Skip to main content

FY Income Equity – 2023 vs R1000V

Download Article
FY Income Equity – 2023 vs R1000

Market Observations & Portfolio Commentary 

Income Equity – 2023 vs R1000V

 

Full Year Market Update 

For the year, the broader market posted solid gains, with the Russell 3000 up 26.0%. At the start of 2023, interest rates were rising, inflation was stubbornly high, and investors were bracing for a recession. Instead, inflation continued falling, consumers kept spending, and the unemployment rate fell to its lowest level since 1969. With slowing inflation, signs of better balance in the labor market, and normalized GDP growth expectations, the Federal Reserve indicated that it would pivot to rate cuts later in 2024. Huge rallies by the mega-cap Magnificent 7 (Apple, Microsoft, Amazon, NVIDIA, Alphabet, Tesla, & Meta Platforms) were a big driver of overall index performance, and narrow market leadership remained a nagging concern for much of the year.

It was a year of bifurcated performance, led by the mega-cap stocks. Enthusiasm over artificial intelligence and robust gains by the Magnificent 7 led to significant outperformance of the Growth Indices and helped mask weakness in other corners of the market. Non-dividend paying companies significantly outperformed companies that pay a regular dividend, especially in the large cap space. Turning to market factors for the year, Volatility and Growth factors posted the strongest results. Value, Yield, and Momentum factors presented headwinds; while Quality and Momentum factors delivered mixed results.

 

Key Performance Takeaways for the Year

  • The London Company Income Equity portfolio gained 5.9% (5.5% net) for the year vs. an 11.5% increase in the Russell 1000 Value Index. Sector allocation aided relative performance, offset by stock selection.

  • The Income Equity portfolio lagged the Russell 1000 Value in 2023 and came up short of our 85-90% upside capture expectations. Headwinds from exposure to higher yielding, lower beta, higher quality holdings relative to the Russell 1000 Value Index led to challenging relative performance. Higher yielding stocks had a historically bad year versus non-dividend payers, as nearly 50% of the Russell 1000 Value’s return came from non-dividend payers.

  • Historically, a reliance on high Quality factors and dividend investing has proven to be a strategy that can lose battles along the way but tends to win the war over time. As the past few years have demonstrated, market trends and leadership can turn on a dime. We don’t chase the ups and downs of the risk trade; instead, we commit long-term capital to Quality companies that have greater control over their own destiny. While the full benefits of quality & dividend investing have been delayed at the large cap level, we don’t think they’ll be denied in the long term. In our view, the characteristics of the Income Equity portfolio remain attractive, and we believe we’re well positioned for an uncertain future.

 

Top 3 Contributors to Relative Performance 

  • Apple (AAPL) – AAPL was strong all year reflecting growth in iPhone sales as well as gains from the mix toward services. AAPL returned significant cash to shareholders via share repurchase and dividends, and the balance sheet remains strong. Valuation based on near term profits is relatively high.

  • Microsoft (MSFT) – MSFT was strong all year reflecting growth in Azure as well as the addition of AI to various products. The balance sheet remains strong and MSFT continues to repurchase shares.

  • Fastenal (FAST) – FAST outperformed in 2023 as management continued to execute on expanding onsite locations and increasing sales through its digital footprint. With low leverage, strong cash generation, and ongoing business investments, we believe FAST is well-positioned to strengthen its already robust set of competitive advantages.

 

Top 3 Detractors from Relative Performance 

  • Diageo (DEO) – DEO’s underperformance in 2023 was primarily the result of demand normalization and a weaker macro environment. The critical U.S. market continues to be soft as retailers worked through excess inventory. Management lowered its financial outlook due to weaker regional trends and higher reinvestment needs to support growth. Overall, we remain confident in DEO’s leading portfolio of brands across key categories and regions, which gives it an entrenched market position in the attractive spirits industry.

