Switzer Dividend Growth Fund monthly update for December 2018

Investment Objective

SWTZ is an income focussed exchange traded managed fund, with a mix of yield and quality stocks. The objective of the fund is to generate an above market yield while maximising franking where possible and to deliver capital growth over the long-term. We select companies that, in aggregate, generate sustainable dividend income. The fund is characterised by a strong and diverse portfolio of companies that exhibit good cashflows and strong business models.

Performance Summary

Over the 2018 calendar year, the Switzer Dividend Growth Fund (SWTZ) paid a distribution yield of 6.0%, or 7.7% including franking credits. Distribution yield is calculated as the distributions received over the 12 months to 31 December 2018 relative to the closing unit price of $2.61 at the beginning of the period.

Given its focus on income and capital preservation, over the long term we expect SWTZ to marginally underperform in rising markets and marginally outperform in falling markets. The decline in the banks in December 2019 resulted in the fund underperforming this month with a return of -1.74%, against a market return of -0.12%.

Portfolio Commentary

The targeted cash level in the fund is usually run at 1.5-2%. At the end of the month cash was higher at around 4.1%, due to fund inflows. Cash will be invested as opportunities arise and value emerges following the recent market falls. The fund went ex-distribution of 3.37 cents per unit (fully franked) on the 2nd of January 2019, which reduced cash by about 1.5%.

SWTZ Recent Distributions

SWTZ Recent distributions
SWTZ Recent distributions

A new position was established in AusNet Services in December 2018. AusNet operates a gas distribution business as well as an electricity distribution and transmission business, all in Victoria. Regulatory returns for the company have just been set, creating more certainty around an already reliable income stream.

The fund participated in the Sonic Healthcare placement which, while not a large position, was sold soon after at a profit. Positions in Woolworths and Caltex were added to over the month.

The fund participated in the Rio Tinto and BHP buybacks. These transactions are negative for pre-tax performance but positive post tax, especially for low or zero tax payers.

Market Commentary

Over the month global equity markets deteriorated significantly. The falls were led by the markets that had been the strongest, such as the US. Australia was also lower but less so, as the domestic index had lagged.

The falls in global equities appear to be liquidity and technically driven, as there was no significant deterioration in traditional fundamentals. Momentum-based strategies now comprise a large part of global trading. Momentum has clearly been broken in many indices which has triggered further selling.

The continual withdrawal of liquidity by central banks is causing increased volatility in markets. Whether the lack of liquidity leads to a decline in economic activity is the question on which the market is focussing. So far, leading indicators are showing economic growth slowing to sustainable levels – not a recession. It is likely liquidity will be withdrawn until economic growth is threatened, then the authorities may pause the tightening. Monitoring the state of credit markets may be instructive at this stage of the cycle.

Sector performance was mixed with the best sectors being Materials, Utilities and REITs. The positive performance of both REITs and Materials is unusual given Materials usually rely on strong world growth and REITs are a haven in times of low or declining growth. The fund is overweight REITs but not Materials, having sold into both RIO Tinto and BHP buybacks. The worst performing sectors included Banks and Diversified Financials. The fund has a significant stake in these sectors given their higher yield characteristics.

Volatility in equity markets is expected to continue. During rallies the fund will work to upgrade the portfolio from its already strong position.

The best performing stocks in the portfolio were BHP (sold into buyback), Charter Hall, AGL, Rio Tinto (also sold into buyback), and Dexus.

Diversified Financials was one of the poorer performing sectors. Despite having pristine balance sheets and cash flows, these companies derive a large proportion of earnings from the level of the stock market which has fallen.

The banks were also weaker over the month, as potential regulatory change in New Zealand may require them to retain more capital which will restrict dividend increases if enacted.

PORTFOLIO OUTLOOK

The decline in the equity market over the last couple of months has offered up relatively attractive investment opportunities for SWTZ and we have invested most of the excess cash.
The underlying earnings (and dividend) outlook for the companies in the fund remain positive. Balance sheets of the companies held remain very good, a positive sign of the health of the portfolio.
Interest rates remain low and economic activity, although slowing, remains positive. While volatility in equity markets is expected to continue, indications of inflation remain largely benign giving confidence that the investment outlook remains favourable.

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