DBLV: April 2020 Portfolio Manager Review
Performance data quoted represents past performance and is no guarantee of future results. Current performance may be lower or higher than the performance data quoted. Investment return and principal value will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than original cost. Returns less than one year are not annualized. For the fund’s most recent standardized and month-end performance, please click www.advisorshares.com/etfs/dblv.
April is the cruelest month, breeding
Lilacs out of the dead land, mixing
Memory and desire, stirring
Dull roots with spring rain.
By T. S. Eliot
“The Waste Land”
T.S. Eliot opened his famous poem “The Waste Land,” paradoxically describing April as “the cruelest month.” Written after the twin traumas of World War I and the Spanish Flu pandemic, the opening stanza of the epic work refers to the melting of forgetful snow, the mixing of memory and desire, and the stirring of dull roots with spring rain. Yet this is not Chaucer’s April “sweet showers” bringing forth flowers. Rather, it is the laying bare of a failed society that has produced human tragedy on a global scale, thereby shaking one’s faith in the entire order of things, including age-old traditions and institutions. Perhaps the greatest poem of the twentieth century, this modernist masterpiece presents conflicting shards of imagery to address the timeless themes of destruction, recovery, and anxiety in an uncertain future. Hardly uplifting stuff, but a very apropos perspective given our present, trying circumstances.
For long-only equity investors, it would seem that it was March, and not April, that was the cruelest month. We collectively braced as the invisible, deadly enemy, which had invaded our shores, was met with a total shut-down of our economy and way of life, and by the end of March, 32 of 50 states had ordered their citizens to shelter-in-place. The white swan of the coronavirus—for we were warned long ago of the eminent dangers of a global pandemic—was joined by the black swan of governments’ surprisingly draconian attempt to shield us from the inevitable community spread of the coronavirus. Economically, this cure will likely be worse than the disease, and the destruction will probably prove unprecedented in scale. Markets and economies, which were richly valued and seemingly old and tired by the start of 2020, collapsed at record speed. Economic activity in March likely fell 20-30% year-over-year (YOY) because of the lockdown, and unemployment rates similarly spiked toward levels that will probably peak in this same range in the coming weeks. Meanwhile, the S&P 500 lost 29% within three weeks, and the broader equal-weighted indexes—likely a better proxy of the broad-based losses—fell 34% over the same period.
Yet as dramatic as those market losses appeared, perhaps still more surprising was the recovery from the worst of them during the following month. April saw an equally unparalleled market bounce, just as rapid to the upside, for the largest indexes, despite the lack of a similar reprieve in the real economy. The world still remained in lockdown at month’s end. At least 30 million Americans were now out of work, with those numbers still rising. S&P 500 corporate earnings in 1Q ’20 were down mid-teens year-over-year and expected to fall more than 35% YOY in 2Q ’20. And critically, no one can really predict accurately yet the full array of adverse impacts of the pandemic on the global economy. The deceleration of new coronavirus cases in the US likely helped to allay the worst of fears, as did the positive, if tentative news, that Gilead’s repurposed antiviral drug, Remdesivir, demonstrated apparent effectiveness in speeding recoveries from the disease. Yet the rapid recovery in equity and credit markets was undoubtedly largely spurred by the enormous interventions of unprecedented scale undertaken by the Federal Reserve and Congress, which now run into the trillions of dollars and dwarf the actions taken during the Global Financial Crisis. Whatever the reasons, the NASDAQ-100 by April 30th was essentially back to its pre-crisis level, while the S&P 500 Index had bounced to within 15% of its pre-pandemic price. Growth outperformed value as investors remained cautious even in the robust rally, favoring cash-rich balance sheets of large cap technology names; the Russell 1000 Growth Index rose 14.8%, while the Russell 1000 Value Index increased 11.2%. The AdvisorShares DoubleLine Value Equity ETF (DBLV) posted a return of +12.2% (NAV), beating its benchmark by 93 basis points (0.93%).
