With the end of 2018 now in sight, the Day Hagan Logix Tactical Dividend Strategy (DHLTD) continues to show attractive absolute and relative (to its benchmark Russell 1000 Value) performance. Year to date through September 30, the strategy is +6.08%* versus the Russell 1000 Value index at +3.92%. Over the last twelve months, Day Hagan Logix is +13.33%*, also ahead of its Russell benchmark. All numbers are gross of fees and total return. What’s more, even in a market environment where growth has meaningfully outperformed value, driving S&P 500 returns higher, our deep value strategy has generated positive Alpha (as a measure of risk-adjusted return) versus the S&P 500 over the last year. In terms of other indexes and peers year to date, the S&P 500 Low Volatility High Dividend index is +0.94%, the AIG Focused Dividend Strategy is +0.20%, and the Schwab U.S. Dividend Equity ETF is +4.39%.
We ended the third quarter with 28 holdings across seven diverse industries. While we lowered our cash position during the month of September, we maintained defensive positioning moving into the fourth quarter based on the same objective valuation methodology we have consistently applied over the last nearly 17 years. Current dividend yield for the portfolio, inclusive of defensive cash, is about 2.6%*. While our Specialty Retail and Communications & Networking industry groupings led portfolio performance for the third quarter and year to date, in September our Energy holdings were strongest (more on what drove those higher below).
During the month of September, we purchased two new names and exited two others that hit our price targets. Starwood Property Trust (STWD) is a new portfolio holding in our Specialized REITs industry. It replaced Welltower (WELL), a healthcare REIT, in the industry. WELL appreciated rapidly during our short, six-month holding period, with a total return of about 27%* before being sold. Lowe’s was also sold out of the Specialty Retail industry in mid-September with a holding period of about 15 months, hitting our price target and generating total return of about +46%*.
STWD has an interesting story. It is the largest commercial mortgage REIT in the United States, diversified with involvement in lending, investing and servicing. An example of this diversification includes the recent purchase of GE Capital’s Energy Project Finance Debt business. As is true with the bulk of STWD’s business, the acquisition consists of primarily floating rate debt (providing a hedge against rising interest rates), secured by real assets and with low correlation to the commercial real estate sector more broadly. Separately, STWD’s large special servicing business, dealing with troubled loans, also provides a hedge in the case of a worsening credit environment. Remarkably, STWD has deployed roughly $41 billion of capital historically with no realized loan losses. With a healthy balance sheet and fundamental strength as an overlay (and a stable dividend yielding nearly 9%), our methodical valuation process showed an attractive entry point for STWD within a buy industry.
Ingredion (INGR) was added to our Food/Beverage Processing holdings, also in September. Similarly to STWD, we saw INGR as a compelling valuation opportunity. INGR is a global ingredient solutions provider with meaningful growth potential internationally. In addition, its specialty ingredients segment has the benefit of being differentiated enough to realize double the gross margins of core ingredients, with strong growth characteristics as well. INGR’s dividend has grown nearly 60% over the past five years. Even with the increases, the company’s free cash flow dividend payout ratio remains modest, under 40%. INGR is also proactive in following consumer health trends, with significant focus on pulse-based (peas, lentil, chickpeas, fava beans) proteins and flours to continue driving growth.
Consistent with the sector more broadly, our Energy exposure led portfolio performance during the month of September, with particularly notable performance from Apache (APA) and Exxon Mobil (XOM). Using APA as an example, recent reports of reduced pipeline constraints in the all-important Permian Basin oil and natural gas producing region gave credence to the idea that takeaway capacity will increase over the coming quarters. As a result, current relative price weakness for oil produced in the Permian should ease, a benefit to exploration and production names like APA. This should also benefit demand for our Oil Services & Equipment holdings Halliburton (HAL) and Schlumberger (SLB). While the basis of our valuation process and related upside expectations do not try to forecast macro energy supply and demand, it does appear that the dynamic of tightening supply and OPEC/Russian reluctance to raise global production should be an additional tailwind for our energy holdings. J.P. Morgan in late September said, “a spike to $90/barrel is likely” (with the price of Brent Oil currently in the low $80s), and others are suggesting $100+ in early 2019. Regardless, given our entry points and modeling on long-term value, we view our current energy holdings as having a highly attractive risk-reward dynamic moving forward.
Finally, our Specialty Retail names have demonstrated solid performance despite longstanding fears around the death of brick and mortar retail. In addition to our recent sale of LOW, names like Monro (MNRO), TJX Companies (TJX) and Tractor Supply (TSCO) have all done very well since purchase (with holding periods so far between nine months and just over a year) and during 2018. All of these names have somewhat differentiated business models, making it difficult for AMZN or others to replicate it online. That doesn’t mean a name like MNRO, to their benefit, can’t strike a deal with AMZN. In the case of MNRO, tires purchased on AMZN can now be installed in any of 1,000 MNRO locations.
In the context of unique business models, Tractor Supply generally serves more of a rural lifestyle with the clever tagline “for life out here.” Goldman Sachs recently did research that shows TSCO same-store sales (SSS) are highly, positively correlated to both inflation and the price of oil. This makes sense as TSCO customers benefit from increasing prices on commodities like corn, wheat and soybeans in an environment of rising inflation. Also, a large percentage of TSCO stores are in oil-producing areas, leading to the same type of positive relationship between SSS and the price of oil. This example demonstrates the differentiation between more traditional retail and our current retail holdings. It’s also important to consider in the context of our investment approach. It is true that the foundation of our portfolio construction is a unique, objective, yield-based valuation approach that has been consistent since 2002 inception. We use this foundation to find attractive, deep value entry points and appropriate exit points as well. However, we do not stop there. A critical facet to what we do is exploring the fundamental strength of a business. In the case of TSCO and other retail names, that means an in-depth look at differentiated demand drivers to test our valuation thesis. The work does not stop with the purchase of a portfolio holding. We continuously monitor our names and the underlying risk-return rationale to ensure the integrity of our portfolio construction.
Lastly, in case you missed our email invitations, we hosted another Day Hagan Logix Tactical Dividend portfolio update webinar on September 21. We discussed our holdings and expectations for the rest of 2018. If you missed it and would like to hear the replay, please let us know. For those of you who sent the kind notes, thank you.
To automatically be included in future email invitations, please go to either www.DHLogix.com or www.DayHagan.com to sign up. Our email system is designed to recognize IP addresses to discourage spam, so it’s best if you sign up directly at one of our websites.
As always, we sincerely appreciate your support and welcome questions and comments.
Donald L. Hagan, CFA
Arthur S. Day
PDF copy of the article: Day Hagan Logix Tactical Dividend Strategy Update October 2, 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. 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 year to date through 9/30/2018 is +5.63%; last twelve months net return is +12.70%.
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. The S&P 500 Low Volatility High Dividend index measures the performance of the 50 least-volatile high dividend-yielding stocks in the S&P 500. The index is designed to serve as a benchmark for income-seeking investors in the U.S. equity market.
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. 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 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.