HITR Flash 2018 Q4

 

 All data for the period ended December 31, 2018 unless otherwise noted.

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“It’s Complicated”

― from the Latin verb complicāre, meaning “to fold together.”

 

What a difference a quarter makes! Last report we noted “continued expansion of global economic growth and strong corporate results, particularly in the US, boosted global equities.”  In that same report, after examining the possible pro and cons facing the market we concluded, “risk of a US recession in the near-term appears low.”

Fast forward ninety days and much remains the same yet everything seems different. Most of the pros and cons remain in place as reported last quarter. In the interest of space I will not recount them here but instead provide a link to last quarters’ Flash Report http://uniplanic.com/hitr-flash-2018-q3/ for those who would like to review the list.

During the quarter markets plunged, not just in the U.S. but around the globe. Market leadership, the FAANG stocks in particular, pulled back sharply and the broader market of stocks, many of which were already down substantially from their recent peaks, pushed lower into an extremely volatile December month end which marked several record intraday point swings of major market averages.

A Perfect Storm of unanticipated events began to plague the markets. A December profit warning from FedEx, which is an economic bellwether as the world’s largest cargo airline, regarding slowing shipping volumes in the EU caused broader concerns about global growth. Add to this interest rates moving higher, with the 10 Year US Treasury Bond pushing over 3% and increasingly hawkish rhetoric from the Federal reserve. Finally, escalating trade tensions and slower economic data out of China emerged as the President and Congress moved toward a budget impasse that would cause a partial government shutdown. The markets reacted with stocks tumbling lower and credit spreads widening sharply.

 


          Source: @StockCharts.com

And then, remarkably, the Perfect Storm appears to have subsided as the new year began. The new Federal Reserve Chairman Jerome Powell, in a stunning about-face emphasized the Fed’s willingness to show some restraint in moving rates higher and slow down on shrinking the Government’s balance sheet. Supported by softening public pronouncements from other Fed members and the markets had some rocket fuel on which to launch a reversal.

And then the market received a stage two booster. China’s industrial sector, which continued to show signs of weakness during Q4, received a boost with a large infusion of liquidity from the China Central bank by China acknowledging the slowdown and by fully shifting toward an easing stance. Then, facing potentially rising US trade barriers China offers a $1.0 Trillion (yes with a T!) trade package to boost spending over six years and eliminate the trade deficit with the U.S. The notion of a more level playing field in global trade has the C-suite of many large U.S. industrial companies more optimistic than we have seen in a decade and the regulatory environment has eased with trade policy now in support of US manufacturers.

The result was a market recovery that began in the first week of January and has not subsided as of this writing on January 20, 2019. It’s complicated as they say, but the ensuing rebound in many of the cyclical industrial stocks which we own coupled with lower rates supporting many of the dividend type sectors helped not only the markets but also many of the HITR Portfolio holdings which had suffered for much of the back half of 2018.

 


      Source: @StockCharts.com

 

HITR Portfolio Review

The preliminary estimated Portfolio Performance for the High Income Total Return Portfolio (HITR) for the period ended December 31, 2018 was as follows:

QTD YTD Yield
HITR K1 Gross -12.07% -10.35% 4.9%
HITR K1 Net -12.61% -12.07%
HITR Non K1 Gross -12.06% -10.66% 4.6%
HITR Non K1 Net -12.61% -12.44%
BLENDED 25 -11.20% -5.85%
S&P 500 -13.51% -4.37%
RUTZ 1000 -13.82% -4.78%

 

The Uniplan High Income Total Return (HITR) portfolio is focused on providing current income and long-term growth by owning dividend paying equity securities.  Within the portfolio these investments are grouped into the categories of Dividend Paying Common Stocks, Master Limited Partnerships (MLPs) or their proxies, Real Estate Investment Trusts (REITs) and Other Income Equities (primarily preferred and convertible stocks, ETFs, and ETNs). This note revisits some of the thematic qualities of the portfolio within each of the categories and the performance by sector across the overall portfolio.