The dramatic bust-boom tale of two months has created at the end of April the cruelest of conundrums for the investment manager. Should the market not still reflect more faithfully the depressed, risk-riddled economy, the devastation of which we still cannot fully measure or comprehend? Or should we count on the government’s massive backstops once again to deliver us to safety? This is the critical question for investors at the present time. I also may prove to be the watershed moment dividing one investment era from the next. We do not pretend to know the answer to this question; however, we do have some tentative observations…
First, we believe the unknowns around the pandemic remain elevated, and so the risks of further damage to the economy and financial markets are hard to reckon. We do not have enough randomized test results using reliable antibody tests to determine the extent of the infection or an accurate assessment of the morbidity and mortality rates, and so we don’t know how far we are from herd immunity. Moreover, we do not even know enough about our bodies’ response to the virus to know how long one is contagious after showing symptoms—complicating the issue of asymptomatic transmission in the prodromal phase—and to know for certain whether a vaccine for this coronavirus is even possible. We do not know how well masks and social distancing will work as we contemplate lifting the lockdowns. There always remains the very real risk of a scary follow-on wave of infection, sickness and death, which even countries successful at handling COVID-19 (think Singapore) have already experienced. On the hopeful side, we recognize that we probably will not see Milan or even New York’s experience play out in the wider US, now that we know what we are dealing with, and because we have ramped up our ICU and ventilator capacity, as well as unleashed herculean efforts to find effective therapeutics (i.e., anti-virals or therapeutic antibody treatments) or, better still, a vaccine. However, the fact remains that anti-virals and vaccines are hard and time-consuming, so the dynamics of the contagion will remain a key risk to the market.
Second, we believe a V-shaped economic recovery is nearly impossible. There is no going back to where we recently were, and the reasons are myriad. First, the prior economic cycle was already long-in-the-tooth and ripe for a downturn, relying as it was on an overlevered consumer. Second, the psychological harm suffered by consumers and corporate executives will not fade quickly, dampening the desire to spend or invest so readily. Third, the current crisis is highlighting structural weaknesses of the prior cycle that must be addressed, such as the need to remake supply chains that are not dependent on China; standing up carefully orchestrated, global value chains would be hard in any environment, but remaking them in a world that is increasingly decoupling will be still more challenging. Fourth, China’s leadership in the recovery should give us pause, as the country supposedly handled the pandemic better than the West but still is not close to a return to full capacity more than two months after its back-to-work orders. Fifth, the US has unique challenges and risks to reopening, including the perverse incentives of paycheck insurance precluding a race back to work, as well as the threat of tort liability for companies that reopen too quickly, and the likelihood that an impending Presidential election will politicize the crisis and make further cooperation across the political aisle impossible. Sixth, the moves by the government to address this crisis, both the near-term monetary and fiscal actions, as well as the expected longer-term actions, will raise debt and regulatory burdens, adding enormous incremental long-term drags on growth and productivity. Finally, the dramatic changes ushered in will undoubtedly carry multiple, adverse unintended consequences, from heightened vulnerabilities of unprecedented debt loads, to changed political realities, to greater international tension between the US and China. We will eventually emerge from this economic crisis, but it will be a long and tough road, and there will have occurred fundamental changes to the socioeconomic landscape, many of which are extremely hard to predict.
Third, we believe the stock market is now likely ahead of itself. While markets need not follow GDP in the short-term, and indeed, tend to discount news farther over the horizon than most any individual investors, there seems to be a lot of discounting occurring at the moment. That the S&P 500 is now down only a fraction of the expected epic hit to GDP is, to our knowledge, an unprecedented development in the long history of economic busts. Stranger still, the market started its precipitous decent in the first quarter of this year from one of the highest valuations of all time, and now, adjusting for the projected earnings declines, is at a still higher valuation! This rapid turn of events in equities does not comport with historical patterns, where the stock market tends to trough at below-normal multiples on prior-peak earnings. Also atypical is the retention of familiar leadership seen so far in the April recovery: growth’s outperformance over value has not mean-reverted but instead, has hit ridiculous levels, probably reflecting a flight to the safe-haven of fortress balance sheets and the reliable growth of the near-monopoly tech platforms and similar, smaller cloud plays. Meanwhile, the breadth of this April rally is, ominously, the narrowest it’s ever been, with the NASDAQ-100 basically flat through this crisis because of a handful of tech giants, while the average stock in the Vanguard Total Stock Market Index, the broadest measure of equities, down 14%. Clearly, market internals and valuation levels appear disconnected from a global economy in severe recession and a world still ridden with many risky unknowns.
In light of these observations, we think an abundance of caution is in order at the present time. We recognize that investors cannot time the market and should stay invested to avoid missing the small percentage of strong rallies that drive a disproportionate amount of long-term returns—Nature’s power law applies to the markets as well. However, we believe that it is prudent to be fearful when all around us are fearful of missing out, and we know that this is especially true during brutal bear-market rallies such as the cruel one we just experienced in April. So we are focused on losing less rather than earning more, while partially hedging against the possibility that Fed interventions and a surprising medical discovery could make the current crisis go away quickly. And while we do not know whether the government can succeed in supporting the capital markets as it attempts to stabilize the economy, as the robust equity rally following the Global Financial Crisis would portend, we will continue to seek sound, long-term investment ideas and strike reasonable balances among those ideas within our portfolio in an effort to secure solid relative returns regardless of the answer to that question.
