DBLV: June 2020 Portfolio Manager Review
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The U.S. equity market saw a dramatic recovery in the second quarter on unprecedented government intervention, even as the economy continues to struggle through a set of challenges arguably greater than anything faced since the Great Depression. While we can debate whether the latter’s recovery path will more closely resemble a U or an L, the sharp V-shaped recovery of U.S. stocks, and the large-cap technology franchises in particular, has created a difficult environment for value-oriented investors seeking returns commensurate with risks. We see the market likely pricing too much good news into an underlying economy still ridden with many risks that either pre-date the pandemic or that have been exacerbated by it. Yet recognizing the need to remain invested under these difficult conditions, we seek to balance our portfolio exposures between those names that should prove defensive in these difficult times and those that present attractive opportunity as the underlying economy begins a broader, sustainable recovery. Our differentiated fundamental value strategy affords us an ability to balance these two types of investments within the DBLV portfolio.
The U.S. equity market experienced during the second quarter a continuation of the robust recovery that began in mid-March. The epic bounce in equities was led by the continued momentum of large-cap growth stocks, which powered the Russell 1000 Growth Index up 27.8% during the second quarter, while the Russell 1000 Value index increased 14.3% over the same period. Meanwhile, the S&P 500 rose 20.5% in the recently completed quarter, and is now down only 3.1% for the year. The AdvisorShares DoubleLine Value Equity ETF (DBLV) posted a return of 17.1% in the second quarter, ahead of its benchmark, the Russell 1000 Value Index, by 2.8%.
The cumulative move from the bottom would appear to have put the markets at the higher reaches of historical valuation ranges, even as the underlying economy continues to suffer through very difficult times. The reason for this dramatic divergence is the unprecedented pace of monetary intervention by the Federal Reserve, along with record levels of governmental fiscal stimulus. The monetary and fiscal programs deployed to date are multiple orders of magnitude greater than those used during the prior global financial crisis (GFC) in 2008. Moreover, the Federal Reserve has reached still further into its box of unconventional tools, broadening the type of assets acceptable as collateral through various new lending facilities that permit the purchase of short-term municipal, corporate or even junk bonds, along with the origination of loans to small and medium-sized businesses. The result of the ongoing money printing and asset purchases associated with this new level of quantitative easing (QE) will likely be a Fed balance sheet exceeding $10 trillion by early next year.
The implications of this extraordinary intervention are profound, and, in our opinion, include profound risks.
First, the government programs have likely delayed but not eliminated the economic carnage following the pandemic and resulting lockdowns. Take unemployment numbers. We were told in June that the official unemployment rate had declined to 11.1%, from an 80-year record high of 14.7% in April; however, due to the misclassification of many unemployed (i.e., workers temporarily furloughed but not fired under the Paycheck Protection Program), the real unemployment is likely much higher that the official number, with total claims as a percentage of total non-farm payrolls approaching 25% at the end of June. Because many individuals through multiple programs are receiving more money while sitting out of the workforce, it is hard to understand what the real unemployment rate is, nor fully observe yet what the impact of such joblessness will be on the economy going forward. Indeed, the stimulus checks, enhanced unemployment benefits, and unemployment insurance have not only replaced lost income for many newly unemployed, but has caused the total personal income figure in May to actually exceed the pre-pandemic number posted in February. This artificial boost in buying power drove a rebound in retail sales in May, up about 17.7% over April, and has enabled many consumers to meet their debt obligations, as has substantial forbearance. Furthermore, the fiscal and monetary stimulus likely also supported the apparent record increases in online brokerage account openings and epic retail investor participation in the market (n.b.: Robinhood, a brokerage popular among millennials, saw a doubling of its online accounts between mid-February and the end of June). However, this sugar high cannot continue indefinitely since more government aid will be needed, as many begin to expire at the end of the current month, with uncertain prospects for the likelihood, size and timing of their renewal. In short, the full picture of the damage cannot yet be taken in by watchful investors, and some of the indicators currently visible are likely misleading.
