DBLV: April 2019 Portfolio Manager Review
Performance data quoted represents past performance and is no guarantee of future results. Current performance may be lower or higher than the performance data quoted. Investment return and principal value will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than original cost. Returns less than one year are not annualized. For the fund’s most recent standardized and month-end performance, please click www.advisorshares.com/fund/dblv.
The AdvisorShares DoubleLine Value Equity ETF (DBLV) posted a positive return of 3.20% in April 2019, lagging its benchmark, the Russell 1000 Value Index, by 35 basis points. Given the consensus view that the “Fed put” remains in place, growth stocks outperformed value names. In April, the S&P 500 returned 4.05%, versus the Russell 1000 Value Index at 3.55%, and the Russell 1000 Growth Index at 4.52%.
The market rally occurring in the first quarter of the year extended through April, boosted by rising market expectations that the Fed’s next move will be a rate cut, especially given early signs that the economy may be slowing. In April, news was dominated by the quarterly release of corporate earnings and by populist pronouncements amongst the Democratic Presidential candidates, who are increasingly engaged in political jockeying ahead of the 2019 primary election.
With more than 70% of S&P 500 companies reporting by May 3rd, it appears that expectations for corporate earnings growth have decelerated, as the number of firms experiencing downward earning revisions is elevated relative to recent history. Although the number of companies meeting or exceeding reduced earnings expectations in 1Q19 was higher than in 4Q18 and broadly in-line with most of 2018, we remain wary of further downward earnings revisions given the expected slowdown in the broader economy, especially given the ongoing risks from the trade conflict with China.
Adding further headline risk are the increasingly vocal populist pronouncements of the decidedly left-leaning field of Democratic candidates. In particular, rising support for Medicare-for-all among many of these candidates has stoked investor fear concerning the prospects for health care companies, particularly those involved in health insurance. While this populist rhetoric will probably rise further, likely impacting other sectors, we are inclined to look through it, and potentially, take advantage of the temporary, adverse price impacts.
In terms of sector attribution, monthly performance for DBLV was helped by exposures in communication services, consumer discretionary, consumer staples, energy, financials, industrials, information technology, materials, and utilities, offset by negative impacts from health care and real estate. Cash had a minor negative impact on performance.
Source: Bloomberg. As of 04.30.2019.
The top positive contributors to performance in April were Anadarko Petroleum (APC), Pioneer Natural Resources (PXD) and Bayer AG (BAYRY):
- APC (energy) is an independent E&P company with attractive U.S. shale, Gulf of Mexico, LNG and midstream assets. During the quarter, Chevron offered to acquire the company for about $65/share. Recognizing that the value of the assets was worth considerably more than that bid, Occidental Petroleum’s (OXY) made an unsolicited offer for the company for $76/share with the backing of Berkshire Hathaway. While the OXY offer price of $76/share is modestly below our estimate of fair value, assuming a WTI oil price of $55, it is reasonable given the range of potential outcomes related to oil price volatility. Although we do not have any insights into whether CVX will counter with a higher offer, we believe the deal will be done at the higher price.
- PXD (energy) is a well-managed independent E&P company with primary assets in the Permian Basin. Its stock traded up in sympathy with the news on APC given the potential for it also to be an acquisition target.
- BAYRY (health care) is a German conglomerate with leading businesses in pharmaceuticals, consumer health, animal health, and crop sciences. The stock rebounded from the prior month’s pullback related to ongoing litigation with Monsanto’s Roundup, a glyphosate-based herbicide plaintiffs’ claim causes cancer. Helping the rebound were BAYRY’s strong Q1 earnings, driven by better-than-expected Pharma and Crop Science results. We continue to see the stock pricing in significantly greater liabilities for Roundup than likely settlement amounts; as litigation plays out over time, we expect the stock to re-rate higher to our assessment of fair value.