We also believe that active management is again becoming relevant, as consumers of passive products have been reminded that keeping up with indexes is only fun when markets move solely in an upward direction. Moreover, we expect that active management will show its value as the differences in relative company positioning begin to emerge through the crisis and into the changed, post-COVID-19 world. For example, less regulated sectors should carry a higher premium in a post-crisis world that invariably carries more big government, and companies less impacted by decoupling supply chains could carry a higher premium, etc. We also expect that human judgment will be increasingly important as the shift toward new leadership invariably occurs coming out of this investment cycle; while growth will likely continue to carry a premium amidst a depressed environment, many value names, which have underperformed to the extreme even after a decade of historic underperformance, represent loaded springs in the eventual economic recovery. Active management, if it is doing its job, will better navigate the transitions we expect to see in these volatile times.
Our fundamental value investment philosophy should be well-suited to the present environment. The strategy uniquely looks for risk-adjusted underpriced opportunities in both the historically durable, safe-haven franchises of the old (and still prevailing) leadership, while also searching for classic value amidst the cyclical, deeply discounted names that should have the potential to sustainably outperform once markets can more clearly digest the extent of current economic devastation and reasonably look beyond it toward the next broad recovery.
In April, our portfolio positioning helped to obtain relative outperformance. In terms of the portfolio’s sector attribution, monthly performance for DBLV was helped by exposures in communication services, consumer discretionary, consumer staples, energy, financials, health care, industrials, information technology, materials, and real estate, offset by negative contributions from utilities. On a relative basis, DBLV was helped by communication services, consumer staples, financials, industrials, information technology, and real estate, offset by adverse results within consumer discretionary, energy, health care, materials, and utilities. Cash had a negative impact on relative performance in a declining market.
As of 04.30.2020.
Top positive contributors to April performance were Parker-Hannifin (PH) Facebook (FB), and Alphabet (GOOGL):
- PH (industrials) is an early or short cycle machinery company that makes motion control systems and related components used in a diverse set of industrial and consumer end markets. The stock is highly correlated with manufacturing PMIs. After the Fed added a material amount of liquidity to the US financial system and various states announced future plans to reopen their economies, PH reacted favorably in anticipation of increasing economic activity. At the end of April, the company reported quarterly earnings and demonstrated strong execution in managing decremental margins while generating cash in the downturn; critically, management stated that April orders had stabilized and that the September 2020 quarter would be the bottom, after which incremental margins coming out of the recession would result in attractive earnings growth. With at least 40% upside, PH should benefit as manufacturing plants reopen and industrial activity starts to pick up again. It remains a core holding in the portfolio and the highest active weight among our industrial names.
- FB (communication services) is a dominant provider of social media services that allow people to connect, share, discover and communicate with each other via its core Facebook, Instagram, Messenger and WhatsApp platforms, which it is integrating. The company also owns Oculus, a suite of hardware, software and developer tools that support virtual reality solutions. FB stock outperformed in April, along with many of the technology platform giants that have acted as a safe haven during the crisis, given the company’s competitively advantaged business model and cash-rich balance sheet. We continue to prefer holding Facebook’s stock as another high quality safe-haven during the present crisis, given its strong business model, supported by natural monopolies, as well as its fortress balance sheet.
- GOOGL (communication services) is a dominant global supplier of online advertising services and related technology in digital content, cloud services, enabling hardware devices and other products and services. Alphabet stock outperformed in April, along with many of the technology platform giants that have acted as a safe haven during the crisis, given the company’s competitively advantaged business model and cash-rich balance sheet. At the end of the month, the company’s management also hinted at a tentative stabilization in advertising revenue declines during their quarterly earnings report, and this spurred a relief rally in the shares to close out the month. We continue to prefer Google’s strong business model and Fort-Knox-like balance sheet as a high quality safe-haven in the current turbulence, and we see continued long-term and high-returning growth within the core online advertising franchise, as well as in the incremental opportunities represented by YouTube, Waymo, Google Cloud Platform, et. al.
