Letter to Investors 2019
Synergy Capital Management, LLC 2019 Return: 16.04%
2019 turned out to be nothing less than a banner year for investors at Synergy Capital Management, LLC. With returns in the mid-teens, we were able to generate investment results that have not been witnessed for several years. Of particular to note was the fact that none of our investment products produced a negative return in 2019: Our best performer being the Victory Trivalent International Small Cap Fund (27.27%), while our worst performer was the Templeton Global Bond Fund (0.65%). Several of our ‘alternative’ investments produced stellar results as well with the PIMCO Commodities PLUS Fund up 19% and the BNY Mellon Global Real Estate Securities Fund surging 23%, which both added to portfolio return and reducing risk in return. Several positive (and surprising) economic themes highlighted 2019 including the US Federal Reserve unexpectedly reducing interest rate late in the year and global economic growth continuing to move forward at a healthy pace. These and other economic items we will discuss further below.
Let’s take a look at each of our individual investments more in depth.
Equity (stock market) Investments:
US Large Cap Stocks:
The US stock indexes as represented by the Dow Jones Industrial Average, S&P 500 and NASDAQ Composite all had healthy years in 2019 with returns of 22.3%, 28.9% and 35.3% respectively. These robust returns were in stark contrast to predictions made at the beginning of 2019 when many analysts were skeptical that domestic stocks would even finish with positive returns. Increases in interest rates, the US/China trade battle, global political unrest and the impression that ‘the bull market must be getting tired’ failed to materialize. The US Federal Reserve actually cut rates several times, GDP growth remained at long-term trend, inflation continued to remain benign, unemployment hovered at lows not seen since the 1960s, and a host of other economic figures baffling pundits that stocks were about to drop off a cliff.
Our holding in the US large cap space, the AMG Yacktman Focused Fund (YAFFX), returned 19.1%. An impressive return in any given year, but still ranking the investment near the bottom of its class in 2019. The reason is due to the fund being constructed in a ‘defensive’ manner as to not decline precipitously in the event of a stock market sell-off. Several of the fund’s top holdings (PepsiCo, Proctor and Gamble, Johnson and Johnson and Coca-Cola) are consumer non-discretionary companies that tend to hold up well in poor economic environments (which as previously mentioned, were in the cards as 2019 began). Heading into 2020, we are going to increase our 16% portfolio position in this fund to maintain our large-cap equity exposure and remain firmly invested in the event of weak domestic stock returns. Steven Yacktman has been running the fund since 2003 and knows how to be on the defense while still maintaining high risk-adjusted returns. Over the past 5-years YAFFX has maintained excellent risk-measures such as a lower beta, R-squared and standard deviation figures than its comparable index (the Russell 1000 Value Index) while generating a higher Sharp Ratio and alpha.
U.S. Middle and Small Capitalization Stocks:
US mid and small-cap stocks turned in an even more robust performance in 2019. The Parnassus Mid-Cap Fund (PARMX) (a 5-Star Morningstar rated mutual fund) galloped ahead 28.75% besting 70% of its peers. Highly concentrated across only 41 equity investments, the fund benefited from heavy weightings in companies such as Teleflex, Motorola and Cerner which all produced returns north of 40%. With a perfect swath mix of value and growth companies across the mid-cap space, we are going to slightly increase our holdings here to start the new year to maintain firm exposure to US equities.
Its small-cap counterpart, the Delaware Small Cap Core Fund (DCCAX) produced a practically similar result with a 25.64% return, ahead of 69% of its competition. DCCAX has a slight growth tilt in the small-cap arena and over a 10-year holding period maintains a very high return ranking with a moderate level of risk. Its management team has been at the helm for over 15 years and actually ‘puts their money on the table’ with high personal investments in the fund itself. Interesting to note is that one of the fund’s top holdings, The Medicines Co., returned over 350% in 2019, a tip of the hat to the managers able to find that diamond in the rough investment.
