DBLV: July 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 return of 1.54% in July 2019, beating its benchmark, the Russell 1000 Value Index, by 71 basis points.
During July, the market initially marched to new highs on rising investor optimism concerning prospects of a new Fed rate-cutting cycle, progress in U.S.-China trade discussions and potential for better-than-expected corporate earnings. However, market volatility jumped late in the month as the optimism around these apparently faded. Despite the market reversal, the market held onto modest gains for the month. With a shift back to a more accommodative monetary environment, growth stocks fared better value stocks. In July, the S&P 500 returned 1.44%, versus the Russell 1000 Value Index at 0.83%, and the Russell 1000 Growth Index at 2.26%.
The rally that continued from June was supported by an anticipation of easing monetary conditions as the Fed was widely expected to make its first interest rate reduction since December 2008. Moreover, in what was a heavy earnings reporting period, July saw corporate earnings performing better than expected, thus alleviating fears of a more severe slowdown. Note that as of August 2, 77% of companies in the S&P 500 had reported Q2 earnings; of those companies, 76% had reported positive earnings surprises, exceeding the 5-year average of 72%. Furthermore, following the reassuring announcement of a trade war cease-fire agreement between President Trump and President Xi Jinping, investors found renewed hope that the trade impasse with China would possibly improve, setting the stage for a more favorable economic and market backdrop. The S&P 500 set a new record high on July 26 on the back of these factors.
Then the news flow turned decidedly negative. While the Fed did cut rates a quarter point during its July meeting, as expected, investors were disappointed by Fed Chairman Jerome Powell’s commentary which suggested that the -0.25% rate move was termed merely an insurance cut or a mid-cycle policy adjustment rather than the beginning of a lengthy rate-cutting cycle, thus providing little assurance that meaningful market support in the form of a Fed put was forthcoming.
Meanwhile, corporate quarterly reports, despite better-than-expected 2Q earnings, hardly excited anyone. Revenue surprises were below the historical trend, suggesting that cost reductions or higher non-operating income rather than sales growth were the main source of the upside. Furthermore, as of August 2, operating earnings for the S&P 500 companies were on track to decline about 1% year-over-year during Q2 2019, according to Factset Research, marking the first time since Q2 2016 that the S&P 500 reported 2 straight quarters of year-over-year decline. Additionally, Q3 2019 earnings for the S&P 500 companies are expected by sell-side analyst consensus to decline year-over-year on average as well, making it potentially 3 straight quarters of declines.
Worse still, the trade talks with China abruptly fell apart again as President Trump charged China with reneging its prior promise to buy U.S. farm products and moved to impose 10% tariffs on the remaining $300 billion of Chinese goods by September 1. Consequently, market volatility soared, reflecting shaken investor confidence.
Needless to say, these developments have done nothing to improve the broader context of risks facing equity investors. Economic growth continues to slow, government debt inexorably expands and political unrest continues to rise in many parts of the world. Both corporate and government debt, which appears to be the only remaining driver of growth in our economy, continues to grow at an unsustainable pace. In July, Congress raised the debt ceiling again, enabling a further expansion of government liabilities such that the US is on track to post a record deficit exceeding $1.6tn in non-recessionary times. Similarly, non-investment grade corporate debt levels have reached record levels, creating a worrying set-up ahead of the next unavoidable downturn in the credit cycle.
Geopolitical risks have also risen, threatening to trigger market instability. The situation in Hong Kong has quickly deteriorated, as peaceful demonstrations have turned into violent protests that could prompt dramatic crackdowns by the Chinese government within a major international financial hub, thereby raising the risk of a major crisis that could destabilize the markets. July also saw rising tensions between the U.S. and Iran, creating potential to rattle the energy markets. And Boris Johnson’s electoral victory has raised risks of a hard Brexit, which would likely create a further headwind to European economic growth, while materially impacting debt, equity and currency markets.
Amidst this relatively challenging economic and political backdrop, the risks to the equity markets remain elevated, as we’ve noted previously. Although this is the longest economic expansion in recorded U.S. economic history, the U.S. economy remains as reliant as ever on government support and further corporate leveraging in order to grow, and we find this far from ideal for further gains in equity indexes after the robust start to the year. And while we know that the markets can show much resilience in the face of major political tumult, we still believe that a cautious stance is prudent and, accordingly, continue to maintain such positioning in the current environment.
In terms of the portfolio’s sector attribution, monthly performance for DBLV was helped by exposures in communication services, consumer discretionary, consumer staples, financials, health care, industrials, information technology, and real estate, offset by negative attribution from holdings within the energy, and utilities areas. On a relative basis, DBLV was helped by communication services, consumer discretionary, consumer staples, financials, health care, industrials, materials, real estate, and utilities, offset by adverse results within energy, and information technology. Cash had a negative impact on performance in a rising market.
Source: Bloomberg. As of 07.31.2019.
The top positive contributors to performance in July were Astrazeneca Plc. (AZN), Alphabet (GOOGL), and Anthem (ANTM):
- AZN (health care) is a UK-based pharmaceutical manufacturer with leading franchises in oncology, respiratory, and cardiology. AZN raised its outlook for the year after reporting strong Q2 results during the month with material revenue growth acceleration, better-than-expected results in its key oncology drug launches, and continued improvement in earnings quality and cash flow generation. Importantly, AZN is expected to report several key Phase 3 results later this year for a number of oncology drugs that could further crystallize value and drive upward estimate revisions. As a result, we continue to expect AZN to post the best revenue and earnings growth in the space over the next five years.