Top detractors from monthly performance were Alibaba Group (BABA), TJX Companies (TJX), and KBR (KBR):
- BABA (consumer discretionary) is the leading online and mobile commerce company in China, with dominant franchises in e-commerce, cloud computing, digital media and entertainment, and other innovative initiatives. In April, BABA underperformed a recovery in the index that was driven by optimism on the severity of the pandemic and the pace of reopening in the US. BABA’s complete lack of US consumer exposure and relative outperformance YTD both contributed to the underperformance for the period. The -6.8% Q1 GDP print for China and increasing tension between the US and China further pressured shares of BABA in the second half of April. To the extent that this pandemic leads to de-globalization of supply chains and even greater acrimony between the world’s two largest economies, BABA’s growth prospects will diminish alongside those of China’s middle class. We reduced our exposure to BABA modestly in mid-April as a result of this increased risk.
- TJX (consumer discretionary) is a retailer of off-price apparel and home fashion products operating primarily under the T.J. Maxx, Marshalls and Homegoods banners. TJX is typically a low beta, recession stalwart because of the value proposition its off-price retailing model provides to shoppers. In the month of April, as US case growth began to show signs of peaking and optimism on a reopening timeframe increased, TJX lagged the broader equity index recovery that was predominantly driven by a rebound in higher beta, more cyclical businesses. Though a reopening of TJX’s stores will be profoundly positive for the business, pure apparel retailers are a low priority on most State’s phased reopening plans, which also contributed to TJX’s relative lack of participation in the recovery rally. Having recognized the near-term risk to TJX that the pandemic posed, we had reduced our exposure in late March but we remain positive on the long term prospects for the business as the globe emerges from shelter-in-place mandates. The stress caused by this pandemic will only accelerate the store closures and secular share losses that department stores and mall-based specialty retailers have been facing, and TJX should see a plethora of attractive inventory opportunities in the second half of the year. In the second half of April, we took advantage of TJX’s relative underperformance by adding back a portion of the amount we had trimmed in late March.
- KBR (information technology) provides technology, engineering and professional services solutions across its Government Solutions, Technology Solutions and Energy Solutions divisions. Services include R&D, test, automation and integration, as well as operational, logistics, security and training support. KBR made multiple acquisitions to transition from its highly volatile legacy, energy-focused engineering and consulting (E&C) business to the more stable government and technology consulting services operations, which reduce the lumpiness of its activities and improve its profitability. Given that the transition is largely behind the company, that its remaining exposure to commodity-driven operations is now less than a third and is largely de-risked, and that its valuation discount relative to other government services pure-plays is too large to ignore, we believe KBR stock offers an attractive risk-reward opportunity currently. KBR shares underperformed during April, as the astounding emergence of historically low and even negative prices for West Texas Intermediate (WTI) crude oil caused the name to sell off in sympathy with the wider and seriously struggling domestic energy industry, even though the company’s exposures to such oil prices are no longer very meaningful. We would expect KBR stock to rebound as such unsustainably low oil prices rebound, and as the company’s continued execution leads to a positive re-rating of its valuation multiple.
During the month, we introduced Air Products & Chemicals (APD) as a new holding. On April 7, we received shares in Otis Worldwide (OTIS) and Carrier Global (CARR) through a tax-free spin-off distribution from United Technologies. Subsequent to the completion of the spin-off, our holding of United Technologies (UTX) was renamed Raytheon Technologies (RTX). We added to our positions in Bank of America (BAC), Bank of New York Mellon (BK), Boeing (BA), Chevron (CVX), EOG Resources (EOG), General Electric (GE), Goldman Sachs Group (GS), IHS Markit (INFO), Mondelez International (MDLZ), Parker-Hannifin (PH), TJX Companies (TJX) and Verizon Communications (VZ). We reduced our position in Alibaba Group (BABA), Ametek (AME), Chubb (CB), Lockheed Martin (LMT), Philip Morris International (PM), and Walmart (WMT). We eliminated our holdings in Comcast (CMCSA), Raytheon Technologies (RTX), Otis Worldwide (OTIS), Carrier Global (CARR), and Xcel Energy (XEL).
As of 04.30.2020.
Active weight refers to the difference in allocation of an individual security or portfolio segment between a portfolio and its benchmark. For example, if a portfolio allocates 15% within the energy sector, and the benchmark’s allocation in energy is 10%, then the active weight of the energy segment of the portfolio is +5%. Active weight can also be referred to as relative weight.
