In this live webinar, Chairman of the Switzer Investment Committee, Peter Switzer spoke to Portfolio Manager, Marcus Bogdan to provide an update on the Switzer Dividend Growth Fund (Quoted Managed Fund), the performance since the appointment of Blackmore Capital, and which equities sectors have the most opportunities and which are the most challenged.
Peter Switzer (PS): Hello and welcome. Thank you for joining us in this webinar. I’m Peter Switzer, the Chairman of the Investment Committee for the Switzer Dividend Growth Fund.
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Today we have the pleasure of speaking to Marcus Bogdan, the Portfolio Manager of the Switzer Dividend Growth Fund. Marcus, thanks for your time today. Marcus, you know, markets are really tricky to navigate right now. How are you seeing it?
Marcus Bogdan (MB): Well, I think we’re at an important inflection point. On the one hand, I think a lot of the negative earnings have been priced in. We’ve had rising interest rates at a very fast clip, we’ve had persistent and stubborn inflation, we’re still having supply chain issues and labour shortages. We’ve got all of the geopolitical issues and the energy crisis that we’re seeing in Europe. There’s an indication that growth is going to slow and that will affect earnings. So, a lot of that I think, has been priced in and is reasonably well understood. The tricky thing is that demand is holding up incredibly well.
The US consumer is still spending, US manufacturing data in September grew and industrial production grew. CBA’s most recent data on credit and debit card data suggests that spending is still elevated. At a company level, we’re seeing that in evidence. Endeavour Group, the largest drinks company in Australia, BWS, Dan Murphy in the hotels business, reported their first quarter result. Hotel sales are up 90%, from a very low base because of lockdown, but consumers are taking premium products and drinks and food, Christmas bookings are as strong as ever. And so, you’re seeing evidence, both at a macro level, and at a company level, of still good demand. That’s a quandary that the market is still wrestling with, because that’s the evidence.
Despite all the other macro, massive issues that are potentially very negative. I think the key question is what’s going to happen to earnings, particularly in the next six months and into 2023? At this stage, earnings are holding up reasonably well.
PS: We often talk about someone like you and investors investing on their own behalf, they always have to climb the wall of worry. That list of worries, that makes me think this is one of the biggest walls we’ve had to climb in a long, long time.
MB: Oh, they’re absolutely significant. I mean, on the one side, six significant negative factors, and you’ve got the differences between consumer sentiment and what consumers are actually spending. It is actually, quite different. Consumer sentiment is very negative, but spending remains elevated.
PS: Yeah. The important point is that markets are in the hands of people doing their best possible guess on what’s going to happen to individual companies and what’s going to happen to the overall stock market. They could be guessing excessively negatively and that the outcome in 2023. I think we agree, it would be a slowdown of some kind, because interest rates have to do that, but just still might end up being a lot less than what the market was thinking when they smashed a lot of these companies.
MB: Sure. So, I do think we are going into slower growth and slower earnings growth, but that’s the fact that we’ve actually come from a very high base. But, if you look at second quarter US earnings, third quarter US earnings, which have just started, they were better than anticipated.
Australia’s recent results season was also more encouraging and better than expectations. What we’re seeing in the first quarter results in the AGM season, which is just starting, again, illustrates the fact that those earnings are still holding up. If they continue to hold up, that means the report cards for the first half of this fiscal year, which we’ll see in February, should be okay.
PS: Okay, so you manage the Switzer Dividend Growth Fund, and obviously you got a stable of companies you’ve currently got, you’ve probably got a stable of companies you’re potentially looking at, that can come in. So, what are you looking for in the companies that you’re either holding, or the ones you might acquire, or even dump?
MB: So, I think the underlying thesis is that the economy is going to tighten, earnings and growth is going to slow. Then there’s persistent inflation pressures. So, we do want a collection of, what I would classify as defensive industrial companies. Companies that are actually got good pricing power and they’re facing into more consumer staple areas. Examples of that would be Amcor, Brambles, and Cleanaway. All in very stable industries, all are exhibiting a level of pricing power, as well.
I think the telecom sector, Telstra, Spark New Zealand, attractive dividends, and they’re benefiting from the growth in mobiles. Also, the potential monetization of their infrastructure, and that will allow for capital returns and higher dividends over the forecast period.
The third area that we like, is actually in the energy space. I think that there’s been a persistent low level of new supply coming on, whilst demand is held up reasonably well. So, we like Santos and Woodside. They’re generating a lot of cash, and for our investors, that’s important because that means higher and stronger dividends.
PS: I guess they give you a bit of growth, because you are a dividend and growth company, so you want to try and pull off the double play, but dividends is the most important part, isn’t it?
