The DCM/INNOVA High Equity Income Innovation Fund’s (the “Fund’s”) first fiscal half year which ended on April 30, 2021 reaped the benefits of the resolution of two main sources of uncertainty that were hanging over the economy and financial markets in 2020. The first was the outcome of the US Presidential elections and the second was the outlook for the containment of the COVID-19 pandemic.
The US Presidential elections were too close to call heading into the polls on November 3rd, 2020. The market also feared that election results might not be known for weeks after the election and this would be an overhang on the economy and financial markets. One prevailing narrative was that if President Trump lost the election, the stock market would tank. A Democratic “sweep” would lead to less investor-friendly policies such as increased regulation and corporate taxation. The opposing narrative was that a Vice President Joe Biden victory would lead to additional fiscal stimulus through more generous unemployment benefits and perhaps a large infrastructure package. That would lead to a stronger economy in the short run.
The election uncertainty was resolved within a few days of the election with Joe Biden becoming the next President. More importantly, the outcome did not result in the strong Democratic dominance in the House and Senate with which the market had been concerned. (Democrats lost seats in the House and did not improve their position in the Senate to the extent legislation could “sail through”.) With the clouds of political uncertainty lifted, the focus shifted to earnings and vaccine advancements helping to “reopen” an economy in which analysts were revising growth expectations higher. Both earnings and vaccine news were strong, and the market rallied over the fiscal half year with the Fund returning 26.99% for the six months ended April 30, 2021.
The release of strongly positive test results for the Pfizer-BioNTech vaccine (showing an over 90% efficacy) on November 9, 2020 lit a fire under equity returns. There was a huge rotation in equities from high-valuation, mega-cap technology stocks into beaten-down energy, financials, and travel-related stocks and the Fund kept up with many of these sector and factor shifts. The FDA approved the Pfizer-BioNTech vaccine on December 11 and the Moderna vaccine on December 18, 2020. Earnings estimates for the fourth quarter of 2020 and the first quarter of 2021 were revised upwards strongly. Sales were recovering and forward guidance for the fourth quarter and 2021 was revised upward by many companies. The Fund kept up with the S&P index in its second fiscal quarter ending on April 30, 2021 with total returns of 12.92% compared with the S&P index returns of 12.98%.
After Growth outperformed Value for over 13 years (since 2007), Value came back into favor starting in late August 2020. Value outperformed Growth over the Fund’s fiscal half year, with the Russell 1000 Value index returning 36.3% compared with the 24.3% returns of the Russell Growth index. This 12% outperformance of Value over Growth followed an underperformance of 36.8% over the Fund’s previous fiscal year ending on October 31, 2020.
The best performing sectors over the fiscal half year were Energy, Financials, Industrials and Materials which were up 75.9%, 53.4%, 35.4% and 32.6%. Defensive sectors such as Utilities, Consumer Staples and Health Care lagged the market with returns of 8.8%, 13.1% and 20.3%. Many of the mega-cap Technology, Media and Telecom stocks that had powered the market since the end of 2019 took a breather over the Fund’s first fiscal half year.
While equities rallied strongly, bonds suffered as 10-year Government bond yields rose from 88 basis points to 163 basis points over the course of the Fund’s fiscal first half year. Inflation expectations also picked up with the 10-year breakeven inflation rates going from 1.7% to 2.4%. The Fed continued with its relaxed stance towards inflation under the belief that the pickup in inflation is transitory.
Anticipating the growth in the economy as the election and vaccine-related uncertainty diminished, we positioned the portfolio away from expensive growth stocks towards beaten down value stocks in cyclical sectors. In mid-October, we trimmed our position in Alphabet (GOOG, Financial), Electronic Arts (EA, Financial) and Amazon (AMZN, Financial) and added Caterpillar (CAT, Financial), Discover Financial Services (DFS, Financial) and General Motors (GM). In mid-November, we added Financials such as Regions Financial Corp (RF, Financial), Truist Financial Corp (TFC, Financial), and Jefferies Financial Group (JEF, Financial). We also added Disney (DIS, Financial) which we expected to do well as the economy reopened and pent-up demand for travel resumed. In late February 2021 we trimmed Amazon and Facebook (FB, Financial) and added Honeywell (HON), HCA Healthcare (HCA) and Methode Electronics (MEI).
The Fund’s overweights in Industrials, Materials, Energy and Financials contributed positively to performance. However, the Fund’s stock selection within Health Care, Information Technology and Energy detracted from performance.
We continue to be encouraged by the results of our innovative dividend income process for the quarter. The Fund pays dividends on a monthly basis and the payout over the fiscal first half year corresponds to an annual net dividend yield of 5.5%. The Fund has a trailing 12-month net yield of 6.7% as of the end of April 2021.
Current positioning
The Fund held 86 equity securities diversified across sectors as of April 30, 2021, and the top five equity holdings as of the end of this period were Alphabet, Apple (AAPL), Microsoft (MSFT), Dow (DOW) and Qorvo (QRVO). The Fund has overweight positions relative to the S&P 500 index in Industrials, Materials, Financials and Energy, and underweight positions in Health Care, Consumer Discretionary, Information Technology and Consumer Staples sectors.
The forecast PE ratio of the Fund of 15.4x is well below that of the S&P index at 21.4x. The Price-to-Book ratio of companies in the Fund is 2.5x; much lower than the 4.5x value for the S&P index reflecting its weighting in value-oriented stocks.
We believe that the Fund is appropriately positioned to perform in-line with the S&P 500, while the income it generates (yield) is expected to exceed the benchmark. We are very positive on the outlook for dividend income generation heading into the fiscal second quarter.
Vijay Chopra, PhD, CFA
Senior Portfolio Manager