In terms of the current portfolio positioning, we are rather defensive, preferring stronger balance sheets over weaker ones, solid competitive positioning over more tenuous, etc. Quality and durability matter a lot right now, but we also are maintaining the loaded springs of value stocks that will do well in a recovery, whenever it comes. Relative to the Russell 1000 Value Index, DBLV is overweight information technology, consumer discretionary, communication services and health care. The portfolio is underweight utilities, materials, consumer staples, financials, real estate and energy. It is equal-weight industrials. The portfolio holdings by absolute and relative sector weights are found in the accompanying charts:
As of 04.30.2020.
We are overweight technology names via our information technology and communication services sector holdings, and we specifically prefer companies that can continue to generate idiosyncratic growth due to their value-creating innovation and/or ability to automate and reduce costs—both of which are especially important to enterprise and consumer customers currently. COVID-19 has accelerated the adoption of digital transformation, thereby strengthening a great number of these disruptors. We view these as motor boats that do not need a strong macroeconomic wind in their sails to perform in the present environment. We also like these companies because their balance sheets are generally rock-solid. We value these businesses not by a formulaic analysis of their relative price-to-earnings or price-to-book levels, but by thinking about their normalized earnings and cash flow generation over a longer period of time.
We are also overweight the consumer discretionary sector, but our holdings are largely defensive in nature, focused on the largest e-commerce players like Amazon and Alibaba that we feel will emerge stronger from the present crisis, as well as on dollar stores and other defensive retailers that are succeeding amidst the disruption caused by those internet giants.
We are moderately overweight weight health care. Although the sector is relatively cheap, it continues to face regulatory risks which we expect will continue to increase, as politicians and citizens grow still unhappier with our healthcare system and more emboldened to exploit the pandemic to grow big government further. Moreover, the companies delivering COVID-19 solutions will not be able to monetize those innovations, while the vast majority of health care companies face more business challenges than opportunities with people avoiding hospitals for not only elective procedures but even largely non-elective ones.
We are underweight the bond proxies collectively (i.e., utilities, consumer staples, REITs) because we prefer paying modestly more for technology companies with strong balance sheets and compelling business models that will likely emerge stronger from the crisis. The classic defensives possess fewer growth opportunities, higher underappreciated risks and relatively rich valuations. The names in these areas which we do own are of high quality and durability, thus meriting the multiple premiums prevailing in these sectors.
We are collectively underweight the industrials, materials and energy sectors, which are amongst the most cyclical areas, and thus, most at-risk in the current crisis. We are maintaining a defensive posture in quality names while allowing for some weighting in underpriced opportunities that we see surviving and thriving in an eventual recovery.
We are underweight the financials. Although we see the fears of credit defaults or negative rates as overblown for the asset-sensitive banks and consumer finance companies, we would prefer to overweight the sector at lower prices, after more unknown unknowns about the current economic downturn are revealed.
Finally, we continue to hold an outsized allocation to cash, maintaining this dry powder for opportunities that we think will arise as we continue through what will be a very bumpy road to recovery.
As always, the DBLV portfolio’s sector exposures primarily reflect the DoubleLine Equities team’s bottom-up investment process, which places an emphasis on individual stock selection. However, the macroeconomic views of DoubleLine Capital L.P. do inform secondarily these sector weightings.
In summary, we are cautious in the near-term, particularly given the robust bounce in equity index levels in April, as the equity markets seem ahead of themselves given the still present risks of COVID-19, the still deteriorating economic conditions, and the still unclear earnings prospects of most companies. Our defensive posture is also informed by the uncertainties associated with a sizable ramp in fiscal deficit spending and the Fed’s balance sheet, which together are ballooning U.S. public debt balances, alongside rising state and local debt as well as further corporate leveraging. We would expect the increased uncertainties will eventually create opportunities to buy at more attractive valuations good franchises with solid business models and the requisite financial strength to weather the current downturn.
We believe the fundamental value strategy of DBLV is well suited to navigate through the current environment of evolving risks and opportunities, as it affords balanced exposure to low-multiple value names, and to high quality, less economically sensitive stocks trading at reasonable prices. At month’s end, the price-to-earnings multiple on 2021 consensus estimates for DBLV was 14.8x, versus the Russell 1000 Value Index at 14.1x, and the S&P 500 at 17.7x. Importantly, we continue to maintain a longer-term orientation to wait patiently for the attractive opportunities we believe will yet appear in this down-cycle.
We thank you for your continued interest in DBLV.
AdvisorShares DoubleLine Value Equity ETF (DBLV) Co-Portfolio Manager
Past Manager Commentary