Second, this unprecedented monetary and fiscal effort by the Fed and federal government may still not be enough to circumvent a credit crisis from occurring, so an extended economic recession or depression remains possible. By many measures, this is the worst economic downturn since the Great Depression. Indeed, the Congressional Budget Office estimates that real gross domestic product in the second quarter contracted by 10.1% quarter-over-quarter, equivalent to a 35% year-over-year decline. While the tentative re-opening attempts and epic stimulus could reverse some of this, the economy is far from out of the dark woods, and there is growing risk that this develops into a credit crisis the longer the downturn drags on. There remains considerable uncertainty about whether government fiscal support will be extended and surrounding the amount and duration of future stimulus. Moreover, monetary stimulus is potentially reaching limits, as it is less effective in stimulating demand in the current environment, because recipients might be too fearful to spend, as rising savings rates would suggest. The failure of these government stabilizers obviously could create dramatic reversals for the financial markets.
Third, the purchase of corporate bonds and other riskier assets is likely distorting the market and economy. Since the government is not price sensitive when it purchases these securities and does not evaluate the underlying risk of these businesses, this could lead to mispricing of risk and misallocation of capital, as the price-discovery mechanism of the market becomes overwhelmed by the Fed’s activities. The result of Fed intervention is often that asset prices tend to appreciate irrespective of the underlying risk, undermining price discovery and encouraging excessive risk-taking by other market participants, who see the Fed put as license to aggressively assume such risk. Meanwhile, zombie companies that generate inferior returns may be able to access cheap capital and otherwise are allowed to operate longer, which can enable excess capacity and inefficiencies to linger in the economy, thereby harming healthier, efficient companies. The resulting moral hazard can lead to future financial excesses, thus increasing risks that credit problems deferred will merely resurface as a larger problem in the future. Finally, asset prices that are boosted by the Fed’s actions could be pressured when assets are eventually sold as the Fed’s program ends.
Fourth, all of this intervention also raises the specter of increased inflation risk. This danger could come from multiple places. The enormous money-printing operation that supports both the fiscal and monetary stimulus underway could catalyze investors’ concerns about the purchasing power of the U.S. Dollar, and the fact that gold is making new highs as we write this clearly highlights this risk. In addition, the simultaneous reduction in capacity—as evidenced by the extremely high levels of furloughed or unemployed workers—along with the maintained purchasing power of such individuals likely causes overall demand to outstrip supply, which is another inflationary driver. The announcements by some companies of wage increases to entice the subsidized unemployed back to work highlights this dynamic. Furthermore, the long-term risks of additional government intervention—particularly in the event of a Democratic sweep of Congress and the White House—leading to greater inefficiency and upward inflationary pressure are very real. Because so much of the phenomenal increases in stock market levels over the last 40 years have come from multiple expansion, driven by interest rate declines, it is important to understand that a reversion to higher inflation and interest rates will make future financial asset appreciation tougher to achieve.
Even as the economy faces challenges and risks that rival those of the Great Depression, stock market valuations appear by most measures well extended at the highest end of historical ranges, which is at odds with the typical pattern of multiples troughing in similarly severe economic collapses. At present, the S&P 500’s fiscal year 2020 forecasted P/E is about 24.8x versus a historical average of 15.1x since the mid-1930s, according to Yardeni Research. Valuations are likely even higher under more normal margin conditions, as the S&P 500’s cyclically adjusted P/E (a.k.a., the CAPE ratio) is about 30.0x, which is also well above its 150-year average of 16.7x. Each of these valuation measures troughed at 15x or lower during the Global Financial Crisis, so concluding that a new bull rally is now underway would be to ignore history’s lesson concerning the valuation levels upon which new bulls are born.