 

COMMON STOCKS: A Narrow Market

As potential trade wars and the unexpected economic slowing in China hangs over the market, the long-awaited uptick in business capital spending and its benefit to the earnings and operating outlook of global industrial companies has been called into doubt. The thematic tilt of the HITR Common Stock Segment is toward a cyclical global industrial recovery. This thesis is under pressure as the World Bank lowered its 2019 global growth outlook, and positive sentiment evaporated like morning fog on a sunny London day.

During Q3 we lowered our exposure to the secondary theme of a recovery in the housing sector. Higher mortgage interest rates and a tightening of residential mortgage underwriting standards prompted us to adjust our exposure in that area.

Our other principal macro thesis, that of a synchronized global industrial recovery, seems to be under stress and the continuing Government shutdown has put pressure on U.S. domestic growth forecasts.  These increased economic headwinds along with a stronger U.S. dollar have effectively hurt valuations and put future growth rates into question. We continue to evaluate and monitor the risk related to these positions relative to other potential opportunities and will be carefully monitoring the Q4 earnings season for important datapoints that might cause a rethinking of our positioning.

The Dividend Paying Common Stocks segment, which currently represents about 30% of the portfolio as of 12/31/2018 and performed as follows:

QTD YTD Yield
HITR Common Stock -14.86% -15.01% 2.82%
S&P 500 -13.51% -4.37% 2.17%

 

Top performing names in the segment were Xilinx (XLNX) up +6.7% for the quarter on managements outlook for continued strong growth in engineered materials and an upcycle for chips which sets up growth for beyond 2018. The next best performer was Pfizer (PFE) down -0.2% for the period on continued defensive buying in the healthcare sector. The laggards were FedEx (FDX) -32.8% on concerns over lower guidance for 2019 as a result of sharply lower shipping volumes in the Euro Zone; this again is a potential early warning signal about global growth. The other lagging name for the period was Westrock (WRK) down -28.6% on concerns over higher input costs for the pulp components of their paper products and fear of slowing global demand.

 

MLPs: Recovering Slowly with Energy Prices

The central theme of our MLP investments continues to focus on mid-stream transportation along with some non-energy exposure to help mitigate volatility. The MLP segment lost traction on the back of lower global energy prices which showed a promising rally in September only to collapse into year-end. Interestingly, worldwide energy demand remained stable with both the EIA and BP moving up their global forecast of demand for 2019.


               Source: @StockCharts.com

The HITR portfolio currently has MLP exposure of 26% with meaningful exposure to non-energy MLPs Cedar Fair and Blackstone. These two investments helped performance relative to the AMZ benchmark in the regular HITR portfolios during 2018 but have contributed to some dispersion between the K1 and non-K1 versions of the product. They have been a drag on performance during this quarter with Blackstone being one of the big losers this period and Cedar Fair being a negative contributor last quarter. It should be noted that both raised their distributions to shareholders in 2018 with steady business outlooks.

Our allocation model has a target of 27.5% MLP exposure with our current weighting being 25.5%. As the energy markets have improved and global energy demand has firmed, we will continue to look for opportunities in the energy segment and will reevaluate our non-energy exposure in the MLP segment if allocation targets were to increase or energy fundamentals continue to improve.

The performance for the MLP Sector for the Period ended 12/31/2018 was as follows:

QTD YTD Yield
HITR MLP -17.42% -18.16% 8.30%
Alerian MLP Index -17.30% -12.43% 8.99%

 

Best performing names in the sector for the quarter-to-date were Enbridge (ENB) down -2.2%; followed by Holly Energy Partners (HEP) down -7.2% on no news for either company. Laggards were Energy Transfer (ET) down -22.8%; and Andeavor Logistics (ANDX) down -31.4% on uncertainty over the company’s future as a result of Marathon Petroleum’s (NYSE: MPC) purchase of the MLPs parent, Andeavor Petroleum Corp (APC), last year. Like APC, Marathon has its own subsidiary partnership in MPLX (NYSE: MPLX). Both of these subsidiaries serve the same function of supporting Marathon’s refining and marketing businesses with oil and refined-product logistics. What MPC will do with ANDX is uncertain and that put the stock under pressure.