The top detractors from monthly performance were Bank of New York (BK), 3M (MMM), Anthem (ANTM) and Astrazeneca (AZN):
- BK (financials) is a trust bank, generating revenue mainly from custody income, commissions and fees. During the quarter, the stock reacted negatively to disappointing earnings, which were primarily driven by a decline in transaction-based revenues due to recent market volatility and lower net interest income. BK’s spread business, which contributes about 20% to total sales, is small versus other banks, as is its interest rate risk. Critically, its core custody business, accounting for most of the profits, remained healthy, as custody assets grew modestly year-over-year. Viewing the market reaction as overly negative, we added on the pullback.
- MMM (industrials) 3M is a conglomerate with leading businesses in consumer, safety, healthcare and electronics end markets. In April, 3M reported results that were below both consensus and management’s already reduced guidance. Demand weakness and channel inventory adjustments in the Automotive and Electronics division led to lower volumes in 3M’s short-cycle businesses, particularly in the Asia Pacific region. Margins also contracted, as actions taken by management to lower costs were insufficient to offset negative operating leverage from the lower volumes.
- ANTM (health care) is a leading managed care organization. In April, volatility in health services stocks spiked on increased Democrat calls for “Medicare-for-all.” We believe such a single-payer system, as details become known, will ultimately prove unpopular politically and thus, will not be enacted. In addition to the many legislative hurdles of passing Medicare-for-all, there exist multiple problems, including the dissolution of consumer choice for over half the U.S. population now receiving health insurance via their employer, the substantial tax increases required to cover the estimated $32-38tn price tag, and the probable hospital insolvencies resulting from much lower payment rates under a single payer system. Setting aside current political fears, industry fundamentals remain positive, as seen in the across-the-board strength in Q1 earnings, including ANTM, which posted another beat-and-raise quarter on solid execution and industry leading growth.
- AZN (health care) is a UK-based pharmaceutical manufacturer with leading franchises in oncology, respiratory, and cardiology. Despite a strong Q1 earnings report with key oncology drugs again exceeding expectations, the stock declined following a $3.5bn equity raise—equal to approximately 3% of market cap—to fund the acquisition of a novel breast cancer agent and to pay down $1bn of debt. While the acquisition is a positive, the market fretted over the signaling on AZN’s valuation and near term cash flow needs. We see these concerns as overdone, and approve of management prioritizing the positioning of AZN for long term growth over short-term stock performance. We expect AZN to post industry-best revenue and earnings growth over the next five years.
During the month, we introduced Target Corp (TGT) as a new holding and retained Alcon (ALC), which was spun out of Novartis (NVS). We added to our positions in the following: Northrop Grumman Corp. (NOC), Bank of New York Mellon Corp. (BK), Anthem Inc. (ANTM), Boeing Co. (BA), General Dynamics Corp (GD), and Northrop Grumman Corp. (NOC). We eliminated our holdings in Verisk Analytics Inc. (VRSK), Dollar Tree Inc. (DLTR), McKesson Corp. (MCK). .
Top 10 Holdings
The top ten portfolio holdings, by weight and active weight, can be seen in the following tables:
|Top 10 Portfolio Weights||Top 10 Portfolio Active Weights|
|AMERICAN TOWER CORP||3.70%||AMERICAN TOWER CORP||3.70%|
|VERIZON COMMUNICATIONS INC||3.63%||DOLLAR GENERAL CORP||3.21%|
|CHEVRON CORP||3.60%||US FOODS HOLDING CORP||2.87%|
|DOLLAR GENERAL CORP||3.21%||ASTRAZENECA PLC||2.55%|
|JPMORGAN CHASE & CO||3.01%||SANOFI||2.50%|
|COMCAST CORP||2.99%||ANTHEM INC||2.42%|
|ANTHEM INC||2.93%||VISA INC||2.41%|
|US FOODS HOLDING CORP||2.93%||FIDELITY NATIONAL INFO SVCS||2.41%|
|PHILIP MORRIS INTERNATIONAL||2.79%||PAYPAL HOLDINGS INC||2.37%|
|FIDELITY NATIONAL INFO SVCS||2.66%||NOVARTIS AG||2.32%|
Active weight refers to the difference in allocation of an individual security or portfolio segment between a portfolio and its benchmark. For example, if a portfolio allocates 15% within the energy sector, and the benchmark’s allocation in energy is 10%, then the active weight of the energy segment of the portfolio is +5%. Active weight can also be referred to as relative weight. As of 04.30.2019
Relative to the Russell 1000 Value Index, DBLV is overweight consumer discretionary, energy, health care, industrials, IT and communication services. It is underweight consumer staples, financials, materials, real estate, and utilities. The portfolio holdings by absolute and relative sector weights are found in the accompanying charts:
As of 04.30.2019
The DBLV portfolio’s sector exposures primarily reflect the DoubleLine Equities team’s bottom-up investment process, which places an emphasis on individual stock selection. However, the macroeconomic views of DoubleLine Capital L.P. do inform secondarily these sector weightings.
