Markets continued to move higher in the second quarter of 2021 (“Q2”) with leadership pivoting from value to growth stocks. This result is a strong reversal relative to Q1 when value outperformed growth by nearly 10 percentage points. Despite an improving macro economic backdrop in the U.S., fears of the Delta variant’s rapid spread domestically and abroad (and the possibility of reintroduced lockdown measures) caused investors to reassess the durability of economic growth, likely slowing value’s momentum. Further, companies across multiple sectors continue to face supply chain issues, labour shortages and commodity inflation which could limit upside to earnings growth coming out of the pandemic. On the positive side, better visibility is giving companies increased confidence in resuming dividends and share repurchases as well as issuing forward looking guidance which is a drastic change from the last 4-5 quarters.
The Caldwell U.S. Dividend Advantage Fund Series F (“Fund” or “UDA”) gained 3.7% in Q2 compared to 6.9% for the S&P 500 Index (“Index”)1. Leading contributors of performance were holdings in the Information Technology, Financials and Consumer Discretionary sectors while cash holdings and exposure to the Industrial and Materials sectors detracted from performance (due to value’s underperformance noted above).
Contributors to Performance
S&P Global (“SPGI”)2 was the leading contributor, gaining 14.8% in Q2. SPGI continues to benefit from robust global debt issuance in its ratings business, particularly high-yield bonds and structured loans driven by strong refinancing and M&A activity. In combination with solid cost controls, SPGI reported better than expected top line, margin and earnings performance in its Q1 results. While a relatively small part of the company today, SPGI’s Environmental, Social and Governance and China initiatives also continue to gain traction and are expected to become a material part of the story over the next few years.
Motorola Solutions (“MSI”)2 was another leading contributor, gaining 14.0% during Q2. The business is recovering with the economic reopening, particularly as the sales cycle gets back to normal. The latest U.S. stimulus plan (which includes roughly $350 billion to State and Local governments) provides a multi-year growth tailwind as governments embark on a product refresh cycle. The blacklisting of two Chinese firms from the U.S. and other Western democratic nations is providing a tailwind to the fixed video security business. Lastly, the company announced a top-up to its existing share repurchase program.
Microsoft Corporation (“MSFT”)2 was also a strong performer in Q2, gaining 13.4%. Following a lull early in the quarter, the stock rallied in June in anticipation of the Windows 11 launch which provides a cleaner interface, better integration with Teams and the possibility for a new PC refresh cycle. An improving economy should drive continued momentum in the company’s cloud business as well as upsell opportunities to higher priced offerings with enterprise customers. The previously weak small and medium business customer segment accelerated from the previous quarter as more were able to focus on digitization projects. We remain confident in Microsoft’s long term growth prospects and ability to increase profitability over time.
Detractors from Performance
Tetra Tech, Inc. (“TTEK”)2 was the leading detractor of performance, declining -11.3% in Q2, despite strong earnings and a guidance raise. Management hinted that growth in the Federal government segment (1/3 of revenue) could drift toward the upper end of the historical 5-10% range under the new Biden administration and the mix could continue shifting to higher margin services. While full year guidance came ahead of expectations, an infrastructure bill could drive further upside. Travel restrictions and lockdowns have delayed some projects in the U.S. and U.K.; however, it seems the worst for the company is behind with restarts improving throughout the year.
Mergers and acquisitions could be a further catalyst for the stock, with management noting ample balance sheet capacity and a strong pipeline of opportunities that would be accretive to earnings.
Church & Dwight (“CHD”)2 was another detractor of performance, declining -3.6% in Q2. While management is confident strong volume trends, lower promotional activity and future pricing actions can sustain margins in the second half of the year, the market is less convinced, particularly given broad-based commodity inflation and lapping prior year quarters that saw extremely strong growth from pantry stuffing at the peak of the pandemic. Of note, CHD’s weakness is not an anomaly as many other consumer products companies underperformed in the first half for many of the same reasons. We continue to like the company’s leading market share positions, above peer revenue growth and free cash flow generation which should sustain strong dividend growth going forward.
During the quarter, the fund initiated a position in Advanced Energy Industries (“AEIS”).
Advanced Energy Industries (“AEIS”) is a global supplier of precision power conversion, measurement and control solutions for semiconductor capital equipment and other industrial applications. Secular trends - such as 5G tower upgrades, semiconductor manufacturing and hyperscale data center expansion - as well as mergers and acquisitions provide multi-year growth tailwinds. The company has a strong history of outperforming merger synergy targets with the latest acquisition providing further cross-selling and margin expansion opportunities. Lastly, a recently initiated dividend adds another positive tailwind to the story and signals management’s confidence in the outlook.
Looking forward, we believe supply chain bottlenecks and labour shortages will naturally run their course which should soothe concerns of persistently higher inflation. Stronger consumer balance sheets and pent up demand also bode well for consumer spending. We will continue to look for companies with strong management teams that navigate tough environments better than peers such that market share, profitability and growth prospects are enhanced when exiting such periods.
Dividend growth investing has been the foundation of the Caldwell U.S. Dividend Advantage Fund’s investment approach, as these stocks typically provide an attractive risk/reward profile over the long-term. As such, we believe our strategy of owning high quality dividend growing stocks is an attractive way for investors to navigate this market.
1Standard performance as at June 30, 2021:
Caldwell U.S. Dividend Advantage Fund Series F: 1 Year: 18.2%, 3 year: 11.0%, 5 year: 10.8%, Since Inception (June 19, 2015): 9.5%.
S&P500 Total Return Index: 1 Year: 28.0%, 3 year: 16.3%, 5 year: 16.5%, Since Inception (June 19, 2015): 14.9%.
2Actual investments, first purchased: SPGI 11/7/2018, MSFT 7/20/2016, TTEK 9/25/2020, CHD 9/25/2020, MSI - 1/28/2019.
All data is as of June 30, 2021 sourced from Morningstar Direct, unless otherwise indicated. Fund returns are from FundData. UDA, Index total return numbers, sector returns and individual stocks returns are in CAD terms. The Fund was first offered to the public as a closed-end investment since May 28, 2015. Effective November 15, 2018 the Fund was converted into an open-end mutual fund such that all units held were redesignated as Series F units. Performance prior to the conversion date would have differed had the Fund been subject to the same investment restrictions and practices of the current open-end mutual fund.
The information contained herein provides general information about the Fund at a point in time. Investors are strongly encouraged to consult with a financial advisor and review the Simplified Prospectus and Fund Facts documents carefully prior to making investment decisions about the Fund. Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Rates of returns, unless otherwise indicated, are the historical annual compounded returns including changes in unit value and reinvestment of all distributions and do not take into account sales, redemption, distribution or optional charges or income taxes payable by any unitholder that would have reduced returns. Mutual funds are not guaranteed; their values change frequently and past performance may not be repeated. The payment of distributions should not be confused with a fund’s performance, rate of return or yield. If distributions paid are greater than the performance of the fund, your original investment will shrink. Distributions paid as a result of capital gains realized by a fund, and income and dividends earned by a fund, are taxable in your hands in the year they are paid. Your adjusted cost base (“ACB”) will be reduced by the amount of any returns of capital and should your ACB fall below zero, you will have to pay capital gains tax on the amount below zero.
Publication date: July 16, 2021.