  • Dominion Energy (D) – D underperformed in 2023 reflecting company-specific concerns as well as a rotation away from the Utilities sector. D’s portfolio review extended through the year, and its formal investor update was delayed. Though the update is coming later than initially planned, we note that D has made substantial progress regarding asset sales and balance sheet improvement. With the stock trading at a discount to its peers, we continue to believe patience will be rewarded.

  • Air Products (APD) – APD’s stock came under pressure in 2023 due to weakening global industrial production and fears of inflation affecting the cost of megaprojects. At this point, the majority of APD’s project pipeline has been de-risked with updated project costs and these investments are all expected to achieve return thresholds >10%. CEO Seifi Ghasemi purchased >$5M worth of stock in November on a pullback in the stock price.

 

Sector Influence

We are bottom-up stock pickers, but sector exposures influenced relative performance as follows:

  • What Helped: Overweight Info. Technology (a better performing sector) & underweight Health Care (a weaker performing sector)

  • What Hurt: Underweight Communication Services (a better performing sector) & overweight Consumer Staples (a weaker performing sector)

 

Portfolio Characteristics & Positioning 

We believe the Income Equity portfolio is positioned for long-term durability and possesses the fundamental ingredients that stand the test of time: wide moats, sustainably high returns on capital, strong free cash flow generation, low leverage ratios, and an attractive shareholder yield (dividends + net buybacks). The portfolio trades at a premium to the Value index, but we believe this is justified as companies in the Value indices have lower returns on capital and higher leverage. As access to capital becomes more difficult and the cost of that capital is more expensive, we believe companies with strong balance sheets and the ability to self-fund their operations could have a structural advantage in 2024 and beyond. In an environment of possibly lower returns and greater volatility, we believe the Income Equity portfolio offers an attractive option for equity investors.

 

2023 Income Equity vs Russell 1000 Value Portfolio Characteristics

Source: FactSet

 

Looking Ahead

After such a strong 2023, we believe investors should temper expectations for 2024. Stocks defied rate hikes, wars, collapsed banks, and recession fears in 2023. Now, calls for a soft landing are consensus; sentiment is overly optimistic; and markets are priced for very little risk. Predicting the future direction of the economy is always challenging. While we do agree the odds of a recession have come down, they are still elevated. A soft landing remains in reach, but much of that hinges on whether the Fed eases soon enough to avoid an employment problem. Perhaps this time it will be different, but historically the odds of sticking the landing have been very low. Even though we have greater clarity over the Fed’s path from here, there still remains a long list of items creating uncertainty that could lead to greater volatility in 2024.

In terms of the equity market, we believe returns in the near term may be modest, with shareholder yield (dividends, share repurchase, debt reduction) comprising a significant percentage of the total return. Economic growth is likely to slow; earnings estimates appear optimistic; and valuations are somewhat elevated. Moreover, investors continue to expect a faster pace of rate cuts than members of the FOMC currently suggest. The difference in the pace of rate reductions could lead to greater levels of volatility in 2024. Markets are impossible to outguess in the short run, but we believe the antidote to uncertainty is quality and that solid company fundamentals will lead to strong risk-adjusted returns in the long run. With that in mind, the characteristics of our portfolios remain attractive, and we believe we’re well positioned for an uncertain future.

 

We believe the Income Equity portfolio is positioned for long-term durability and possesses the fundamental ingredients that stand the test of time.

Annualized Performance 

As of 12/31/2023

Income Equity - 2023 vs R1000 Annualized Returns

Inception date: 12/31/1999. Past performance should not be taken as a guarantee of future results. Performance is preliminary. Subject to change.

Connect

Get in touch with us to get started on your journey

Contact Us

Disclosure Notes

 

The London Company’s performances are size weighted and annualized based on calculations for the period ending December 31, 2023. The characteristics discussed herein relate to a representative account, and not every client’s account will have these exact characteristics. As London manages its client portfolios according to each client’s specific investment needs and circumstances, London cannot affirm that the characteristics of the account shown are similar to all accounts participating in the strategy. This is due in part to the timing of trades by the Advisor, market conditions, cash availability, and the timing of client deposits and withdrawals. Therefore, prospective clients should not assume that similar performance results to those shown would have been achieved for their accounts had they been invested in the strategy during the period. None of the information contained herein should be construed as an offer to buy or sell securities, or as investment recommendations.

