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Sustainable Income Strategy – January 1, 2024
Summitry’s Sustainable Income strategy produced strong returns in the fourth quarter of 2023, with a composite of client accounts delivering gains from dividends, interest and capital appreciation of roughly 10%. It’s important to note that returns from this strategy will ebb and flow over time, as do the stock and bond markets in which this strategy invests. This was a particularly good period that benefitted from a benign backdrop of falling interest rates and rising markets, but the underlying securities as a group also exceeded the returns of benchmark indexes we use to assess our performance. For the fourth quarter and year ended 12/31/2023, the composite of Sustainable Income accounts under management exceeded our chosen benchmark comprised of the S&P 500 Dividend Aristocrats (70%) and the Bloomberg Aggregate Bond Index (30%) by +192 basis points and +102 basis points, respectively, net after fees. Individual client account performance varied around this composite average, reflecting their specific mix of stocks, bonds, preferred stocks and bond ETF’s.
Here is the record for the SI Composite since inception (please see performance disclosure at end of this note).
The year unfolded as follows: Q1 was an extremely difficult period for Sustainable Income overall, as it was for dividend-paying equities in general, but our strategy was further challenged due to its common stock exposure to regional banks (M&T Bank) and preferred stock exposure in both regional and money center banks. In Q2 and Q3, we recovered much of this deficit to the benchmarks as the regional bank crisis abated. Q4 was a breakout period for dividend-paying equities as investors broadened their interest beyond the narrow universe of mega-cap growth companies that had driven most of the performance of the US equity markets throughout 2023.
Ten companies in the Sustainable Income portfolio increased their dividend in Q4, including: UNVGY (+6%), VZ (+2%), MCD (+10%), USB (+2%), V (+16%), COR (+5%), EMR (+1%), LMT (+5%), MSFT (+10%), TSM (+6%). No companies reduced their dividend during the quarter.
Of the many factors that we consider when selecting companies to own in the Sustainable Income portfolio, the capacity and commitment to pay sustainable and growing dividends are among the most important. The capacity to pay growing dividends is derived from earnings growth and strong balance sheets. The commitment comes from company managements and boards of directors who choose to share surplus earnings with shareholders in the form of a dividend or through the repurchase of the companies’ own shares at attractive valuations. Not every great company will pass through earnings in the form of a dividend, which is a reasonable choice if the earnings can be reinvested in the business in initiatives that promise high returns on investment. Those stocks will not qualify for the Sustainable Income strategy, but they may be held in other strategies managed by Summitry. But when a management team cannot redeploy cash in a manner that will generate a high return within the company’s operations, we would prefer they remit that cash to shareholders in the form of a dividend. These are ideal stocks for Summitry’s Sustainable Income portfolio strategy.
Q4 2023 Top Contributors
Q4 2023 Top Detractors
In November, we initiated a position in Visa (V), a stock we’ve long held in Summitry’s Core equity strategies. We have considered a holding in Visa for Sustainable Income in the past, knowing that it has the capacity to pay growing dividends, a fortress balance sheet, and a strong competitive position in the global consumer payments business, but chose not to because the dividend yield was below a preferred threshold for the portfolio. Given the track record of dividend growth and the potential for continued rapid growth in Visa’s dividend, we reconsidered our earlier stance and added it to the portfolio. Underlying this change of view is the recognition that the expected growth in dividend is ultimately more important than the yield at the time of purchase, particularly during periods of meaningful inflation. We maintain a long-term outlook when we invest and believe that the dividend we will receive as owners of Visa stock, when we look out several years, will be very attractive relative to our cost today.
We did not exit any of our positions in Q4.
The Sustainable Income portfolio has traditionally held approximately 30% of its assets in bonds and preferred stocks, whose primary purpose is to increase the overall portfolio yield rather than offer long-term appreciation potential. Nevertheless, in the short term these securities rise and fall in price, sometimes considerably, in reaction to changes in the interest rate environment. A decline in interest rates in the fourth quarter–signaling Wall Street views that inflation seems to be under control–drove a strong performance from income securities in general, with the Bloomberg Aggregate Bond Index rising by +6.8%. Our holdings participated, delivering positive returns in the quarter in aggregate. Longer duration securities such as preferred shares generally benefitted most from the decline in rates. Shorter-duration income securities also participated in the market gains, but to a lesser extent.
The Sustainable Income strategy has produced respectable returns in volatile markets and over a market cycle. Looking forward, in an interest rate environment that offers higher yields on fixed income and preferred securities than we have experienced for many years, Sustainable Income remains a good choice for the client who seeks growth of income over time and reduced portfolio volatility, while retaining some opportunity for growth.
This article is for informational purposes only. Nothing herein constitutes investment advice or any recommendation that any particular security, transaction, or strategy is suitable for any specific person. The securities identified do not represent all the securities purchased, sold, or recommended for client accounts. Past performance does not guarantee future returns. Investing involves risk.
 Sustainable Income Composite includes all Sustainable Income accounts with a long-term target of 70% investment in primarily U.S. dividend paying stocks and 30% investment in income producing securities which include bonds and/or ETFs, preferred securities, REITs and MLPs. The allocation among asset classes generally may vary around this long-term target by plus or minus 10 percentage points and we may hold cash balances. The primary objective of the strategy is to produce monthly income that grows at a rate faster than inflation through a portfolio principally invested in equities, and a secondary objective to participate in the long-term appreciation of the equity securities held. Bonds and preferred stocks are selected to add stability to the portfolio’s cash flow. Summitry employs a value-based investment strategy focusing on high-quality multi-national businesses that can be purchased at a discount to their estimate of intrinsic value. The benchmark for this composite is a blended benchmark consisting of 70% S&P 500 Dividend Aristocrats Index, and the Bloomberg Aggregate Bond index (30%) (Formerly Barclays Capital Aggregate Bond Index) and is rebalanced monthly. After March 31, 2020, the equity portion of the blended benchmark was replaced from the S&P 500 Index to the S&P 500 Dividend Aristocrats Index. Summitry believes this most closely represents the strategy pursued in the equity allocation. Anytime the individual components are shown, should be considered supplemental information. The minimum account size for this composite is $250 thousand.
The U.S. Dollar is the currency used to express performance. Returns are presented net of management fees and include the reinvestment of all income. Net performance is calculated by reducing the gross performance by the model fee of 1.25% applied monthly. The inception and creation of the Sustainable Income Composite was on June 30, 2015.