- GOOGL (communication services) is a dominant global supplier of online advertising services and related technology in digital content, cloud services, enabling hardware devices and other products and services. Alphabet stock outperformed in July after underperforming in June, as the company’s 2Q earnings report beat expectations and helped to boost the stock during the most recently completed month. We continue to view the market’s currently heightened fears over potential regulatory action as overdone, and we prefer holding such a high quality business in the current market environment.
- ANTM (health care) is a leading managed care organization and a licensee of the Blue brand in 14 states. During the month, the administration surprisingly moved away from a proposed drug rebate rule in Medicare Part D that led to a positive reaction in managed care stocks, as this regulation was viewed as a potential headwind to future profitability. Additionally, ANTM reported better-than-expected Q2 earnings and increased its FY19 outlook for a second time this year, as the new PBM transition continues to track ahead of plan. While recognizing the potential for future stock volatility arising from continued regulatory headlines and calls for a single payer system from some progressive Democratic presidential candidates, we continue to see ANTM as best positioned in the space to gain market share and grow earnings with its cost advantage and Blue brand.
The top detractors from monthly performance were Telefonaktiebolaget LM Ericsson (ERIC), Pioneer Natural Resources (PXD), and Paypal Holdings (PYPL):
- ERIC (information technology) is a Sweden-based communications technology solutions supplier to telecom service providers. The company’s core Networks segment offers mobile radio access networks, transport solutions and related network and support services. ERIC continues to benefit from the ongoing growth of mobile data usage and the roll-out of fifth-generation (5G) wireless networks. The company’s stock underperformed during the month after solid gains since last fall, following the release of disappointing forward guidance on the company’s most recent earnings call. Specifically, management noted that further margin expansion would be challenged by more competitive bidding for 5G contracts going forward, as incremental opportunities shift from North America, where Huawei is boxed out, to other geographies, where the Chinese company’s ability to aggressively price is extant. Consequently, we have elected to take profits in ERIC rather than wait for better prospects for margin expansion and higher earnings on the other side of the 5G ramp.
- PYPL (information technology) is the dominant online payment solution and a leader in mobile payments. Over the last two quarters, we have trimmed our position in PYPL to lock in gains from its strong stock performance. Recently, its stock pulled back after providing forward revenue guidance that was modestly below expectations even as its Q2 2019 operating performance exceeded expectation, reflecting robust transaction payment volume growth resulting from rising customer engagement, active account growth and an expanding addressable market. The guidance shortfall was primarily due to transitory issues and overly-exuberant expectations, as opposed to any changes to its strong long-term fundamentals. We see PYPL sustaining its growth rate on favorable secular mobile payment trends and formidable competitive advantages.
- PXD (energy) is a well-managed, independent E&P company with high quality assets in the low-cost Permian Basin. Macroeconomic-driven concerns over underlying oil demand and worries about industry oversupply together have weighed upon the overall energy sector. In July, PXD, along with other shale producers with disproportionate exposure to the Permian basin, sold off in sympathy with Concho Resources, a competitor that reported less-than-favorable 2Q results. Despite that news, we believe that fundamentals in the oil industry are actually stabilizing, and that the issues adversely impacting Concho were mostly company specific. We see good value in PXD’s current stock price, which does not fully reflect its future earnings and cash flow potential, and so we took advantage of the pullback in price to add to our position.
During July, we added Goldman Sachs Group (GS) as a new holding. We increased our existing weights in United Technologies (UTX), Microsoft (MSFT), Boeing (BA), and EOG Resources (EOG). We reduced our positions in Bayer AG (BAYRY), Intercontinental Exchange (ICE), Northrop Grumman (NOC), Willis Towers Watson (WLTW), Paypal Holdings (PYPL), Novartis AG (NVS), Visa (V), Chubb (CB), and Anthem (ANTM). We eliminated our holdings in LM Ericsson (ERIC).
The top ten portfolio holdings, by weight and active weight, can be seen in the following tables:
As of 07.31.2019
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.
Relative to the Russell 1000 Value Index, DBLV is overweight consumer discretionary, energy, health care, and technology. It is underweight consumer staples, financials, materials, real estate, and utilities. It is roughly equal-weight industrials, and communication services. Note that the RLV rebalanced at the start of July, impacting portfolio relative weights. The portfolio holdings by absolute and relative sector weights are found in the accompanying charts:
As of 07.31.2019
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.
While we are constructive on the long-term outlook for the U.S. equity market, we remain cautious in the near-term, because of growing uncertainties related to the ongoing trade dispute with China, wider threats to global free trade other adverse geopolitical developments that can impede global growth, rising U.S. debt balances driven by chronic deficit spending, and the economy’s continued dependence on support from the Fed and corporate leveraging. We have been concerned about how this ominous backdrop will impact the sustainability of high corporate profit margins, the pace of slower earnings growth and the prospect of downward pressure on valuation multiples. All of these constitute substantial near-term headwinds, and yet the major US equity indices remain close to record highs.
In the present environment, we continue to believe that lower-multiple value stocks should post better relative performance after having lagged growth stocks for nearly a decade.At month’s end, the price-to-earnings multiple on 2019 consensus estimates for DBLV was 16.7x, the Russell 1000 Value Index 14.9x, and the S&P 500 18.2x. In light of this, we still regard the presence 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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