The Day Hagan Logix Tactical Dividend strategy (DHLTD) performed strongly in the midst of a difficult and volatile October. As a strategy with a significant focus on risk management, DHLTD beat its Russell 1000 Value benchmark by 131 basis points for the month*, while beating the broad-based S&P 500 by 297 basis points*. For the year-to-date through October, DHLTD is now +1.98%* versus the Russell 1000 Value benchmark in negative territory at -1.46%. On a one-year basis, DHLTD is 9.99%* versus the Russell 1000 Value at +3.04% and the S&P 500 at +7.35%; the one-year number comes with a beta (measure of volatility) of 0.62*. Performance numbers are all total return and gross of fees. While a rotation to value was clear in October, the Russell 1000 Growth is still meaningfully ahead of the Russell 1000 Value year to date. We expect the rotation to continue and work to the benefit of our differentiated, deep value portfolio as we move into the final two months of the year.
U.S. markets lost around $2.5 trillion of value in October, and the so-called FAANG (Facebook, Amazon, Apple, Netflix, Google/Alphabet) contingent that had been previously keeping the market afloat was among the weakest performer. As we’ve discussed in prior letters, it’s hard to justify those companies’ valuations, even after their October drop, with a name like Netflix reporting negative $859 million of Free Cash Flow for their third quarter alone! Every economic sector was negative for the month except for the safe havens of Consumer Staples and Utilities. For the DHLTD portfolio, however, three industry groupings were in positive territory: Specialized REITs, Specialty Retail and, for a short part of the month, Asset Management.
We purchased four asset manager equities in late October, including Invesco (IVZ), BlackRock (BLK), T. Rowe Price (TROW) and Eaton Vance (EV). For those clients that have been with the strategy over the last few years, you may recall that we previously purchased the Asset Management industry in February 2016 at a price trough, subsequently selling out of the industry (with buys and sells of individual stocks along the way) completely in January of this year. Overall, Asset Management generated a total return of about +60% during the 2016-to-early-2018 holding period. Fast-forward to late October of this year, and it’s interesting to see the industry stocks that we sold in January were down nearly 25% since then, demonstrating the value of exiting positions at the appropriate time. In effect, industry weakness gave us another attractive entry point in October (with some of those same stocks as well as new ones).
Our price targets on the four asset managers purchased are an average of 46% above current levels. We think all four of them bring different attributes to the table. BLK, of course, is the “800-pound gorilla” and the largest asset manager in the world, with about $6.4 trillion in assets under management. Even with its acquisition history (e.g., the iShares ETF franchise from Barclays and others more recently), the company has the balance sheet strength and massive free cash flow (FCF) generation to continue investing in growth. One example of this is in expanding its wealth management distribution, further diversifying from its institutional client focus.
Next, IVZ is one of the strongest assets under management (AUM) growers in its peer group and is well diversified across passive, active and alternative strategies. IVZ also has a significant international distribution presence, which will provide synergies with their recently announced acquisition of Oppenheimer Funds from Mass Mutual in an all-stock deal. Oppenheimer has a meaningful percentage of international equity strategies with untapped distribution potential and also brings to IVZ strength in U.S. Wealth Management and a retirement market relationship with Mass Mutual. IVZ management expects meaningful accretion from the Oppenheimer deal starting in 2019.
TROW is another well-known asset manager and has zero debt as its corporate cash position continues to meaningfully grow. This very strong balance sheet gives TROW flexibility for shareholder-friendly actions, including share repurchases in Q4 to date that are already higher than Q3 as a whole. TROW has increased its dividend 32 years in a row, including a 23% increase in 2018. TROW’s strong manager performance (80%, 84% and 84% of TROW managers have outperformed their peer group over the last 3, 5 and 10 years respectively) provides asset stability as the company has average quarterly inflows of $2.8 billion over the last 10 years. Retirement accounts and variable annuity portfolios, generally stickier given higher switching costs for clients, are two-thirds of TROW AUM.
Finally, the smallest of the group, EV, still has about $450 billion under management. EV is somewhat differentiated, using niche products to drive growth. One example is its Parametric Portfolios unit, which manages a range of engineered alpha strategies. Interestingly, while it is not yet a meaningful source of revenue for EV, their creation of the exchange traded mutual fund (ETMF) market, which is actively traded on exchanges, may very well reflect the evolution of ETFs and mutual funds. As it gains traction, EV is starting to also derive licensing fees.
At the end of October, factoring in the Asset Management purchases, the portfolio has continued to reduce its cash/short-term investment position opportunistically. We always strive to be fully invested, but we will not buy industries and underlying stocks that do not pass our valuation criteria and fundamental screens. At present, we are conducting due diligence on industries that have moved closer to a buy range. Given the way different industries move regardless of the broader market direction, market weakness is not a prerequisite for adding holdings to the portfolio, although the October declines have brought our overall, eligible universe into a more reasonable valuation range.
On the subject of cash as defensive positioning, 2008 and 2009 provide a good illustration of not only the value of holding cash but also the strategy’s ability to put cash back to work at an appropriate point in time. 2008 performance for DHLTD was about 2000 basis points ahead of both the Russell 1000 Value and the S&P 500, meaningfully protecting downside. Even without cash, equity-only performance (not factoring in the cash that worked to our benefit) was still a compelling 1500 basis points ahead of both indexes. In 2009, large cash positions in the portfolio early in the year (over 50%), went down to 11.9% by April 30 and 3% by June 1. 2009 calendar year performance for DHLTD was +26.70%*, 700 basis points ahead of the Russell 1000 Value and in line with the S&P 500. Cash as a risk management tool has been effective for us since strategy inception, but in order for us to have meaningfully outperformed (with lower risk) our benchmark, we have to be able to get fully or close to fully invested at the right juncture to sufficiently capture upside. We have done just that historically.
On the last day of the month, our smallest portfolio position at the time, OMI, reached a forced sell based on a dividend cut and our stop-loss criteria. The impact on overall performance was modest, but regardless, we expect (on rare occasions) for this to occur, as it has since 2002 inception. In the case of OMI, we felt the dividend cut was not necessary (adjusted earnings more than covered the dividend) but rather was a management judgement call to pay down debt from recent acquisitions. This is a decision with which we disagree. The company previously had 19 years of consecutive dividend increases. While, again, the impact on portfolio performance is not substantial, we feel it is worth highlighting, as it provides insight into our process. Seeking out trough valuations in buying undervalued industries and individual stocks will inevitably lead to occasional, negative outcomes on a single equity or, even less frequently, an industry grouping. Our investment strategy and underlying methodology factors in these infrequent negative outcomes over time. Our focus, of course, is on overall portfolio risk-return, and we have been successful in realizing benchmark outperformance with lower risk for the last nearly 17 years, over multiple market cycles.
As always, we sincerely appreciate your support and welcome questions and comments.
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 November 2018 (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, 2016. 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. 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 year to date through 10/31/2018 is +1.49%; last twelve months net return is +9.39%.
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 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. 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.