Dear Fellow Shareholders,
With over 30 years of experience in the investment business, I can’t tell you how enthusiastic I am right now for the prospects of the Centaur Total Return Fund (the “Fund”).
I took the reins of DCM Advisors in the middle of this year and have gotten to know the women and men dedicated to the research and portfolio management of the Fund very well. I have observed them in investment meetings and have seen the quality of their work on various projects and will say this—you have a team of very intelligent, experienced, curious and passionate professionals working on this Fund.
Much of my enthusiasm is centered around the work this team has done over this past summer and fall to innovate. Going into 2020, I believe the Fund will see the positive effects of this innovation in the area of dividend generation. While innovation and hard work won’t automatically produce results that meet or exceed shareholder expectations, I believe the combination will be a contributing factor for the success we all want to achieve.
I am also enthusiastic because our team’s spirit of innovation and quest to improve the portfolio’s prospects for achieving our objectives is ongoing. The team is constantly looking at new ways to add impact and new factors to apply. Indeed, the results of their work towards the very end of the Fund’s fiscal year were quite positive. And it is with this energy that we head into 2020.
I want to once again, thank you for your trusting our experience, innovation, dedication and wisdom to steward the Fund.
Sincerely,
Marc R. Rappaport
The Centaur Total Return Fund (the “Fund”) was up 3.2% over the fiscal year ending on October 31, 2019. During this period, the Fund was positioned as a balanced fund following a short transition period after DCM Advisors took over the interim management of the Fund. The Fund had a beta of 0.6 relative to the S&P 500 index. The Fund’s volatility over the course of the year was 9.8%, which was 40% lower than that of the S&P 500 index at 17.0%.
The past fiscal year was dominated by concerns about the Fed’s policy stance, trade friction with China and a slowdown in global trade and manufacturing. Growth expectations were cut as international and domestic economic data pointed to a slowdown. This resulted in declining bond yields, with the 10-year benchmark treasury yield dropping from 3.1% on October 31, 2018 to 1.7% on October 31, 2019. Despite slowing economic and earnings growth, the equity market as reflected in the performance of the S&P 500 index was up 14.3% over the course of the Fund’s fiscal year. Markets were supported by the Fed’s pivot to an accommodative policy stance at the end of January 2019.
DCM Advisors took over the interim management of the Fund on November 16, 2018. During the transition period, the Fund held fewer than 10 equity positions and had a cash and cash-equivalent security balance of almost 70% as the previous manager had liquidated most of the equity positions. Following a short transition period, the Fund was positioned as a balanced fund, with a combination of equities and fixed income, initially set at 60% equities and 40% fixed income.
We invested the equity portion of the Fund in a diversified portfolio of primarily dividend-paying blue-chip stocks with attractive valuations and sustainable, high profitability. The emphasis was on finding undervalued securities with an above-market yield. We also focused on stocks where earnings were supported by cash flows, and where earnings and price momentum were positive.
Additionally, we also increased portfolio diversification by increasing the number of equity holdings. Increased diversification provides a buffer in a slowing earnings growth environment, as companies are prone to revising earnings estimates downwards, which can lead to a severe negative price reaction. A diversified portfolio is better positioned to mitigate against this risk.
The fixed income portion of the Fund was initially positioned mainly in cash and low-duration government and investment-grade corporate bonds. We later added high-yielding securities to boost the yield of the Fund.
The U.S. equity market was very volatile during the Fund’s fiscal first quarter, with a sharp sell-off over the October-December 2018 period, dropping nearly 20% at one point. Volatility increased as the markets absorbed the fact that the U.S. economy and earnings growth would slow down in 2019 as the effects of the 2018 tax cuts faded. In addition, the threat of trade tariffs against China and the possible disruption of the global supply chains roiled equity markets. Furthermore, economic data from China and Europe was weaker than expected. Markets called into question Fed Chairman Powell’s October 3, 2018 comments about future rate hikes being on autopilot, and the hawkish Fed policy stance at the December 2018 meeting of the Federal Open Market Committee (FOMC).
Weaker economic data and increased market volatility led the Federal Reserve to pivot to a neutral policy stance at the January meeting of the FOMC following three rate hikes in 2018. This contributed to a sharp rally in the equity market during the Fund’s fiscal second quarter, with the S&P 500 index providing a total return of 9.5%. The bond market also rallied with the ETF based on the Bloomberg Barclays US Aggregate Bond Index up 1.8%. The Fund was up 2.6% in the Fiscal second quarter. Value and high dividend stocks lagged the broad equity market with the S&P 500 Value index and the Dow Jones Select Dividend Index lagging the S&P 500 index by almost 200bps each. The equity sleeve had a strong tilt towards value and above-market dividends resulting in underperformance relative to the broad equity market. The Fund had a large allocation to short-duration fixed income securities within the fixed income sleeve which lagged the broad bond market.