International Developed Markets:
Led by acclaimed contrary international fund manager David Herro, the Oakmark International Fund (OAKIX) surged ahead over 24% in 2019. The fund topped its comparative index (the Morgan Stanley All Country World Index) by a hefty 2.70% which is even more impressive considering its exceptionally low management expense fee. Herro achieved these results with lofty investments in the UK, Germany, Switzerland and France which surged ahead 12.1%, 25.48%, 25.95% and 26.37% respectively last year. The fund is described as ‘higher risk’ due to its higher 3, 5 and 10 year standard deviation figures (a measure of volatility) versus its competition, which may result in Morningstar’s meagre 3-Star ranking of OAKIX. As such, fund holders should be aware of this ‘higher-risk-for-reward potential’ and stay invested for the long-term to reap the rewards Herro is able to produce: over the past 10 years, OAKIX has outperformed its competition in 6 of those years by a large margin (and in two years returned less than the fund’s category average by less than 0.50%). Heading into 2020 we are going to slightly increase our weighting here from 10% to the 12% area.
Bolstering our international developing markets return was the Victory Trivalent International Small Cap Fund (MISAX). Quantitatively driven, MISAX has produced utterly phenomenal returns, outpacing both its comparable benchmark and category peers 8 of the past 10 years. During these 8 years it has never placed below the top third of its class. Japan, UK, France and Canada are the fund top 4 country holdings. With a 27.27% return in 2019, MISAX’s slight growth leaning heading into 2020 and 5-Star rating from Morningstar will continue to make it entrenched as one of our top portfolio holdings.
Although we reduced our holdings in the emerging markets area late in 2019, countries such as Brazil, Russia and China produced stellar stock market returns over the year. Our long-term holding here, the Oppenheimer Developing Markets Fund (ODMAX) increased 24% ranking it in the top quarter of its competition. Sporting a low expense ratio (1.24%) and an excellent upside/downside capture ratio over the past 3 years, ODMAX maintains its exposure towards large-cap growth firms. Manager Justin Leverenz continues at the helm, spearheading the fund for almost 13 years. A 5-Star Morningstar fund with a buy-and-hold long-term strategy (investment turnover is only 7%), this low-risk/high-return emerging markets offering will bolster our portfolio into the foreseeable future. With many stock analysts bullish again in 2020 on emerging markets, we will be increasing our holdings here from the 3.5% area closer to 5% as 2020 gets underway.
Fixed Income Investments:
Domestic Multisector Bonds:
With domestic economic growth cruising along over the past several years, the US Federal Reserve began 2019 with the mindset of continuing on its path of gentle increase rate increases (after 9 rate bumps). However, slight hiccups in the domestic and global economy, including slow business investment, sluggish inflation, rising trade tensions and slowing global growth gave the Open Market Committee incentive to drop rates 4 times over the remainder of the year. Given interest rate movements being the prime determinant of bond prices, the Fed’s actions lifted bond prices across the board over the course of the year.
Our bond investments took advantage of these interest rate decreases to produce excellent returns in 2019. Our largest holding, the Loomis Sayles Bond Fund (LSBRX) managed by longtime Wall Street bond aficionado Dan Fuss, surged ahead 11.36% in 2019, its best return since 2012. This healthy return was enough to rank the investment in the top 28% of its class in 2019. A more volatile multi-sector bond fund, Fuss holds a higher proportion of AAA-rated high credit quality corporate bonds with much shorter maturity dates than his competition. According to Morningstar, LSBRX ‘has a deep and seasoned team, contrarian strategy, and solid long-term returns that count in its favor’. The fund maintains positions long-term (only 17% turnover) while attracting investors with a relatively low management expense fee of 0.91%.
