Market Commentary
The S&P 500 fell 19.6% in the first quarter of 2020 as COVID-19 wreaked havoc across the globe. Volatility, as measured by the Volatility Index (“VIX”), spiked to 82.69, an all-time record, and weakness was broad based with every sector posting negative returns. The Energy sector was the worst performer, falling 51.1% as the price war between Russia and Saudi Arabia led to a 66.5% drop in the price of oil. Information Technology and Healthcare were the strongest performing sectors, falling 12.2% and 13.1%, respectively. Widespread layoffs (the U.S. saw over 16 million jobless claims in a 3 week period in March) and demand destruction triggered unprecedented fiscal and monetary policy intervention. In March, President Trump signed off on a $2.2 trillion economic stimulus package. For its part, the Federal Reserve announced nearly $4 trillion in liquidity programs and cut rates 150 basis points back to near zero. The question of “will there be a recession” shifted to “how long will it last” as some economists forecast a 20%+ contraction in U.S. GDP in the second quarter. Understandably, investors are on edge.
Performance Summary
Over the first quarter of 2020, the U.S. Dividend Advantage Fund, Series F returned -10.6%* compared with the -20.0% return of the S&P 500 (“Index”). The global flight to safety led to a very strong gain in the U.S. Dollar (+9.3% vs the Canadian Dollar), which drove much of the Fund’s outperformance versus the Index. Positive contributors to performance were driven by sector allocations to Information Technology, Consumer Discretionary, Materials sectors while performance was adversely affected by allocations to the Healthcare, Consumer Staples and Financial sectors.
Contributors to Performance
Microsoft Corporation (“Microsoft”) was a leading contributor of performance, remaining unchanged through the quarter, and outperforming the S&P 500 by 20%. Microsoft reported a solid fiscal second quarter with particular strength in its Intelligent Cloud segment. A leading hybrid cloud model and a stronghold in the enterprise IT market has allowed the Azure cloud platform to nearly double its market share over the last 5 years to become the #2 global cloud provider. With the enterprise cloud shift still in early stages and continued progress in shifting more business to a subscription based model, we remain enthusiastic about Microsoft’s long term prospects and ability to increase profitability over time.
Outperformance in the Consumer Discretionary sector was mainly attributable to Pool Corporation (“Pool”), which returned -7.4% and outperformed the S&P 500 by 12.6%. Pool reported a strong 2019 fourth quarter and full year, despite suboptimal weather in the first half of the year. Looking ahead, an improved business mix - with less exposure to new pool construction - and a larger portion of recurring revenues should continue to provide steady margin improvements and less earnings variability over time. Further, contractor backlogs are strong heading into 2020 and the company stands to benefit from ongoing consolidation in the pool and irrigation distributor market.
Outperformance in the Materials sector was mainly attributable to positions in Air Products & Chemicals Inc. (“Air Products”) and AptarGroup Inc. (“Aptar”). Air Products returned -15.1%, outperforming the S&P 500 by 4.9% % and the Materials sector benchmark by 11.5%. Aptar returned -13.9%, outperforming the S&P 500 and Materials benchmark by 6.1% and 12.7%, respectively.
Detractors from Performance
In Healthcare, the fund was adversely affected by its positions in Quest Diagnostics Inc. (“Quest”), which fell 24.8%, and CVS Health Corp. (“CVS”), down 20.1%. Stay-at-home orders led to a large slowdown in physician referral activity and therefore routine lab tests in March, and COVID-19 testing was not enough to make up for the shortfall. As a result, the company was forced to withdraw full year guidance. CVS modestly beat estimates and reported solid progress on their HealthHub in-store clinic initiative, however the potential impact of COVID-19 on the insurance segment caused concern for investors. And while they’ve largely abated, worries surrounding a single-payer insurance system in the U.S also caused CVS (and other insurers) to be dragged down during the quarter.
In the Consumer Staples sector, Tyson Foods Inc. (“Tyson”) was a performance detractor, falling 36.4% and underperforming the S&P 500 by 16.4%. Tyson reported mixed first quarter 2020 results, with better than expected margins in Beef and Pork offset by lower margins in Chicken and Prepared Foods. Despite the sell-off, Tyson has been successfully growing its value-add product portfolio, which comes with higher margins and lower earnings volatility versus its more commoditized businesses and the African Swine Fever provides upside optionality given the disease's impact on global supply/demand balances across all proteins.
In the Financial sector, U.S. Bancorp and JPMorgan Chase & Co. (“JP Morgan”) were detractors of performance, underperforming the S&P 500 by 21.9% and 15.4%, respectively. Despite a strong balance sheet and consensus beating quarter, JP Morgan’s Net Interest Margins (“NIMs”) began to come under pressure as a result of Fed rate cuts in the second half of 2019. In addition to NIM pressure, U.S. Bancorp reported an underwhelming quarter, with expenses rising and credit quality deteriorating slightly. Given the stage of the current credit cycle and recent Fed actions, it is likely that the macro environment will be a headwind for banks for the foreseeable future.
Portfolio Activity
During the quarter, the fund exited its position in International Business Machines (“IBM”).
Outlook
The fund remains heavily invested as we believe our companies’ long term investment theses are not fundamentally impacted by COVID-19. That said, we are diligently monitoring management commentaries on how the virus is impacting businesses and will adjust the portfolio as necessary. 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 the Fund’s investment approach, as these stocks typically provide an attractive risk and reward profile over the long-term. We believe this is an opportune time for investors to increase their exposure to dividend funds.
* All data is as of March 31, 2020 unless otherwise indicated. Fund performance is reported on a Canadian dollar, total return basis. Caldwell U.S. Dividend Advantage Fund Series F returns as at March 31, 2020: 1 Year: -0.5%, 3 year: 2.3%, Since Inception (July 19, 2015): 5.4%.
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: April 17, 2020.