Many will point to the record low interest rates as playing a key role in driving market multiples and thus equity index levels. With the yield on the 10-year Treasury falling to 65 basis points at quarter’s end, the S&P 500 now offers a more competitive dividend yield of 1.87%–in contrast to the historical pattern of the 10-year Treasury yield exceeding the (growing) S&P 500 dividend yield. However, the risk associated with this analysis is that interest rates are at record lows precisely because there is little growth. Indeed, earnings for S&P 500 companies are expected to decline about 44% year-over-year in the second quarter and about 21.5% in fiscal year 2020, which means that even looking out three years, it is likely that one is paying more than 20x for hard-to-forecast earnings in 2022. This lack of growth offsets the benefit of the lower discount rate, and therefore, calls into question the propriety of paying such high valuation multiples on the market overall.
Note that individual companies, especially those emerging from the economic crisis with a strengthened competitive position, might justifiably command such a premium, but it is doubtful that the market overall should do so. Further, the relatively high dispersion of current earnings estimates not only reflects the great uncertainty about the path of economic recovery and the highly varied prospects of companies going through the current crisis, but also underscores the need to actively manage one’s equity investments in this uncertain environment.
While the broader valuation metrics appear stretched for the major equity indexes, there remain pockets within the broader stock market that offer attractive risk-reward opportunities. This includes companies offering long-term value not yet fully recognized by other market participants, as well as, strong franchises that benefit from sustainable secular trends that have actually been enhanced during the pandemic and economic downturn. Hence, amidst an admittedly challenging macro environment, with elevated systemic risks around the pandemic and economy, we continue to follow our investment strategy by seeking out fundamental value where we can find it.
Looking beyond the twin problems of the pandemic and the economic collapse, we would note two other simmering issues. First, the Presidential election poses additional risks that do not appear to be reflected fully yet within the market. The stock market has climbed over the last month even as Biden has gained a significant lead over Trump in the polls and betting sites, and even as those polls and prediction markets signal growing prospects of a Democratic sweep in Congress. Such a blue wave would enable Democrats to push forward with an anti-corporate agenda that includes higher taxes and increased regulations, which together could pose a further headwind to corporate profitability and market multiples. Biden has already indicated that he intends to return the corporate tax rate to 28% from 21%. While it is unclear how fast such policy changes would be made under a Biden White House with Democratic Congressional control, we see these risks growing and potentially weighing on certain segments of the market, if not overall prevailing valuation levels.
Finally, we should note that China-U.S. relations have continued to deteriorate through the ongoing pandemic. China appears to have been the source of the pandemic, and has been criticized for not being rapidly or completely forthright in reporting dangers surrounding COVID-19 to the rest of the world. As a result, relations with the U.S. have soured further, as the two economic superpowers have exchanged escalating threats, including China’s apparent unwillingness to make previously promised purchases of agricultural and other products under the trade agreement, as well as America’s increasing efforts to cut off Huawei’s access to critical semiconductor content. Further escalation of these disagreements, which both sides are now describing in rather bellicose terms, could raise additional risks of costly supply chain decoupling and market share shifts impacting many highly-valued companies in the equity market.
In summary, we are still only in the very early stages of recovery from a terrible pandemic and an economic collapse, among other challenges, and the path to a full recovery from these twin tragedies remains highly uncertain and likely will carry setbacks along the way. Ultimately, the recovery will depend both on the course of the COVID-19 pandemic, advances in treatments and vaccines, and efficacy of containment efforts, as well as on the ability to restart fully economic activity in the aftermath of this pandemic, all of which are inherently unpredictable and susceptible to fits and starts in hospitalizations and risks of re-closures.