MB: It is, but I think you’ve underlined a really important point. We want sustainable and resilient dividends, and we want dividends to grow over time.
PS: Tell us about the Fund’s investment objective, and what is the process to make sure you deliver on that objective?
MB: The core investment objective is to grow both capital price appreciation of the underlying shares, and dividends through the investment cycle. We also want to do that with lower volatility and better downside protection in weak markets. We do that with a focus on quality earnings.
Those sorts of companies that have got long histories of performance, long histories of going through different economic cycles, and they’re facing into more resilient markets. So, those industrial companies, those telecom companies, those consumer staple companies, all fit that bill. They have allowed the portfolio to have that better protection when conditions become more difficult.
In terms of the process, there is a strong process on looking at the earnings quality of the companies that we have. Where they are in their investment cycle? What do their returns look like? Are they a significant player in the industries that they’re operating in? Is that industry growing? The other really important component, which is starting to play out now, is balance sheet strength. As interest rates rise, we want to be in companies that have got strong balance sheets so they can absorb any higher-interest costs, but also take advantage of broader weakness and be able to acquire companies or improve their market position because they’re underlyingly strong. And finally, we want management teams that have got clear catalysts to add shareholder value.
PS: What has been the performance of the Fund over the last year, in terms of your actual returns?
What you would make total by looking at the frankings, and the outlook for growth. You know the market’s down, and the unit price has fallen. It’s one thing we’ve seen with the patented fund, it can’t ignore the market because you are investing in top quality companies and top-quality companies have been hurt by the selloff. But your dividend and your income generation performance has been pretty good.
So, tell us how it’s gone over the last 12 months?
MB: Sure, sure. I took over the fund in April, 2021. We’ve had a positive return on the Fund, a modest return. The overall market has fallen in that period of time. Certainly, in the last six months, we’ve had an outperformance of around about 3% compared to the market.
You’re right, the dividend is important. The headline dividend yield at the moment is 6%, the market is around 5%, and then you’ve got the benefit of franking on top of that. So, your total income, through both the dividend and your franking, is over 8% today.
PS: Okay. How many companies have you got in the Fund right now?
MB: We generally have between 22 and 26. We’ve got 25 in the portfolio today.
PS: Okay. You’ve talked about the sectors, but one of your big jobs is anticipate what might happen to dividends. If the slow down ahead ends up being less than what we expect, do you suspect that dividends will hold up around current levels? If the slowdown is really, really severe, then some companies will cut their dividends.
MB: So, again, it’s all about the companies you want and the industries you want to be positioned in. We’ve got to focus on the companies that we still expect, whilst growth may slow down, that it will still be positive.
PS: So resilient to a certain-
MB: Resilient. The earnings are absolutely critical in that component because the earnings determine the dividend. If the earnings are growing, prima facie, the dividends will grow as well. Now, the dividend growth may slow, but it will still be moving ahead as those companies’ earnings are also growing.
PS: We all know that income really was challenged during the Coronavirus lockdown period. Lots of companies cut their dividends. We’re going through a nice rebound for dividends. What’s the history of dividends and recession? I know I’ve done some work in the past, I think during the GFC (global financial crisis), dividends weren’t cut all that severely. I was surprised, some of the big companies like Woolworths or whatever, they didn’t seem to cut their dividends all that hard. Companies exposed to the GFC did. So, what is the history of dividends? Do they tend to be resilient even during slowdowns?
MB: Well, I think the global financial crisis is a great example, because you needed two things to work for you. One, you needed the earnings to be relatively stable, but secondly, they had to have a strong balance sheet. The global financial crisis was all about companies with poor balance sheets, even though the underlying businesses might have been sound. The poor balance sheet trumped the earnings.
What we wanted to do, and what we did through that period of time, was focusing on those companies that had stronger balance sheets. That allowed them to continue to pay dividends. If we fast forward to today, again, the balance sheet position is incredibly important. It’s equally as important as the earnings. If those two things are stable and strong, we expect that those companies will still be able to pay very good, attractive dividends.
PS: I remember reading something that was really insightful about investing in dividends. In fact, I wrote it. You could have laughed at that one, Marcus.
MB: Okay. I might have smiled.
PS: I know you were a very serious fund manager, but I think it was the CommBank in particular, it did cut its dividend during GFC, but the next year they increased it. If you put the three years together, the one before the actual cut, it was actually a rising trend. So, it was only like a one-year penalty for a very serious economic and financial problem. It made me think much more about the importance of dividends in a portfolio.
MB: Also, through time as well. So, Commonwealth Bank floated in the early 1990s. It’s been a dividend compounder through all that period. You can take one year or a six-month period, but looking through the cycle, you’ll see that positive dividend growth.
