Q1 2019 | Caldwell U.S. Dividend Advantage Fund Commentary

Market Overview

In the first quarter of 2019, U.S. Equities recovered remarkably following the worst quarterly performance seen in more than seven years. The S&P 500 closed the quarter up 13% as the U.S. Federal reserve (“the Fed”) took a more dovish stance in March by announcing that interest rate hikes were essentially off the table for the remainder of 2019. Markets were further driven higher as concerns around trade tensions eased as President Trump communicated positive outcomes from negotiations with China and therefore, delayed increasing tariffs.

Performance Summary

• Over the first quarter of 2019, the U.S. Dividend Advantage Fund, Series F returned 8.6%* compared with the 10.93% return of the S&P 500 index.**
• The underperformance relative to its benchmark during the quarter was largely a result of cash drag and an overweight allocation to Health Care and Consumer Discretionary sectors.

Contributors to Performance

• Key contributors to the fund’s performance relative to the benchmark were allocations to Consumer Staples and Information Technology.
• The outperformance in the Consumer Staples sector was mainly attributable to our overweight position in Tyson Foods Inc. which was our largest holding given its low valuation and improving fundamentals. Tyson returned 30% in the quarter, outperforming the S&P 500 by an incredible 17%. Tyson’s valuation had been impacted by the trade war as pork inventories had risen significantly in the U.S., hurting their pork margins. The chicken market had also been under pressure but showing signs of improvement. In Q1 Tyson mentioned that there could be significant upside to pork prices as China has been battling African Swine Fever, which is spreading throughout the country. If this continues and is unable to be controlled, there could be a global shortage of pork, as China is the largest producer and consumer of pork globally. This could also have an impact on other protein prices as consumers substitute to chicken and beef. Management believes this could provide significant upside to their business as they are one of the largest protein processors in the world.
• The outperformance in Information Technology was mainly attributable to an overweight in Broadcom Inc. and Motorola Solutions Inc.
• Broadcom returned over 18% in the quarter and outperformed the S&P 500 by over 5%. Broadcom’s valuation had been impacted by its acquisition of CA Technologies in July 2018 as the market had not expected the company to announce any large acquisitions. There were also concerns regarding the strategic fit of CA Technologies as they are a software company and Broadcom is known as a hardware provider. Shares have since recovered as management communicated the strategic rationale for the acquisition and gave synergy and growth targets which were above investor’s expectations.
• Motorola Solutions returned 22% in the quarter, resulting in 9% outperformance. Motorola reported a strong Q4 and gave very strong 2019 guidance which resulted in the shares being up 14% on the day. Motorola is one of few providers that can offer a true end-to-end solution for Public Safety customers within a highly mission critical environment. Motorola is positioned for strong long-term growth.

Detractors from Performance

• Key detractors of fund performance were allocation to cash and stock selection in the Consumer Discretionary and Healthcare sector.
• The largest detractor from fund performance was the cash allocation in Q1. The fund did a good job protecting the downside during the Q4 2018 sell-off, however the cash balance was a 1.5% drag to performance in Q1 2019. We believe the cash balance helps preserve capital in a volatile market, and provides us with the ability to deploy capital when high quality companies present attractive valuations.
• Individual detractors were Booking Holdings Inc., which is an Online Travel Agency (“OTA”) that provides consumers with airline and accommodation reservations. Booking experienced company specific issues regarding increased marketing spend and weakness tied to their European business which is currently their largest market.
• In the healthcare sector, CVS Health Corp, an integrated healthcare company, experienced poor performance due to challenges around reimbursement rates for drugs, uncertainty around new government policy proposals, and execution risks around the company’s transformation from a traditional pharmacy to an integrated healthcare company. We believe CVS is positioned to be a leader in the integrated care delivery space and will disrupt the primary care market as they roll out new store formats focusing on consumer healthcare.

Portfolio Activity

• During the quarter, the fund initiated a position in Medtronic PLC and Motorola Solutions Inc.
• Medtronic is one of the largest medical device companies in the world with a focus on heart disease which is the number one cause of death globally. With their recent acquisition of Covidien (another large global medical supply company), Medtronic has increased their importance in the global medical device supply chain as the industry continues to consolidate. Growth is expected to accelerate as key product launches begin to contribute and as access to healthcare improves around the world. The company generates significant free cash flow and has a strong history of dividend increases with a 5-year compounded annual growth rate (“CAGR”) of over 12%.
• Motorola Solutions Inc. is an end-to-end solutions provider in the public safety safe. They offer a full range of mission critical products and services from first responder radios to full command centre communications in one aggregated and auditable system. Motorola’s software solutions are shifting to an “as a service” model which provides the company with more recurring revenues and increases customer switching costs given the heavy integration required and the high cost of failure. The company’s strong balance sheet and cash flows support future business growth, dividend growth (13% CAGR over the past 5 years), and share repurchases (10% CAGR over the past 7 years).

Outlook

• Looking forward into Q2, the fund has a strong cash balance and is well positioned to take advantage of market volatility while protecting unitholder’s capital.
• With rates now likely to remain lower for the foreseeable future, we believe that dividend strategies could be some of the biggest beneficiaries in this type of environment. Dividend growth investing has been the foundation of our investment approach for the U.S. Dividend Advantage Fund, as these stocks typically provide an attractive risk and reward profile over the long-term. Given the lower interest rate backdrop along with attractive valuations of dividend growth stocks, we believe this is an opportune time for investors to increase their exposure to dividend funds.

* Caldwell U.S. Dividend Advantage Fund returns as at March 31, 2019: 1 Year: 10.0%, 3 year: 8.3%, Since Inception: 7.1% (Fund launched on July 19, 2015, see disclaimer).
** Canadian Dollar Returns

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. Management fees have not changed and expenses will be capped such that the Management Expense Ration of the Fund will not exceed 2.45%.

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. Caldwell Investment Management Ltd makes no representations or warranties on the accuracy and completeness of the information included and sourced externally. 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: June 24, 2019.