Many unknowns remain surrounding the shape of the economic recovery, including: 1) an economy still heavily reliant on uncertain future government support, especially in an unpredictable election year; 2) risks of pandemic-prompted re-closures hampering the restart of economic activity; 3) state and local governments may be forced to cut spending and lay-off employees, adding incremental challenges to the economy; 4) the Presidential election could result in higher taxes and regulatory burdens that squeeze future earnings; 5) particularly vulnerable industries, such as travel and leisure, will likely be smaller for longer, causing protracted losses of jobs, corporate earnings and market capitalization; 6) the propensity to spend by consumers and the capex levels of businesses could be hampered by the psychological harm caused by the virus; 7) heightened trade tensions with China, exacerbated by the source of the pandemic, could disrupt supply chains further and exacerbate the already weak economy; and 8) longer-term risks of further zombie-fication of the economy and stoking of meaningful inflationary forces, which are potential unintended consequences of the record increase in government debt and money supply from the nearly unlimited quantum of QE that is ongoing.
Although we think the broader market is not pricing in completely these substantial risks and unknowns, we do expect many states will continue to move forward with their re-opening plans, in spite of any resurgences in infections and hospitalization. We would expected this to lead to a slow improvement in the economy over time, as people get back to work, and assuming a major credit crisis is averted with the help of additional government support. Furthermore, we recognize that the recovery could accelerate if a coronavirus vaccine becomes available late this year or early next. We will continue to remain disciplined with regard to valuation, as we evaluate the path of recovery relative to market expectations.
In light of these observations, we continue to search for attractive investment opportunities while believing that 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. We also expect that active management will show its value in the present investing environment, as the differences in relative company positioning begin to emerge through the crisis and into the changed, post-COVID-19 world. We will continue to seek sound, long-term investment ideas and strike reasonable balances within our portfolio among those investment ideas offering potential safety in uncertain times and those holdings that represent compelling long-term value once a broader recovery is underway. Our differentiated fundamental value investment philosophy allows us the opportunity to capture both of these opportunity sets, in our ongoing effort to secure solid relative returns.
In the second quarter, our portfolio positioning helped to obtain relative outperformance. In terms of the portfolio’s sector attribution, quarterly performance for DBLV was driven by positive contributions from communication services, consumer discretionary, consumer staples, energy, financials, health care, industrials, information technology, materials, real estate, and utilities. On a relative basis, DBLV was helped by communication services, consumer staples, financials, health care, industrials, information technology, and real estate, offset by adverse results within consumer discretionary, energy, materials, and utilities. Cash had a negative impact on relative performance in a rising market.
As of 6.330.2020.
Top positive contributors to second quarter performance were Parker-Hannifin (PH), Facebook (FB), and Microchip Technology (MCHP):
- PH (industrials) performed well in the second quarter. Parker Hannifin is an early or short cycle machinery company that makes motion control systems and components that are used in a diverse set of equipment for industrial and consumer end markets. The stock’s outperformance was driven primarily from the reopening of the US economy and the anticipated increase in manufacturing activity. The company has improved operating margins in recent years, and this execution helped mitigate the recession’s impact in the first calendar quarter of the year. After generating better than expected decremental margins Q1 and outlining substantial cost reductions, the company stated that April 2020 orders had stabilized, marking a bottom. With the reopening of the US economy, the market anticipated a recovery in sales combined with a smaller cost structure, which together would result in significant earnings growth. We believe the equity value has material upside, to be realized as industrial activity rebounds.
- 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; it also owns Oculus, a suite of virtual reality solutions. FB stock outperformed in the second quarter of 2020, along with many of the technology platform giants, rising more than 35% over the period, as the market re-rated the company’s earnings prospects, which, although tied to advertising, are expected to be less impacted than most companies given the continued secular growth of digital ads. We chose to exit the position during the second quarter, given multiple rising risks surrounding its advertising revenue—which is more dependent on smaller businesses that are more vulnerable in the current economic environment—as well as heightened customer and government scrutiny surrounding its policies to police hate and political speech.
