primarily in the context of making sure it doesn’t change our objective, yield-based valuation modeling and fundamental screening work. We seek to buy industries and underlying stocks at trough valuations and “on sale” for longer-term outperformance with modest risk.
Given a backdrop of volatile market conditions, we are happy to make ourselves available for a conversation at any time. Please keep checking the Day Hagan Logix website (www.dayhaganlogix.com) for trade notifications, commentaries and webinars, including our most recent webinar on January 2nd. All of these updates can be pushed to your email automatically if you register on the website.
Wishing you all the best in the New Year.
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 January 2019 (PDF)
Day Hagan Logix is registered as an investment adviser with the United States Securities and Exchange Commission. SEC registration does not constitute an endorsement of the firm by the Commission nor does it indicate that the adviser has attained a particular level of skill or ability. Day Hagan Logix claims compliance with the Global Investment Performance Standards (GIPS®) and has prepared and presented this report in compliance with the GIPS standards. Day Hagan Logix has been independently verified for the periods April 30, 2002 through December 31, 2017. A copy of the verification report is available upon request. Verification assesses whether (1) the firm has complied with all the composite construction requirements of the GIPS standards on a firm-wide basis and (2) the firm’s policies and procedures are designed to calculate and present performance in compliance with the GIPS standards. Verification does not ensure the accuracy of any specific composite presentation. 2 Calculation Methodology: Pure gross of fees returns are calculated gross of management, custodial fees and transaction costs and are shown as supplemental information. Net of fees returns are calculated net of actual management fees, transaction costs and gross of custodian (trust) fees. Net of fees returns for wrap accounts are calculated net of management fees, transaction costs and all administrative fees charged directly to the client by the broker-dealer. Net return for the strategy for 2018 is -7.86%.
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.
Alpha is a statistical measure that calculates an active manager’s return in excess of a benchmark index or a “risk-free” investment.
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. Past performance is 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.
There is no guarantee that any investment strategy will achieve its objectives, generate dividends or avoid losses.