During a volatile month of August for the markets, the Day Hagan Logix Tactical Dividend Strategy (DHLTD) outperformed its benchmark Russell 1000 Value, as well as relevant comparisons like the S&P 500 Low Volatility High Dividend ETF, the S&P 500 Equal Weight ETF, and the S&P 500 Enhanced Value Index ETF. Year-to-date, the strategy has returned +9.73%*. All numbers are gross of fees and total return.
2019 has been a challenging year to navigate for many well-known and even legendary investors. For example, Warren Buffet’s Berkshire Hathaway (BRK.B) is flat year-to-date while continuing to sit on over $122 billion in cash. Famous hedge fund investor Ray Dalio’s Pure Alpha Major Markets Fund is down nearly -18% through August 23, 2019 (source: Bloomberg). As far as DHLTD goes, we continue to generate consistent, absolute returns with modest risk over a market cycle by using the same objective discipline we have applied for over 17 years. We have navigated good, bad and flat markets and have a great deal of confidence around our methodology and its ability to protect investors in the name of long-term outperformance with low beta.
Our investment methodology involves finding attractively valued industries and underlying equities within those industries at trough (low) valuations. Not surprisingly, the way to find trough valuations is to identify companies that meet our stringent financial criteria but that are currently out of favor and have dropped in price. Food processing is an example of one of those out of favor industries that we purchased in 2018. Not many investors would have guessed Tyson Foods (TSN) would vastly outperform during the up market in 2019. Yet, the untapped value we saw when we purchased TSN as part of a broader group of Food Processing stocks is being realized in a significant way. TSN was not only the leading performer in the portfolio for August, but year to date as well, now up over 70%* in 2019.
The market is now paying attention to industry-leading sales growth in TSN’s core business lines, including continued strong performance in its prepared foods division. The buzz around alternative proteins (meatless and blended) has also benefitted TSN brands liked “Raised & Rooted” and “Whole Blends,” providing another tailwind for growth. In addition, African Swine Fever has devastated the Chinese hog supply (China had been the global leader in pork supply, providing nearly half of global pork production) which should provide a multi-year boost for protein inflation. Rising protein prices significantly benefits TSN and other domestic producers, even with an uncertain global trade backdrop.
A more recent development in our food processing holdings relates to Kellogg (K) which was up nearly 8%* for the month and over 17%* for the quarter-to-date through August. After much negative noise around packaged foods the last few years, K is showing impressive organic growth and reestablished momentum on well-known brands like Pringles, Cheez-It, Rice Krispies and Pop-Tarts, including a focus on higher margin “on the go” packaging. Kellogg has also worked to divest non-core brands (for example, a recent $1.3B sale of certain brands to Ferrero) while restructuring the business and containing costs, leading to notable balance sheet improvements. Finally, similar to TSN, K is gaining benefit from alternative, non-meat proteins with its Morningstar Farms brand the subject of IPO rumors.
During the month, we added to our bank holdings, given what we saw as compelling valuations based on our objective modeling process. A Bank of America (BAC) position was purchased in mid-August. Not surprising to anyone reading this letter, BAC has a well-diversified business. Its non-interest income is rapidly catching up to interest-related income, providing the company protection in various interest rate scenarios moving forward. BAC is a leading retail bank, small business lender, credit card issuer, brokerage firm (via Merrill Lynch) and global investment bank. Given the evolution of technology in banking, BAC continues to massively invest in this arena with a roughly $10B annual technology budget. BAC has managed to do this while expecting expenses in 2019 to be flat year-over-year. The stability of BAC’s balance sheet is indicated by a recent 42% increase in the bank’s capital return plan, meaning a more than 14% yield to shareholders over the next twelve months between dividends and the benefit of share repurchases. At current prices, we find the risk-return of BAC’s stock to be compelling along with our other bank industry holdings.
Related to our Medical Distributors holdings, in early August AmerisourceBergen (ABC), McKesson (MCK) and Cardinal Health (CAH), the ‘Big 3’, all showed negative volatility on the news around a potential, collective settlement offer related to opioid lawsuits. As has often been the case for these stocks, any news around opioid liabilities initially produces an adverse reaction. However, taking a step back provides perspective. Our Medical Distributor industry holdings are up about 11.4%* for 2019 through August, ranging from flat performance* (CAH) to up over 26%* (MCK). In addition, any significant settlement from medical distributors, if that comes to pass, will likely happen over an extended timeframe, mitigating the impact for these large companies. States’ attorney generals reportedly were asking for a settlement to be paid over decades. Therefore, while the subject of opioid liability presents continued headline risk, we see attractive year-to-date performance as indicative of the positive drivers of the businesses long-term, despite the noise. Our thesis and price targets for our Medical Distributor holdings remain intact.
The DHLTD portfolio has a current dividend yield of 3.2% inclusive of our highly defensive cash position at around 25%. This is meaningfully higher than the yield of our benchmark Russell 1000 Value primary index, as well as that of the S&P 500. We do incorporate yield as part of our overall, complex valuation modeling and screening process, but for the overall strategy, the income is more of a positive byproduct of our process than a primary goal.
Interestingly, for the first time since 2009, the dividend yield on the S&P 500 is higher than the 30-year U.S. Treasury bond yield, which in our view may provide additional appetite for higher-yielding stocks. Nonetheless, regardless of the yield on our existing portfolio, which does provide attractive additional return, we are focused on what we believe to be meaningful price appreciation and total return potential in the industries and underlying stocks we hold.
We look forward to being in touch and are always happy to talk further about the portfolio or answer any questions you may have.
Robert Herman, MBA
Donald L. Hagan, CFA
Jeffrey Palmer, CIPM
Arthur S. Day
Steve Zimmerman, MBA
Regan Teague, CFA
Print Copy of Article: Day Hagan Logix Tactical Dividend Strategy Update September 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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