Day Hagan Strategy Update

DAY HAGAN STRATEGY UPDATE

DAY HAGAN TACTICAL DIVIDEND STRATEGY UPDATE: OCTOBER 5, 2016

SUMMARY

General commentary regarding the financial markets and an update regarding the Day Hagan Tactical Dividend Strategy.

POSTED

October 5, 2016

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Through the third quarter of 2016, the Day Hagan Tactical Dividend (DHTD) Strategy returned +9.6 percent (+9.2 percent) year to date, gross (net) of fees, compared to the S&P 500 at +7.8 percent and the Russell 1000 Value at +10.0 percent. All numbers are total return.

It was a relatively quiet quarter in terms of portfolio activity and performance for the strategy. Although performance was in positive territory for the third quarter (+1.4 percent gross), the portfolio largely moved sideways (inclusive of a meaningfully defensive cash position) as we allowed systemic market risks to play out, while concurrently monitoring for industries moving into our buy zones. This quiet, sideways action is not atypical for our strategy. Interestingly, these quiet quarters have often been precursors to subsequent outperformance. The most recent example is Q4 2015, which consequently led to decisively positive relative and absolute performance for Q1 2016.

Our strategy continues to focus on deeply discounted industries and stocks, using our proprietary measurements and evaluation of value. Based on our methodology, the resulting portfolio seeks strong, shareholder-friendly operating businesses that generate cash flow accompanied by solid balance sheets. Historically, our approach has been rewarded with attractive return metrics and meaningful downside protection over time. We continue to seek appropriate holdings meeting our time-tested criteria.

In early July, we sold our Restaurant industry holdings and did not see a suitable replacement, which led to an increase in our cash levels. Interestingly enough, fund data provider Lipper indicated during Q3 that a very small percentage of U.S. equity funds (<5 percent) had cash positions greater than 10 percent. We are not surprised by this, as we saw similar diverging data points when we raised our portfolio cash levels in the early part of 2008.

Our disciplined and objective approach to valuation leaves us confident that elevated cash percentages in the portfolio are currently the most appropriate course of action. The six industries (across sectors) and overall twenty-six underlying equities we hold in the portfolio have meaningful upside based on our process.

As it relates to selling the restaurant names, Bob Evans (BOBE) was a forced sell as it hit our multi-variable stop-loss screen. There was no suitable replacement within the restaurants (leading to insufficient diversification in holding the industry moving forward) and our fundamental overlay alerted us that sales and traffic were becoming concerns for the group. Despite the stop-loss on BOBE, and speaking to the benefits of an industry-based approach, we held the Restaurant industry for about three years and generated annualized performance (inclusive of BOBE losses) exceeding +30 percent. As capital preservation is a primary focus of the portfolio, we seek to buy industries at trough valuations, exit at fair value, and avoid trying to take the last dollar off the table as valuations get stretched.

Our Airfreight & Logistics industry, although flattish for the quarter (+0.2 percent) leads year-to-date portfolio performance through Q3. During the quarter, Asset Management and IT Services were the top performing industries. Within asset management, Invesco (IVZ) stood out overall as the top portfolio contributor in Q3. This is notable because IVZ was a much maligned name among the “experts,” especially in light of the post-Brexit vote market volatility in late June and early July. We believed throughout that IVZ’s strategic and equity values were compelling based on our process.

There are tailwinds right now for dividend-yielding equities. The relative dividend yield on the S&P 500 versus the 10-year U.S. Treasury Note is at a 50-year high, with over 60 percent of equities in the index having a yield higher than the 10-year Treasury note (source: Bloomberg). While the strategy does indeed benefit from this environment, we are not concerned over the longer term that dividend-yielding stocks may at some point (likely not any time soon) go out of favor. Our strategy views the stable generation of cash through normal business operations as the measure of a quality company. Historically, this has been a strong indication of a company’s ability to reward shareholders. As you know, our process and methodology are unique among income-seeking equity strategies, which lead to differentiated portfolio selection and construction. Our industry-based, absolute and relative yield approach to deriving conclusions around industries and the stocks within them has historically revealed areas of potential capital appreciation accompanied by sufficient downside protection. Our track record since early 2002 demonstrates the benefits of maintaining this disciplined approach.

If you have any questions or would like further details, please feel free to contact us.

Sincerely,

  • Donald L. Hagan, CFA
  • Robert HermanĀ 
  • Jeffrey Palmer
  • Arthur S. Day

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: The data and analysis contained herein are provided "as is" and without warranty of any kind, either expressed or implied. Day Hagan Asset Management (DHAM), 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 Day Hagan Asset Management 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. DHAM, accounts that DHAM 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. DHAM 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 DHAM recommendations or DHAM performance rankings, one should also consider that DHAM 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 DHAM’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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