Dear Fund Investors,
The six-month period running from November 1, 2018 through April 30, 2019 was a transitional period for the Centaur Total Return Fund (the “Fund”) as DCM Advisors, LLC took over the interim management of the Fund on November 16, 2018. During the transition, the Fund had a cash and cash-equivalent security balance of almost 70% as the previous manager had liquidated a majority of the equity positions.
For the six-month period ending April 30, 2019, the Fund produced a positive return of 1.97%. The S&P 500 produced a return of 9.76% over the same period. The performance differential can be attributed to (a) the substantial cash position of the Fund during the unique transition period and (b) the high volatility in the equity and bond markets during the transition period when the Fund held high cash balances.
Following the transition period, the Fund was positioned as a balanced fund with a combination of defensive equities and fixed income, initially set at 60% equities and 40% fixed income. The equity sleeve is tilted towards Value and defensive securities to provide capital preservation and an above-market yield. 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. We also focus on stocks where earnings are supported by cash flows, and where earnings and price momentum are positive.
The fixed income portion of the Fund was invested in cash and short-duration bonds for a majority of the first quarter ending on January 31, 2019. The spread between two-year maturity and ten-year maturity notes was in the 12.5 to 20 basis point range. Given the uncertainties of investing we opted for the defensiveness of the short notes. We then built a corporate bond portfolio with maturities from 2020 to 2025. The fixed income portion of the benchmark is mainly in long-duration bonds.
Toward the end of March 2019, we rebalanced the fixed income holdings to increase the yield. We swapped many individual bond positions for fixed income Exchange Traded Funds (“ETF”) to provide more yield and broader credit diversification. Each ETF consists of an extensive underlying portfolio of securities that can mirror its overall respective market activity. We invested in both investment grade and high yield ETFs, again to provide us with what we feel is higher investment income and broader credit holdings. We feel this gives us liquidity, broad credit diversification, and an attractive yield component to the Fund.
The U.S. equity market was very volatile over the six-month period, with a sharp sell-off over the October-December 2018 period, followed be a sharp rebound from the end of December through the end of April 2019. The market dropped almost 16.5% from November 7, 2018 through December 24, 2018. Market 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. Further, economic data from China and Europe was weaker than expected. Weaker economic data and increased market volatility led the Federal Reserve to adopt a neutral stance following three rate hikes in 2018. This contributed to a huge rally in the equity and fixed income markets.
From the low of December 24, 2018 to the end of April 2019, equities rallied 25%, one of the sharpest rallies in a four-month period. Value and high dividend securities have lagged the market during this rally. The S&P 500 index was up 25.3% through the end of April 2019. The S&P Value index lagged the S&P index by -2.4%.The equity sleeve of the portfolio has lagged the broad market due to its defensive and dividend-oriented style. We expect the Fund to catch up with the category over time as the current risk-on rally fades, and Value and dividend yield comes back into favor.
The 10-year U.S. Treasury note prices rallied strongly when yields fell from 3.1% on October 31, 2018 to 2.6% at the end of January 2019. This rally was linked to signs of weaker global growth data, and the dovish stand adopted by the Federal Reserve over the course of the quarter. The fixed income portion of the benchmark rallied almost 3.0% (as reflected in the Barclays U.S. Aggregate Index) while cash and short-duration bonds in the Fund did not fully participate in this rally due to their short duration. At the end of the first quarter the bond positions were spread over technology, finance, energy, consumer products and durables.
Current positioning
The top five equity holdings as of April 30, 2019 were PennyMac Mortgage Investment Trust, CSX Corporation, Popular, Inc., Mastercard Inc. Class A, and ConocoPhillips. The portfolio is diversified across sectors, with overweights relative to the S&P 500 index in Information Technology, Materials, Energy and Real Estate. The portfolio is underweight in Health Care, Consumer Staples, and Communication Services.
The equity sleeve of the Fund has a trailing PE ratio of 14.5x compared with 20.3x for the S&P index. The price-to-book ratio for the portfolio is 2.4x compared with 3.5x for the benchmark. However, the forecast 3-5 year EPS growth rate is 11.6% which is only marginally lower than that of the benchmark at 11.8%.
In April 2019, Morningstar moved the Fund from the Moderate Target Risk Allocation category to the Moderately Conservative Target Risk Allocation category. This category has a benchmark that is roughly 40% in equities and 60% in fixed income.
In the middle of April, we made an asset allocation shift and rebalanced the Fund to a “50%/50%” equity/fixed income split. With equity valuations that were extended, and profit expectations that were likely to be further reduced, especially for the fourth quarter of 2019, we felt it was prudent to reduce equities.
The Fund’s portfolio held 58 securities at the end of April 2019, including 46 equity securities or ETFs, and 12 fixed income securities or ETFs. The Fund has a current gross yield of 3.9% across its equity and fixed income positions. The equity sleeve has a gross dividend yield of 3.4% which is roughly 80% higher than that of the S&P Index (which has a gross yield of 1.9%). On the fixed income side, our duration is closer to that of the category benchmark.
In summary, we believe that the Fund is appropriately positioned to perform well relative to its category over the coming quarters.
Respectfully submitted,
Vijay Chopra and Gregory Serbe
Co-Portfolio Managers, Centaur Total Return Fund