Just an interesting diversion of that is looking at the miners now that are, you know, they’ve become the great dividends. BHP pays more dividends than anyone else. And the discipline around the capital, the free cash flow that’s generated. We expect that BHP and those types of companies, Woodside, will continue to pay very attractive dividends.
PS: I guess it’s fair to say they might shrink over time, but they’ll still be good, quality dividends. That’s the point you’re making – BHP’s nearly 11% there at one, but if it drops to five or six or something, it’s still a really nice return, isn’t it?
MB: Absolutely. They’re very disciplined on their capital. We do think that commodities will stay stronger for longer, because they just haven’t had the new supply coming on.
Decarbonization is all about mineralization, so you need those minerals. We think the demand’s going to be strong, and hence, the cash flows will be good.
PS: On that subject of CBA and its floating and its dividends, I saw a great chart, and you’ve probably seen one as well, where they actually looked at the growth of the dividend, which was basically a 45-degree line, and if you invested in Commonwealth Bank at that time, you’ve got that nice return. If you invested the same money in a term deposit, it was a straight line. Oscillating between a couple of percentage points, but it was not an upward sloping line. I thought, that is one of the strongest arguments for investing in quality, dividend-paying companies.
MB: Yes. In addition to that, you’ve got the franking on top of that as well. Which is something unique to Australia. But it’s a powerful-
PS: But also, there’s a very important lesson you’ve got to educate novice investors around, is that if you go after dividends in top quality companies, you still have to live with the ups and downs of your capital. As long as you’re happy with 5 or 6% plus franking credits, it’s not a bad strategy.
MB: No, because the capital will oscillate, and we’re seeing it oscillate quite significantly in this period of time. Whilst the dividends are linked to earnings, and they just incrementally improve over time.
PS: Okay. So, I’m going to ask you two questions now. What is your best-case scenario for your Fund and your potential brilliant performance? And the flip side is, what are your worries that could actually undermine the performance of the Fund? And you?
MB: The base case is that the economy slows, earnings slow. We want to be in those types of companies that we’ve outlined, those higher quality companies. We still get earnings growth; we still get dividend growth. The overall market actually doesn’t expand that dramatically because we’re in a slower growth environment. We’re capturing that growth in the portfolio.
In terms of the downside, there’s two potential downsides. One, is that, for whatever reason, we forget about all the negatives and the world suddenly recovers at a much faster rate. Then those more cyclical companies will do exceptionally well, particularly against the quality companies, because they’re coming from a lower base. And they’ve got a sharper recovery arc. That’s sort of an upside risk.
The downside risk is that we do go into a broader global recession. Australia is caught up on that, and that the overall that we see a contraction in earnings, and that will also affect dividends. Our base case is that we’ll continue to see modest growth, and that we’ll be able to muddle our way. I think Australia is in a particularly advantageous position, compared to many other parts of the world, particularly in Europe.
PS: One final point, and this will surprise you, that I tend to be a little bit more optimistic than you, Marcus. I think a lot of the selloff we’re seeing it now is an anticipation of that worst-case scenario that you’ve already talked about. That that makes perfect sense.
If I was a short-term investor, that’s the way I’d be playing. I’m a long-term investor, so I play it differently. But it seems to me, that if, for example, all of a sudden, the US gets a better inflation number in November or December, then the market will probably take off. You’ll probably find in your Fund, that maybe your growth component of the dividend might actually go faster than you would’ve anticipated, and your dividends might be, in a sense, insulated, because there’s a whole lot of optimism. So that’s a third scenario that is a possibility.
MB: It is a possibility. What we are seeing already in the third quarter US earnings, big companies like Bank of America that have got a very-
PS: Goldman Sachs is another one.
MB: Overview of the US consumer, what’s in savings accounts, whether there’s distress loans, all of those things have been better than expectations. Now expectations have come down quite considerably. But at this stage, even in the US, which is obviously the powerhouse in terms of global economies, is still expected to see 3% earnings per share growth for 2023.
PS: Yeah. A lot of us have forgotten, and I must admit, I haven’t been thinking about it until I just listened to you then. Remember, the central banks are fighting inflation, which has really been driven by cost. They’re smashing demand, or trying to, but in the interim period, costs are now starting to come down right across the world. That’s going to be interesting. Before Christmas, we might get a shock that inflation drops because of in-built costs that haven’t been picked up by the statistician. I guess that’s my most positive and optimistic scenario. Let’s hope I’m right. Good luck.
MB: Yes. Thank you, Peter.
PS: My pleasure. That’s Marcus Bogdan of the Switzer Dividend Growth Fund.
Thanks, Marcus, for your time today, and everyone who has joined us in the webinar. Now, if you have any questions, please contact us 1300 052 054 or emailing us at firstname.lastname@example.org.
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