Equity market volatility increased substantially over the Fund’s fiscal third quarter ending in July 2019 as trade war rhetoric picked up, with the US and China imposing tariffs on each other. In response, we shifted away from those companies with high global exposure. Some of the defensive names that were added to the Fund in July were Cintas, Nestle, Zoetis, Estée Lauder and Kimberley Clark. We repositioned the portfolio to emphasize profitability in addition to value and dividend yield. Bond yields continued to tumble, with the benchmark 10-year US Treasury bond yield dropping from 2.5% to 2.0% over the May through July 2019 period reflecting the growing economic uncertainty. With inflation expectations well-contained, the Fed cut rates in July. It subsequently cut rates in September and October of 2019 as well.
By early September, the 10-Year US Treasury Bond Yield dropped to 1.45%. In the Fund’s fiscal fourth quarter, we made significant changes to portfolio positioning in response to low bond yields, more clarity in the Fed’s accommodative policy and major easing in trade tensions. We reduced our fixed income exposure markedly to take advantage of the year’s substantial bond rally (we wound up avoiding a good bit of pain as the US Treasury Bond prices declined heading into the end of the Fund’s fourth quarter). As a result, we were very pleased with the Fund’s growth in the fourth fiscal quarter, especially the last two months, which reflected our shifts.
For the fiscal year, the performance of the equity sleeve of the Fund lagged the broad equity market due to its value and high dividend tilt early in the year. The fixed income sleeve had a large allocation to short-duration securities which lagged the longer-term securities as the yield curve flattened.
Late in the Fund’s fourth fiscal quarter, we made the decision to eliminate the fixed income security holdings and convert the portfolio into an equity portfolio. Our aim is to outperform the broad equity market and achieve an above market dividend yield, targeted at 3.5 – 4.0% under current market conditions. The portfolio will have a core representing around 80% of holdings that will be is designed to outperform the broad equity market. The remaining balance will be invested in a dividend capture sleeve designed to generate high dividend income using a proprietary dividend capture process.
We also have rebalanced the core portfolio to be slightly more growth-oriented, as such companies do well in a slowing economic environment. We added growth-oriented names such as Alphabet, Facebook and Starbucks. We added to the Healthcare sector with superior growth companies such as Bristol-Myers Squibb, Edward Lifesciences, Corcept Therapeutics and Zimmer Biomet. Conversely, we lowered the weighting in Industrials by selling Cummins, Federal Signal and Ingersoll-Rand. The portfolio weighting in technology was increased by adding names such as AMD, Visa and Qorvo, and adding to our Microsoft position.
The dividend capture sleeve of the Fund is tilted towards Financials, Industrials, Utilities and Real Estate stocks due to the higher dividend yield of these sectors. The Fund currently sports a dividend yield of 2.3% compared with 1.9% for the benchmark. The dividend yield is expected to increase to 3.5 - 4.0% as we fully implement the dividend capture process and we are very excited about the prospects of bringing our capabilities in dividend capture to the Fund going forward.
Current positioning
The top five equity holdings as of October 31, 2019 were Microsoft (MSFT, Financial), Simon Property Group (SPG, Financial), Hercules Capital (HTGC, Financial), Janus Henderson Group (JHG, Financial) and Sabra Health Care REIT (SBRA, Financial). At the end of its fiscal year, the Fund held 83 equity securities diversified across sectors, with overweight positions relative to the S&P 500 index in Health Care, Financials and Energy, and underweights in Information Technology, Consumer Discretionary, Communication Services, Utilities and Industrials. The PE ratio of the Fund is 18.6x compared with 20.3x for the S&P index.
We believe that the Fund is appropriately positioned to perform well in an environment of increased volatility in equity markets and slow but improving macroeconomic growth. We are very positive on the outlook for dividend income generation heading into the new fiscal year.
The Shareholder Letter seeks to describe some of the investment adviser’s current opinions and views of the financial markets. Although the investment adviser believes it has a reasonable basis for any opinions or views expressed, actual results may differ, sometimes significantly so, from those expected or expressed. The securities held by the Fund that are discussed in the Shareholder Letter were held during the period covered by this Report. They do not comprise the entire investment portfolio of the Fund, may be sold at any time and may no longer be held by the Fund. For a complete list of securities held by the Fund as of October 31, 2019, please see the Schedule of Investment sections of the annual report. The opinions of the Adviser with respect to those securities may change at any time.
Statements in the Shareholder Letter that reflect projections or expectations for future financial or economic performance of the Fund and the market in general and statements of the Fund’s plans and objectives for future operations are forward-looking statements. No assurance can be given that actual results or events will not differ materially from those projected, estimated, assumed, or anticipated in any such forward-looking statements. Important factors that could result in such differences, in addition to factors noted with such forward-looking statements, include, without limitation, general economic conditions, such as inflation, recession, and interest rates. Past performance is not a guarantee of future results.
