DAY HAGAN LOGIX TACTICAL DIVIDEND STRATEGY UPDATE AUGUST 2, 2018

 

As we hit the dog days of August, the Day Hagan Logix Tactical Dividend strategy continues to outperform its Russell 1000 Value benchmark. Year to date through July, Day Hagan Logix is +3.24%* versus the Russell 1000 Value at +2.20%. Over the last twelve months, Day Hagan Logix is now +11.86%*, 232 basis points ahead of the Russell; all numbers are total return and gross of fees. During the month of July, the strategy was +1.80%*, led by our Airfreight & Logistics holdings. Our energy sector exposure was a laggard, down modestly (roughly 30 basis points*) in July, but it remains comfortably positive for the year, up over 5%*. More on our energy holdings in the letter below.

In addition to its benchmark, Day Hagan Logix Tactical Dividend has fared better than relevant peers in 2018. For example, the $13.5 billion AIG Focused Dividend Strategy is down -3.32% through July while the Schwab U.S. Dividend Equity ETF is down -2.38%. We continue to hold a defensive cash position based on our objective valuation methodology, so Day Hagan Logix outperformance and upside capture come while adhering to our capital preservation philosophy and risk management protocols. Since our inception in 2002, we have achieved an attractive downside capture of 52.74% versus our primary benchmark, with a beta of 0.61.

While we view ourselves as deep value-oriented, our process over the last 16+ years utilizes a differentiated and proprietary approach to valuation and portfolio construction as compared to a traditional value player. Even though value, as an investment style, has lagged growth over the last decade, the Day Hagan Logix strategy has returned +12.19%* annually (gross of fees), outperforming not only our primary benchmark by +324 basis points (+3.24%) per year, but also the broader-based S&P 500 Total Return by +152 basis points per year.

Still, we believe a reversal from growth to value would further benefit our performance moving forward. Although it’s too soon to call it a trend, we saw some encouraging signs from value stocks, especially in the latter half of July, with value outperforming growth for the month as a whole. In fact, Morgan Stanley compared the relationship between the Russell 1000 Growth and Russell 1000 Value indexes and found that the ratio between growth and value (in other words, growth performance versus value performance) declined in the last three trading days of July by close to 4%, the largest growth underperformance vs. value over a three-day period in over nine years.

Much has been made of growth’s multiyear outperformance and the idea that “this time it’s different” (a familiar refrain for any of us that have been around the markets for a long time). We can’t help but think of famed value investor Julian Robertson (head of hedge fund Tiger Management) in March of 2000, the height of the internet heyday. Robertson had regularly produced 30%+ returns going into the late 1990s but slowed with the sharp turn to technology growth stocks. He wrote about “the demise of value investing” and “no real indication” that an end was coming. As we know in hindsight, Robertson’s comments came at the peak of the market and just before value stocks made a historical comeback, drastically outperforming growth over the subsequent years. This is not to suggest that we know exactly when a sustained reversal from growth to value is coming. But with history as our guide, we believe it is inevitable and, no, this time is not different. Either way, as we’ve shown over the last decade while growth outperformed value, we are confident in our ability to drive benchmark outperformance at risk levels consistent with our investment philosophy and long track record.

We’ve discussed in previous letters the impact of Amazon on a variety of industries. In this letter, we’d like to provide a couple of specific examples of how Amazon noise can move our portfolio holdings, but ultimately prove to be highly transitory. The first example relates to Monro, Inc. (MNRO), which provides automotive repair and tire services. Monro is a large player in a space that remains fragmented with many “mom and pop” players. In early May, Amazon announced it was partnering with Sears Auto Centers, where Sears would provide full-service tire installation for tires of any brand ordered on Amazon. The actual impact on Monro’s overall business was not as significant as the perception, but the stock dropped by nearly 8%* the next day, from over $57 down to below $53 on May 9. As a more thoughtful analysis followed, MNRO bounced back in early June to a stock price higher than the pre-Sears/Amazon deal announcement. By late July, MNRO had reported that they also are teaming up with Amazon to provide tire installation services, ultimately in over 1,000 retail locations (versus 400 Sears Auto Centers). As we write this, MNRO’s stock price is over $67, about 18%* higher than its price before the original Sears announcement.

