Select Dividend Q3 2024 Investor Letter

Fade the Chattering Class

Hard landing, recessions, elections, geopolitics… the Chattering Class always has a reason to be bearish. Risk sentiment is surprisingly neutral at best. Investors are positioned defensively and margin debt – a key ingredient for any bubble - remains low.

We are surprised in our investor conversations at how the majority seem to have taken a dour view on the economy. We have believed since late last year that the end of a Fed hiking cycle was the beginning of an equity rally. Our research was prescient as major equity markets are up ~20% YTD and our portfolios were positioned to participate in such a market rally.

The Fed is Ahead of the Curve

The Federal Reserve kicked off the cutting cycle with a rare half point cut. Many investors speculated “What does the Fed know that we don’t?” In our view, the Federal Reserve is being very proactive and is ready to preempt any labor market weakness. This is not a recessionary rate cutting cycle whereby the central bankers have fallen behind the curve.

Many forget that past proactive interest rate cuts have paved the way for further equity gains in previous cycles. Proactive rate cuts in 1995, 1984 and 1966 led to further equity rallies of ~20% within the first year following the cut and the 2019 cuts were on track until a global pandemic derailed the Fed’s plans.

1995  Redux

Today’s economic setup seems to most mirror that of the mid-1990’s. Chairman Greenspan cut rates 75 bps over several months in 1995 to get back to a neutral monetary policy. The 1995 rate cutting cycle was a canonical, mid-course correction.

Today, the Fed realizes that interest rates are very restrictive and believes that the neutral rate is ~150-175 bps lower than the current Fed Funds rate. The Fed is easing monetary policy without waiting for economic weakness much as Greenspan did in the mid-1990s.

The Fed Put is Back

The FOMC has pivoted to the second part of its dual mandate – maximum employment – now that inflation dragon has been slayed. Which means in practice that a recession is not an option and the Fed Put is back.

This is good news for investors. The macro data paints the picture of a US economy chugging along. We believe the Fed is cutting rates into a relatively strong economy which is bullish for risk assets, and it will likely cut rates aggressively if the labor market deteriorates any further. But the Fed will continue to cut at a slower rate even if the equity markets inflate further as the FOMC’s mandate does not include bubble popping. Investors can have their cake and eat it too.

Political handicappers are having a field day this election cycle, while investors are having nightmares. It is silly season for campaigning politicians who attempt to snare voter attention without outlandish promises.

Our research shows that the equity markets perform strongly in most election years, driven by strong postelection rallies. This makes sense as tribal voters remain defensively positioned headed into an election fearing that the opposing party may win. If their party wins, their risk sentiment and positioning may become more aggressive, and if not may remain more defensive. The same is true for the opposing tribe. But one party wins and their supporters’ risk posture changes as they clink champagne glasses. Thus, we believe, equity markets grind higher.

The political betting markets are pricing in a toss-up Presidential election and a divided Congress. If neither party secures a clean sweep of the White House and Congress, we expect the markets to celebrate the DC gridlock. Investors crave certainty.

Most importantly, remember that the relationship between politics and the market is seldom direct. Even with the constant flow of political updates, the key factors influencing investment performance are still earnings, interest rates, and valuations.

Performance Update

The Select Dividend strategies have kept pace with or outperformed their broad strategy benchmarks over the last 12 months. This might seem like an average result; however, it is anything but in a narrowly driven Tech market. The Select Dividend strategies remain in the top quintile of their peer groups* over the trailing 1-year period.

Our Small Cap Core strategy has performed strongly YTD, outperforming the iShares Russell 2000 ETF by 13.0% on a net basis. Small Cap Core benefits from less index concentration - particularly in technology – allowing our disciplined investment process to capture idiosyncratic alpha.

*GSD (net) ranked in the 21^st percentile. Advisory Research composite peer rankings represent percentile rankings which are based on the respective monthly returns and reflect where those returns fall within the indicated eVestment Alliance (EA) universe. The universe for this analysis is all Global Dividend managers in the EA universe, and ranking data is based on performance as of 9/30/24. The analysis was generated on 10/11/24 and is subject to change as additional firms within the category submit data. EA provides third party databases, including the institutional investment database from which the presented information was extracted. The EA institutional investment database consists of thousands of active institutional managers, investment consultants, plan sponsors, and other similar financial institutions actively reporting on over 10,000 products. Advisory Research pays an annual fee to eVestment to access their platform and to use their data, including peer group rankings, in marketing materials. Advisory Research does not pay specifically for the ranking.

Past performance does not guarantee future results. Investing in securities involves risk, including the possibility of the loss of principal.

Gross performance is shown net of all trading costs/commissions and gross of all management fees. Net performance is shown net of all trading costs/commissions and management fees. Unless otherwise stated, performance greater than one year is annualized. Actual client portfolio results may differ, based on, among other things, an account’s particular investment objectives and restrictions, asset levels, and timing of contributions and withdrawals.

Please see Advisory Research’s Form ADV Part 2A, which is available upon request, for more information.

Certain information contained herein constitutes forward looking statements, projections and statements of opinion (including statements of financial market trends). Such information can typically be identified by the use of terminology such as “may”, “will”, “should”, “expect”, “anticipate”, “project”, “estimate”, “intend”, “continue” or “believe” or comparable terminology. All projections, opinions and forward-looking statements are based on information available to Advisory Research as of the date of this presentation, and Advisory Research’s current views and opinions, all of which are subject to change without notice. Due to various risks and uncertainties, actual events or results may differ materially from those reflected or contemplated in forward looking statements. Additionally, information and views presented herein may be drawn from third-party or public sources which are believed, but not guaranteed, to be reliable and which have not been verified for accuracy or completeness.

Advisory Research is providing this material for informational purposes only. The information provided is not intended to recommend any company or investment described herein and is not an offer or sale of any security or investment product or investment advice. Before making any investment decision, you should seek expert, professional advice and obtain information regarding the legal, fiscal, regulatory, and foreign currency requirements for any investment according to the laws of your home country or place of residence.

Benchmark comparison is presented using the iShares MSCI ACWI ETF, iShares Russell 1000 ETF, and the iShares Russell 2000 ETF as Advisory Research considers these ETFs to parallel both associated risk and the investment style presented by each strategy.

The iShares MSCI ACWI ETF seeks to track the investment results of an index composed of large and midcapitalization developed and emerging market equities. The iShares Russell 1000 ETF seeks to track the investment results of an index comprised of large- and mid-capitalization U.S. equities. The iShares Russell 2000 ETF seeks to track the investment results of an index composed of small-capitalization U.S. equities.  

Advisory Research’s strategies are actively managed and not intended to replicate the performance of any cited index: the performance and volatility of Advisory Research’s investment strategies may differ materially from the performance and volatility of a cited index, and their holdings will differ significantly from the securities that comprise the index. You cannot invest directly in an index, which does not take into account trading commissions and costs.

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