 

Definition of Firm: The London Company of Virginia is a registered investment advisor. Registration does not imply a certain level of skill or training. More information about the advisor, including full descriptions of its investment strategies, fees and objectives, can be found in the firm’s Form ADV Part 2, which is available upon request by calling 804.775.0317 or visiting www.TLCadvisory.com. The London Company claims compliance with the Global Investment Performance Standards (GIPS®). GIPS® is a registered trademark of CFA Institute. CFA Institute does not endorse or promote this organization, nor does it warrant the accuracy or quality of the content contained herein. Please visit www.TLCadvisory.com or contact us at 804.775.0317 to request a complete list and description of The London Company’s composites and/or a presentation that adheres to the (GIPS®) standards.

 

Composite Creation/Inception Date: December 31, 1999

 

Composite Definition: The Income Equity strategy invests mainly in common equities with a focus on higher overall dividend yield orientation, which may be supplemented with primarily investment grade, preferred equities. This strategy has a more conservative orientation, with a focus on capital preservation, income and growth, in order to provide greater yield and downside protection relative to our Large and Mid Cap strategies. Our Income Equity strategy is designed to generate above-average, absolute returns over full market cycles. Accounts in this product composite are fully discretionary taxable and tax-exempt portfolios with no minimum dollar amount of assets. The product is measured against the Russell 1000 Value Index and has a creation and inception date of December 31, 1999. There is no use of leverage, derivatives or short positions. All actual fee-paying discretionary portfolios are included in one or more composites that have been managed for a full calendar quarter with limited restrictions and similar objectives. As of July 1, 2022 The London Company redefined the composites to exclude all dual contract relationships and any potentially bundled fee scenarios. This policy is not retroactive, but will continue to apply going forward.

 

Benchmark Description: The Russell 1000 Value Index measures the performance of the large-cap value segment of the U.S. equity universe. It includes those Russell 1000 Index companies with lower price-to-book ratios and lower expected growth values. Benchmark returns are not covered by the report of independent verifiers.

 

Performance and Fees: Gross of fee returns are calculated gross of management and custodian fees and net of transaction costs. Net of fee returns are calculated net of actual management fees and transaction costs and gross of custodian and other fees. Returns may be net of miscellaneous fund expenses. The gross figures do not reflect the deduction of investment advisory fees. Returns are calculated and stated in U.S. dollars. Returns are calculated gross of withholding taxes on foreign dividends and interest. Dividends are reinvested. Policies for valuing investments, calculating performance, and preparing GIPS Reports are available upon request.

 

Past performance should not be taken as a guarantee of future results. The report is for informational purposes only. Data, while obtained from sources we believe to be reliable, cannot be guaranteed and all statistics are subject to change. The statements contained herein are solely based upon the opinions of The London Company and the data available at the time of publication of this report, and there is no assurance that any predicted results will actually occur. Information was obtained from third-party sources, which we believe to be reliable but are not guaranteed as to their accuracy or completeness. This report contains no recommendations to buy or sell any specific securities and should not be considered investment advice of any kind. An investment in a London Company strategy is subject to risks, including the loss of principal. Referenced strategies may not be suitable for all investors. The appropriateness of a particular strategy will depend on individual circumstances and objectives. In making an investment decision, individuals should utilize other information sources and the advice of their investment advisor.

You are now leaving The London Company’s website. The link below is provided as a convenience, and The London Company is not responsible for the content provided on the destination site.

Continue

By continuing on this site or clicking Yes to Accept, you agree to our use of cookies and other technologies to process your personal data to personalize your experience and for other purposes.