OTHER INCOME: Relative Spreads Suggest Lack of Value

The focus in the Other Income sector has been defensive due to rising rates and their potential negative impact on preferred valuations. The Other Income Segment has been relatively flat for the year-to-date as lower quality preferreds continued to rally on what seems to be an unquenchable demand for yield from the retail investor.  Our holdings underperformed when our cash is included in the segment and we are cautious with a weighting of 15% including cash and lower exposure in preferreds due to several names being recently converted. We continue to look for interesting opportunities in the segment, particularly in the convertible preferred space, but have not uncovered any opportunities that look to have a favorable risk-reward profile.

QTD YTD Yield
HITR Other Income -5.20% -3.00% 3.33%
Barclays Pfd & Cvt -7.62% -3.18% 6.24%

 

Best performer QTD was Cash.  The laggard was Farmland Partners Preferred (FPI-PB) which lost -24.3%. The preferred, which is indexed to the price of US farmland moved lower on the threat of tariffs by China on US agricultural exports and a slanderous anonymous article published by a short seller in Seeking Alpha that accused the company of a conflict of interest with certain former members of management.


REITs: Strong Operating Fundamentals Continue
 

Our thematic tilt in the REIT sector is primarily focused on alternative real estate opportunities such as data centers and cell phone towers which provide strong growth opportunities.  These positions are balanced against higher yielding value and specialty REITs which provide more current income and longer-term value propositions relative to their underlying real estate valuations or net asset value. Our REIT selections were ahead of their respective benchmark for the QTD but remained behind for the year to date. The REIT segment currently represents 26% of the portfolio with a model target weight of 30% as of 12/31/2018:

QTD YTD Yield
HITR REITs -5.98% -6.62% 5.08%
NAREIT All Equity -6.07% -4.06% 4.32%

 

The best performing REITs were both in the cell phone tower sector AMT up +9.5% and CCI down -1.5%; both seen as defensive names in the growing cell phone tower segment. Apple Hospitality (APLE) and Equinix (EQIX) were the laggards during the quarter down -16.4% and -18.1% respectively.  Both names seemingly took a rest after strong performance in 2017 with concerns about business travel in the hotel space and tech segment fear for EQIX with the FAANG sell-off causing anything tech related to suffer in Q4.

ALLOCATION: Migrating Toward Average Relative Values

The HITR allocation model, uses the yield values of each portfolio segment relative to each other to determine a theoretical top-down portfolio allocation based on how tight or wide the yields are relative to long term historical averages. In theory, if all yield spreads were within one standard deviation of average, each segment would have a 25% target allocation.

During the period of 2014 through 2016, the yields of MLPs, REITs and Preferreds were relatively tight when compared to Common Stocks.  This relationship began to change over the last two years as REITs and MLPs underperformed Common Stocks and Preferreds. This has resulted in a slow migration of allocation targets back toward REITs and MLPs, with the three segments (REITs, MLPs and Common Stocks) very close to long term average valuations relative to one another; a valuation condition that we have not observed since prior to the financial crisis.

HITR Allocation Summary Table
As of 12/31/2018 Current Model
Sector & Benchmark Weight Weight
Common Stocks 29.5% 27.5%
S&P 500
MLPs 25.5% 27.5%
Alerian MLP Index
REITs 26.2% 30.0%
FTSE NAREIT All REIT
Other Income 18.8% 15.0%
Barclays Pfd & Cvt Sub Index

*May not add to 100% due to rounding

 

CONCLUSION:

We attempt to take a long-arc view of the market and remain focused on dividends and their underlying growth while being mindful of credit quality and relative valuation. This requires  a level discipline not to chase stocks that have moved outside of near-term valuation bands and to reposition capital when market movements and our allocation model weightings change in response to potential value opportunities.  We continue to target high quality companies that look like “winners” in a cyclical global recovery due to their strong balance sheets, conservative business posture, and ability to generate growing operating cash flow; however, our “synchronized global recovery” theme has come under pressure due to economic and political headwinds and will be under review as earnings season provides a better view into 2019 operating forecasts. Our focus is currently skewed toward bigger capitalization companies on a relative value basis with a focus on special situations and demand-driven dividend growth stories.  Patience is the key in this type of challenging market environment and each of our investments provides current income so we are paid to wait until valuations stabilize.