- MCHP (information technology) supplies various microprocessors, microcontrollers, analog, memory and related products and tools used in embedded control systems sold to a wide variety of sectors, including automotive, industrial, communication, data center, lighting and power supply. MCHP was up more than 60% last quarter, driven by a bounce from the first-quarter lows posted by the broader semiconductor sector that was the sharpest rise since the tech wreck of the early 2000s. The market’s reassessment of prospects across several end-markets, including those hit hardest by COVID-19, drove the strong outperformance. We continue to hold the name, given the highly favorable long-term trends supporting the company’s business, including the growth of cloud computing and factory automation, or the advent of electric vehicles or 5G communication solutions.
Top detractors from quarterly performance TJX Companies (TJX), Verizon Communications (VZ), and Philip Morris International (PM).
- 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-resistant stalwart because of the value proposition its off-price retailing model provides to shoppers. In the month of April, as US COVID-19 case growth began to show signs of peaking and optimism on a reopening timeframe increased, TJX lagged an index recovery that was predominantly driven by a rebound in higher beta, more cyclical businesses. Though the reopening of TJX’s stores is profoundly positive for the business, pure apparel retailers have been a lower priority on most U.S. 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 world 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 and in the middle of May, we took advantage of TJX’s relative underperformance by adding to our position, given our sanguine view on the company’s long-term prospects coming out of this pandemic.
- COF (Financials) – COF is a leading credit card and auto finance company. The company has a strong understanding of consumer risks and has been good at underwriting subprime credit by leveraging technology and statistical data. Over the last few years, COF has migrated its portfolio mix towards higher quality credit, by growing its prime credit card business and lowering its exposure to high balanced revolvers. Over the last few months, consumer finance companies have been under pressure due to uncertainties surrounding credit card defaults following the rise in unemployment, resulting from the COVID-19 pandemic. More recently, COF stock underperformed its peer group on concerns that it may have to cut its dividend, despite performing well during the Fed’s financial stress tests, because of a new regulatory rule. At 0.44x P/B and 0.65x P/TBV, the stock appears to be pricing in not only the risk of a dividend cut, but also a meaningful hit from credit losses. We expect these feared credit losses ultimately to prove smaller than feared and thus, view the stock as attractively valued.
- VZ (communication services) is a leading communications provider to consumers, businesses and governments, currently supplying about 95M wireless retail connections, 6M broadband connections and 4M Fios video connections, as well as related solutions to hundreds of thousands of businesses and public entities. Verizon is expected to benefit from the planned merger of two competing wireless players, Sprint and T-Mobile, as well as from the launch and rollout of 5G wireless services. VZ stock underperformed last month as the safe-haven stock lagged in the dramatic second quarter equity market bounce, as would be expected. Given the importance of wireline and broadband connectivity, Verizon retains utility-like qualities and yet also sports a multiple that is lower than regulated utility companies. We choose to own the stock as a defensive name expected to better weather risk-off market environments.
- PM (consumer staples) is the world’s largest supplier of tobacco products to markets other than the U.S. and China. The stock underperformed in the second quarter primarily because of its defensive nature and its exposure to international markets. Compared to the U.S., many countries have generally implemented stricter stay-at-home measures to combat the spread of COVID-19 and not all are able to provide the same level of government stimulus to consumers that the U.S. has. This is resulting in weaker near-term trends for PM’s products, but it should be noted that foreign countries overall have been more successful in reducing infection rates and, therefore, appear to be on a better path toward fully reopening than the U.S. Additionally, retail closures disrupted the company’s ability to drive conversion to its higher margin heat-not-burn products, though PM’s management team has recently expressed positivity on heat-not-burn product performance relative to internal expectations. These headwinds have weighed on PM’s stock price performance in the near term. Over the medium and long term, however, the highly attractive dividend yield (>6.5%) and a valuation (only 13.4x consensus 2021 EPS) make PM a stock worth holding onto.
During the rather volatile quarter, we made a number of portfolio adjustments. We introduced as new holdings: Ameren (AEE), American Express (AXP), Air Products and Chemicals (APD), Citizens Financial (CFG), Capital One Financial (COF), Dupont De Nemours (DD), Kellogg (K), Lam Research (LRCX), M&T Bank (MTB), Nextera Energy (NEE), Norfolk Southern (NSC), Northrop Grumman (NOC), Pepsico (PEP), and Reynolds Consumer Products (REYN).
