DAY HAGAN LOGIX TACTICAL DIVIDEND STRATEGY UPDATE: JULY 2017
Summer greetings. For the month of June, the Day Hagan Logix Tactical Dividend (Day Hagan Logix) strategy returned +1.6%*, ahead of the S&P 500 (+0.6%) and in line with the Russell 1000 Value Index. For 2017 through June 30, Day Hagan Logix is now +2.7%* gross of fees (+2.4%* net), while having maintained highly defensive portfolio positioning throughout the year—a stance we believe necessary from a risk-mitigation perspective. June marked a departure from growth's significant performance leadership over value this year; more on that below. Since Spring 2002 inception (15+ years of track record), the strategy has returned 9.6%* on an annualized basis versus the S&P 500 (7.2%) and the Russell 1000 Value (7.3%) while maintaining attractive risk metrics and alpha generation. (All numbers are total return.)
In terms of style and as noted above, value performed ahead of growth across all U.S. equity capitalization ranges in June, representing a change in leadership from prior months. Year to date, value continues to lag significantly. For example, through June 30, large-cap U.S. value equity performance is still over 900 basis points (9.0%) behind large-cap growth equities (based on the Russell 1000 Value index vs. the Russell 1000 Growth index). In fact, at one point in June, the value vs. growth performance gap represented the largest deficit since the heady days of the Internet bubble in 2000. Much of this stems from narrow leadership among large technology growth stocks. From a more traditional valuation metric perspective, the ratio of the Russell 1000 Value Price/Earnings (P/E) ratio to the Russell 1000 Growth P/E ratio has ranged over the last decade from 0.77 to 1.10. The ratio is currently near the bottom of that range at ~0.80, indicating that value by historical standards is highly compelling. Recent evidence of the Day Hagan Logix strategy's focus on value was made very clear during two days of trading in early June (June 9 and 12). During those two days, the Nasdaq 100 Index (a tech-heavy growth index representing the 100 largest, nonfinancial names listed on NASDAQ) was down over 3% while Day Hagan Logix was up over 1%.
Taking the analysis a step further, Ned Davis Research shows that dividend-paying equities within the S&P 500 are notably behind non-dividend paying equities year to date from a performance perspective. One example of this is that dividend cutters and eliminators, as a group, were up approximately 6%, while consistent dividend payers were up less than 1% through May. In other words, companies that have cut or eliminated their dividends are significantly outperforming companies that pay a constant dividend. This is the exact opposite of what historically long-term trends suggest.
The Day Hagan Logix strategy takes a deep value, contrarian approach utilizing dividend yield valuation modeling as a foundational starting point. As a result, the "risk on" market leadership for the first six months of the year has been a headwind for the strategy. Even so, we continue to generate positive returns while keeping a wary eye on the future in order to protect against downside. We believe the industries and underlying names we hold in our portfolio have highly attractive risk-return characteristics. While we continue to seek opportunities to put our cash to work, we are unwilling to bend our objective, disciplined methodology to buy additional names that don't meet our stringent criteria. Our investment philosophy and strategy have been consistent since the inception of the strategy in 2002.
The Day Hagan Logix portfolio continues to hold six industries, across sectors, with 25 underlying names, the low end of our historical number of holdings. Our Asset Management positions led industry performance in June and now, year to date. During the first half of the second quarter, we did some portfolio rebalancing that reduced our cash position by about 3%. We also bought liquid, conservative cash substitutes in an attempt to generate a modest yield on a portion of the remaining cash. In mid-June, we sold McKesson (MCK) from Medical Distributors as it hit our price target, generating a total return of about +29%* for the position since November 2016 purchase. We also saw the opportunity to buy an energy name, Apache (APA), at an attractive entry point.
Having a contrarian point of view in the positions we purchase/hold (frequently necessary in buying a name at what we see as its trough valuation) can mean we are, at times, early in seeing our thesis play out. This was the case in our purchase of APA, with negative noise around the energy sector driving the name down further initially. However, APA has bounced back nicely and, since purchase on June 16, the name is now back to around its cost basis. Regardless of short-term performance, we view APA as a compelling story given its valuation buy signals on all aspects of our yield-based valuation modeling, with a strong, stable balance sheet that supports dividend consistency. While APA, like any energy name, is certainly correlated to the price of oil (which incidentally, in the face of extreme bearishness, went up for seven straight trading days to end the second quarter), we continue to feel expectations built into the stock price are unreasonably low. Strategic divestitures of some international assets and a refocusing/recalibration of risk to be more U.S.-centric (especially in the Permian Basin region in western Texas and southeastern New Mexico where APA had a 96% well success rate in 2016) are beginning to pay off. Even more specifically, their west Texas Alpine High discovery should provide compelling organic growth starting in 2H 2017, which we believe is not well understood by the broader market.
The MCK sale in mid-June requires some recent historical context. The name was purchased almost immediately after a poorly received earnings call (related to concerns about competition as well as generic price deflation) in late October 2016 pushed the name down 23% in one day. Based on our valuation modeling as well as a renewed qualitative and quantitative fundamental dive based on the earnings release, we determined the name was indeed attractively valued and suffered from a market overreaction. As previously mentioned, after hitting our price target we sold MCK for a gain of about 29%* over a 7½-month holding period. The price when we sold MCK was higher than it had been prior to the October earnings call. This "case study" is a good illustration of how the Day Hagan Logix process views value and opportunity.
We continue to view our retail industry holdings as having meaningful strategic upside but acknowledge the near-term volatility has been difficult. Costco (COST) and Wal-Mart (WMT) have both generated double-digit returns since October 2016 purchase, but had a difficult second half of June (COST more so than WMT) on the heels of Amazon's announcement that it was acquiring Whole Foods Market. While the knee-jerk overreaction (to some extent, we believe a validation that an online-only model for grocery is very difficult to make work) has abated, it did lead us into a stop-loss sale of Target (TGT). While we continue to view the future prospects of TGT and grocery more generally with much more optimism than the market, we have a disciplined, multifaceted stop loss in place for a reason. Our capital preservation focus historically has translated into ~50% downside capture versus our index benchmark. Overall, our retail industry since buying the names in October of last year has lost a modest 1.6%. In addition, our Kohl's (KSS) holding shows signs of turning a corner with June performance of roughly +2.2%. Finally, Lowe's Companies (LOW) recently moved into a clear buy range based on our methodology. We purchased the name in the latter half of June as a part of a consolidated retail industry grouping sharing common economic drivers. It's worth noting that LOW is selling at a measurable valuation discount to Home Depot (and its home improvement peers) which historically has been a precursor to outperformance.
Our valuation process is about consistency in order to maximize upside and reduce downside. We do not believe in chasing returns and historically our outperformance with meaningfully below-market risk has served our investors (including ourselves) well. If you would like to discuss our methodology in more detail or even if you just have one-off questions, please feel free to call or email us. We appreciate your continued support as our assets under management continue to grow.
- Robert Herman
- Donald L. Hagan, CFA
- 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: *Note that individual's 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 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.