We still see relative value in a subset of the market, but remain cautious on the broader market given lackluster earnings growth and further signs of economic slowdown. In particular, we are growing more concerned about the sustainability of high corporate profit margins, the risk of continued slowing of earnings growth and the prospect of downward pressure on valuation multiples, all of which underlie our worries about near-term headwinds. While we do recognize that the Fed might redeploy accommodative monetary measures to preempt a substantial slowdown, thereby supporting the equity market in general and growth stocks disproportionately, we also believe that the Fed will likely wait for confirming data before reaching back into its limited monetary tool kit to re-stimulate the economy. This means that the Fed might be slow and less well-equipped to intervene when the next recession arrives. It is important to remember that the fed funds rates remains low at 2.5%, well below the rate level seen in past recessions since 1989, during which the average rate reduction by the Fed to re-stimulate the economy was about 5.5%; therefore, given the lack of dry powder in the low fed fund rate, the Fed will likely be forced to expand its balance sheet in the next recession. Given that the Fed has made barely a dent in its balance sheet, with more than $3.5tn of Treasuries and Agency MBS holdings, such a further balance sheet expansion would be to new record levels.
While no one can accurately predict the exact duration of the current bull market and economic expansion, it feels to us like we are in the late innings of the cycle, where risks are more elevated. The current expansion is among the longest experienced over the last 100 years. The extraordinary accommodative measures provided by central banks and governments around the world over the last decade have almost certainly prolonged the current economic cycle and, with it, the extraordinary bull market in asset prices, thereby affording the greatest benefit to investors holding the highest-risk assets. With the premium of growth stocks over value stocks still near historic highs, we believe the reward-to-risk is more favorable with value stocks, especially when one takes a longer-term view. Compared to the broader S&P 500, the relative earnings multiples of value stocks in general and of DBLV’s holdings in particular appear attractive on a relative basis at current levels. At month’s end, the price-to-earnings multiple on 2019 consensus estimates for DBLV was 16.5x, the Russell 1000 Value Index 15.0x, and the S&P 500 17.9x. In light of this, we continue to regard the current environment of elevated risks as supportive of the value-based strategy behind DBLV—particularly over a long-term investment horizon.
We thank you for your continued interest in DBLV.
AdvisorShares DoubleLine Value Equity ETF (DBLV) Co-Portfolio Manager
AdvisorShares DoubleLine Value Equity ETF (DBLV) Co-Portfolio Manager
Past Manager Commentary
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There is no guarantee that the Fund will achieve its investment objective. An investment in the Fund is subject to risk, including the possible loss of principal amount invested. Investing in mid and small capitalization companies may be riskier and more volatile than large cap companies. Because it intends to invest in value stocks, the Fund could suffer losses or produce poor results relative to other funds, even in a rising market, if the Sub-Advisor’s assessment of a company’s value or prospects for exceeding earnings expectations or market conditions is incorrect. Other Fund risks include market risk, equity risk, large cap risk, liquidity risk and trading risk. Please see prospectus for details regarding risk.
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Holdings and allocations are subject to risks and to change.
The views in this commentary are those of the portfolio manager and may not reflect his views on the date this material is distributed or anytime thereafter. These views are intended to assist shareholders in understanding their investments and do not constitute investment advice.