 

Richard Imperiale
Portfolio Manager
January 20th, 2019

 

Important Information: 1. Uniplan Investment Counsel is a boutique investment firm, with roots dating back to 1984, that manages a variety of portfolios primarily for US clients.  2. The composite was created January 1, 2001. Performance is calculated in US dollars utilizing a time-weighted total rate of return. Total return for the composite is represented by the asset weighted returns of the portfolios within the composite.  Trade-date valuation is used. 3. Performance is net of all transaction costs and net performance is net of transaction costs and (maximum allowable total) investment management fee, but before any custodial fees (that may be incurred separately by the client). 4. The benchmark for the composite is the Russell 1000 Index that measures the performance of the 1,000 largest companies in the Russell 3000 Index. The Russell 3000 Index represents approximately 98% of the investable US equity market. The index is adjusted to reflect reinvestment of dividends. It is not possible to invest directly in an index. The index figures do not reflect any deductions for fees, expenses or taxes. 5. The dispersion of annual returns is measured by the standard deviation of asset-weighted portfolio returns represented within the composite for the full year. The standard deviation of the gross annual returns for the period January 1, 2001 through December 31st, 2018 is 14.19% for the composite and 16.94% for the Russell 1000 Index. 6. The composite does not have a minimum size criterion for composite membership. All fee-paying discretionary accounts with similar investment objectives are included. Leverage is not used in this composite as a means to generate higher returns. There may be non-fee paying portfolios in the composite.  Individual account holdings may vary depending on numerous factors including the size of an account, cash flows, and account restrictions.  7. There have been no changes in the personnel responsible for the management of this composite. 8. The composite contains both traditional and wrap fee portfolios. Uniplan has a flexible and negotiable fee schedule reflecting the differences in size, composition and servicing needs of clients’ accounts. 9. Uniplan Investment Counsel does not claim GIPS compliance. A complete description of investment advisory fees is contained in Uniplan’s Form ADV and is available upon request. Individual account performance may vary from the results shown because of differences in inception date, restrictions and other factors. Past performance is no guarantee of future results.  Investment involves a risk of loss.

All investments carry a certain degree of risk, including possible loss of principal. REITs are subject to illiquidity, credit and interest rate risks, as well as risks associated with small- and mid-cap investments. It is important to review your investment objectives; risk tolerance and liquidity needs before choosing an investment style. Value style investing presents the risk that the holdings or securities may never reach their full market value because the market fails to recognize what the portfolio management team considers the true business value or because the portfolio management team has misjudged those values. In addition, value style investing may fall out of favor and underperform growth or other style investing during given periods.

Uniplan Investment Counsel) is a registered investment advisor. The views expressed contain certain forward-looking statements. Uniplan Investment Counsel believes these forward-looking statements to be reasonable, although they are forecasts and actual results may be meaningfully different. This material represents an assessment of the market at a time and is not a guarantee of future results. This information should not be relied upon by the reader as research or investment advice regarding any security. Past performance does not guarantee future results. Prices, quotes and other statistics have been obtained from sources we believe to be reliable, but Uniplan Investment Counsel cannot guarantee their accuracy or completeness. All expressions of opinion are subject to change without notice. It should not be assumed that recommendations made in the future will be profitable or will equal the performance of this security. A list of securities purchased and sold in the portfolio during the past year, including the purchase or sale price and the current market price, is available upon request by calling 262-534-300

 

 


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