The Switzer Dividend Growth Fund (SWTZ) is an income-focussed exchange traded managed fund with a mix of yield and quality companies. The objective of the fund is to generate an above-market yield while maximising franking where possible and to deliver capital growth over the long term. We select companies that, in aggregate, generate sustainable dividend income. The fund is characterised by a strong and diverse portfolio of companies that exhibit good cash flows and strong business models.
Over the past 12 months, SWTZ has paid a distribution yield of 7.3%, or 9.6% including franking credits. Distribution yield is calculated as the distributions received over the 12 months to 30 June 2019 relative to the price at the beginning of the period.
Given its focus on income and capital preservation, over the long term we expect SWTZ to marginally underperform in rising markets and marginally outperform in falling markets. The portfolio was higher over the month of June 2019 being up 2.1%.
The targeted cash level in the fund is usually 1.5-2%. At 30 June 2019, cash was marginally above this target at around 2.5%. Major bank dividends are expected to be received early next month and will then be invested opportunistically.
Over the month, activity picked up with the fund taking profits in a few stocks. These included Woodside Petroleum, Amcor and Wesfarmers. We also reduced our weights in the portfolio to the banks and Suncorp. Telstra was trimmed after strong gains in its share price over the last 6 months.
Telstra share price
On the buy side we added to positions in Caltex Australia and The Star Entertainment Group after the share prices fell post earnings downgrades. The position in Macquarie Bank was also increased taking advantage of a soft share price post results.
Global equity markets, led by the US, bounced back from May’s weakness to achieve new highs. Positive messages from the Federal Reserve regarding likely interest rate cuts in the months ahead outweighed soft data reads and trade issues.
The Australian market was also higher over the month but lagged world markets. The Reserve Bank of Australia lowered the cash rate which was taken positively as was the relaxing of lending standards by the banks.
There has been a slew of earnings downgrades which justify the RBA cutting interest rates. Most of these earnings downgrades have been due to weak domestic demand.
Australian interest rates 1990 – present
Australian bond markets continued to rally with the 10 Year bond rate falling below 1.3% to settle around 1.35% by month end. At the start of this calendar year bond yields were 1% higher.
Local economic activity slowed during the early part of 2019 in the lead up to the Federal election. It is little surprise then that sectoral performance was led higher by sectors exposed to international rather than domestic growth. The best performing sector was Materials (6.2%), followed by Industrials (5.6%) and Healthcare (4.4%). Lagging sectors included Consumer Discretionary (-1.5%), Information Technology (1.1%) and Energy (2.2%).
SWTZ sector allocation
Source: Bloomberg, Switzer Asset Management
Best performing stocks over the month included Sydney Airport (11.1%), BHP Group (9.0%), Insurance Australia Group (8.0%) and Coles Group (7.2%). Poorer performing stocks were mainly domestic focussed stocks that have had weak earnings over the last six months. These included Challenger (17.7%) (our second smallest position), Link Administration Holdings (-16.3%), Lendlease Group (-8.8%) and The Star Entertainment Group (-7.8%).
Over the last several months, 20 of the top 200 stocks on the ASX have downgraded earnings. The widespread earnings weakness is mainly stemming from weak domestic operating conditions. There appears to have been an appreciable slowing in economic activity heading into the Federal Election in May.
The election outcome was undoubtedly a positive for corporate confidence. Other positives include the proposed tax cuts, interest rate cuts and the relaxing of lending criteria by the banks. The next result season in August will likely show the extent of the weakness in the economy in the first half of the year, but will hopefully be accompanied by more positive outlook commentaries.
The ongoing decline in interest rates should be a positive for yield-focussed strategies, like SWTZ. Although there may be a bounce higher in yield post any trade resolution, underlying world growth remains modest at best.
The fund remains significantly exposed to those high income generating securities. In our view, these investments will be increasingly valuable in a world of low rates.
Interest rates remain low and economic activity, although slowing, remains positive. While volatility in equity markets is expected to continue, indications of inflation remain largely benign giving confidence that the investment outlook remains favourable over the medium term.