Net additions to our positions were: Bank Of America BAC), Bank Of New York Mellon (BK), Chubb (CB), Chevron (CVX), EOG Resources (EOG), General Electric (GE), Goldman Sachs (GS), IHS Markit (INFO), KBR (KBR), Microchip Technology (MCHP), Mondelez International (MDLZ), Medtronic (MDT), Parker-Hannifin (PH), Prudential Financial (PRU), Raytheon Technologies (RTX), TJX Companies (TJX), Valero Energy (VLO), Verizon Communications (VZ), and Willis Towers Watson (WLTW).
Net reductions to our positions were: American Tower (AMT), Air Products & Chemicals (APD), AstraZeneca (AZN), Bank Of America (BAC), Boeing (BA), Chubb (CB), Citizens Financial Group (CFG), Capital One Financial (COF), Chevron (CVX), Dollar General (DG), Flex (FLEX), Alphabet (GOOGL), Goldman Sachs (GS), Intercontinental Exchange (ICE), JPMorgan Chase & Co (JPM), KLA Corp (KLAC), Microsoft (MSFT), M & T Bank (MTB), Philip Morris International (PM), PNC Financial (PNC), Roche Holding (RHHBY), Sanofi (SNY), Taiwan Semiconductor (TSM), and US Foods Holding (USFD).
We eliminated our holdings in: Alibaba Group (BABA), American Express (AXP), Ametek (AME), Bank Of New York Mellon (BK), Comcast (CMCSA), Facebook (FB), Fidelity National Information Services (FIS), General Electric (GE), Kellogg (K), Lockheed Martin (LMT), Nextera Energy (NEE), Northrop Grumman (NOC), Otis Worldwide (OTIS), Raytheon Technologies (RTX), Walmart (WMT), and Xcel Energy (XEL).
As of 6.30.2020.
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 consumer discretionary, consumer staples, energy, financials, health care, and information technology, and underweight industrials, materials, real estate, communication services, and utilities. The portfolio holdings by absolute and relative sector weights are found in the accompanying charts:
As of 6.30.2020.
We are overweight information technology, and specifically, we 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 player, Amazon, which 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 increased our exposure to consumer staples, taking the sector to an overweight, given our concerns about the frothiness of the market. Staples did not participate as much with market rally over the last couple of months. We added companies with strong established brands that provide earnings that are more resilient to economic weakness.
We are overweight the financials, after adding to our positions during the pullback in June. The asset-sensitive banks and consumer finance companies currently trade at a significant discount to the market and appears to be reflecting recessionary concerns and fears of credit defaults. We see long-term value in our financial companies and believe there are substantial upsides when a recovery does occur.
We are moderately overweight 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 communications services, after taking profit on Facebook and exiting our Comcast position. We believe consumer staples provide a more defensive positioning.
We are underweight the utilities and REITs, because we see greater value in consumer staples companies with more durable earnings, and in technology companies with strong balance sheets and compelling business models that will likely emerge stronger from the crisis. The classic defensives in utilities and REITs 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, or possess attractive valuation.
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.
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 likely 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 on equities in the near-term, particularly given the robust market rally since the market bottom in March, as the broad equity indexes seem to have gotten 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 the weak economy’s dependence on an unprecedented ramp in fiscal deficit spending and the Fed’s balance sheet, alongside rising federal, state and local debt. We would expect the increased uncertainties will eventually create more widespread 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 quarter’s end, this balanced exposure yielded a P/E multiple on 2020 consensus estimates for DBLV was 19.1x, versus the Russell 1000 Value Index at 18.7x, and the S&P 500 at 23.4x.
We thank you for your continued interest in DBLV.
AdvisorShares DoubleLine Value Equity ETF (DBLV) Co-Portfolio Manager
Past Manager Commentary