Networking company Cisco (CSCO) provides another recent example of how Amazon announcements or rumors need to be put in proper perspective. In mid-July, CSCO dropped nearly 4%* after a report surfaced that Amazon’s cloud service business (Amazon Web Services, also known as AWS) was going to sell its own networking switches (which connect devices together on a computer network) to business customers. The report went on to say that Amazon could price white box (generic) switches 70-80% lower than a firm like CSCO. All of the information cited people with knowledge of the plan. By the following week, Amazon Web Services denied the report and CSCO released a statement that said, “Cisco and AWS [Amazon Web Services) have a longstanding customer and partner relationship,” further indicating AWS was not building a commercial network switch. CSCO and its networking peers bounced back as a result, but the story playing out does show how sharp reactions can be, even if the initial report has little or questionable substance.

As we look at our energy sector exposure moving into the third quarter, despite headline-based volatility, we view our underlying thesis, based on objective valuation methodology and continuous fundamental screens, as intact. Our energy stocks have attractive price targets with our thorough understanding of accompanying risk. It is interesting to view cash operating costs per barrel of oil equivalent (BOE) for different geographic regions. To us, it is an indication that free cash flow generation potential remains significant at current, or even lower, oil prices. Using our Apache (APA) holding as an example, the company indicates that current cash operating cost in the Permian Basin is about $13/BOE. More generally, much has been made about constrained pipeline capacity to move oil out of the Permian region (Permian Basin = West Texas and Southeastern New Mexico) leading to lower average price realizations for oil produced there. However, with a roughly $13/BOE cash operating cost, APA shows that they are still realizing $38/BOE, generating a healthy operating cash margin. As they partner to build more takeaway capacity, their margins are likely to grow even stronger in the Permian.

There is no question the domestic energy landscape has changed the global picture. Remarkably enough, some projections indicate a doubling of Permian capacity over the next 5-6 years, which would make it larger than nearly any other oil region in the world except for Russia and Saudi Arabia. Recent reports also suggest that supply and demand dynamics could lead to another spike in oil prices (Bernstein analysts wrote that the potential exists for oil prices to go to $150). While we are not in the business of forecasting future oil prices, we do see our energy stocks as highly attractive at current (and even lower) oil prices.

Finally, using the CBOE Volatility Index (the VIX) as a measure of market volatility, August has historically generated high VIX readings. Five times since 1990, August has been the most volatile month of the year. With a variety of macro uncertainties in the weeks and months ahead, we would not be surprised to see the volatility from earlier this year resurface. In any case, since 2002 the Day Hagan Logix Tactical Dividend strategy has been battle-tested through two extreme corrections and a variety of market environments, showing meaningful outperformance and nearly 40% less volatility than its benchmark.

We look forward to staying in touch and, as always, thank you for your confidence in the Day Hagan Logix Tactical Dividend strategy.

Sincerely,

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

PDF copy of the article: Day Hagan Logix Tactical Dividend Strategy August 2018 (PDF)

Day Hagan Logix Tactical Dividend (DHLTD) and benchmark performance through July 31, 2018:

  • DHLTD Year-to-Date Net Return = +2.93%
  • DHLTD Trailing 12-month Net Return = +11.24%
  • Russell 1000 Value Index Trailing 12-month Return = +9.54%
  • DHLTD 10-Year Average Annual Net Return = +11.34%
  • DHLTD Net Average Annual Return Since Inception (4/1/2002) = +8.68%
  • Russell 1000 Value Index Average Annual Return since 4/1/2002 = +7.50%
  • S&P 500 Total Return Average Annual Return since 4/1/2002 = +7.82%

Beta measures a portfolio's volatility relative to its benchmark. A Beta greater than 1 suggests the portfolio has historically been more volatile than its benchmark. A Beta less than 1 suggest the portfolio has historically been less volatile than its benchmark.

Standard deviation is a historical measure of the variability of returns. If a portfolio has a high standard deviation, its returns have been volatile. A low standard deviation indicates returns have been less volatile.

A downside capture percentage of less than 100 indicates that a fund has lost less than its benchmark in periods when the benchmark has been in the red.

The Russell 1000® Value Index measures the performance of those Russell 1000® Index companies with lower price-to-book ratios and lower forecasted growth values. It is not possible to invest directly in an index. The strategy's returns may not correlate with the returns of the benchmark indices. Beta represents a measure of the volatility, or systematic risk, of a security or a portfolio in comparison to the market as a whole. 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 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. DH Logix 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 DH Logix recommendations or DH Logix performance rankings, one should also consider that DH Logix 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 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.

Performance: 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.

There is no guarantee that any investment strategy will achieve its objectives, generate dividends or avoid losses.