A true ‘core bond’ holding with a 30-year track record, The PIMCO Total Return Fund (PTTAX) continues to be a good counter-investment to the Loomis Sayles Bond Fund in our US fixed-income sector. The fund invests in high-quality, intermediate-term bonds that are selected across all sectors and geographies in order to avoid concentration risk (particularly with respect to credit). As such the fund tends to perform well when equity markets, which move in lock-step with credit, are weak. Though not having a particular stellar year in 2019 (7.89% return and 77th percentile class ranking), PTTAX has 86% of its portfolio in high grade A or above bonds. The fund has a heavy weighting in the securitized market at 28% vs LSBRX which contributes to the portfolio’s heavy over 30-year maturity.
In an attempt to squeeze out a little more return in 2019, rather than holding small portions of our portfolio in cash, we added a new product, the Lord Abbett Short Duration Income Fund (LALDX) to our investment portfolio. Another 5-Star Morningstar investment, LALDX invests in a variety of short maturity debt securities like corporate bonds, US government securities as well as mortgage and other asset-backed debt. Consistency is the trademark of LALDX: over the past 10 years the fund has never produced a negative return and in fact has never been ranked below the 40th percentile of its peers (and only twice been out of the top 1/3 in its class). It returned 5.42% in 2019 to help bolster the fixed income component of our portfolio. Lord Abbett is a solid name in the bond-investing space with an investment team at the helm averaging over 20 years of experience. As 2020 begins, we will continue to maintain a portfolio weight of 5% in LALDX to bolster our cash returns. The fund can also be used as additional firepower should equity prices drop significantly to warrant additional investment.
Floating Rate Bonds:
Our exposure to the floating rate market surged ahead over 8.50% in 2019. The Eaton Vance Floating Rate Advantage Fund (EAFAX), another 5-Star Morningstar ranked product, surprisingly turned out as our best performing fund in the fixed-income sector. Having relatively low correlation with traditional fixed-income and equity investments, the fund is an important diversifier in our investment portfolio. Floating rate securities in the BB-and-below range (junk status) make up 85% of the fund which adds to risk but also allows veteran fund managers Scott Page and Craig Russ to pursue higher returns. In fact, over the past 10 years EAFAX has had only 1 year (2015) of negative performance, and even that at a paltry -1.84%. Eaton Vance has been a pioneer in the floating rate market since 1989 and the aforementioned fund managers are often featured experts in financial publications, CNBC and Bloomberg with their floating rate investment analysis.
Our weakest performing portfolio component of 2019 was in the area of international bonds. Barely squeaking out a positive return (0.63%) and ranked near the bottom of its class (95th percentile), the Templeton Global Bond Fund (TPINX) was a major disappointment. With heavy weightings in emerging markets fixed income (Mexico, Brazil, Indonesia and India), the fund attempts to seek out current income with capital appreciation and growth of income by investing 80% of its assets in bonds of governments, government related entities and government agencies located around the world. The fund is highly invested in shorter-maturity issues and a large allotment to A and BBB bonds, which may account in part to its lower return than the category average. Independent mutual fund rating service Morningstar states that the fund’s ‘distinctive approach works because of the manager’s patience and the team’s expertise, supporting an Analyst Rating of Gold’. The fund also sports an extremely low management expense fee of 0.94% and excellent 3, 5, and 10-year downside capture ratios. Therefore we will continue to maintain our 5% holding with TPINX heading into 2020 with no fund replacement in the immediate horizon.
With stock markets at home and around the world on a seemingly endless upward trajectory over the past 12 years, we decided to dedicate a small portion of our portfolio to a new product that typically does not follow traditional stock and bond returns. The Litman Gregory Masters Alternative Strategy (MASNX), a ‘core alternatives strategy’ fund, was our choice here. The fund attempts to achieve absolute and relative long-term returns with lower risk and lower volatility than the stock market, and with relatively low correlation with stock and bond market indexes. It essence, it is constructed to zig when traditional investments zag, providing additional portfolio diversification. The fund is composed of 5 ‘sub-funds’ managed by proven firms DCI, DoubleLine, FPA, Loomis Sayles and Water Island. Over the past 5 years, MASNX has produced above average returns with below average risk when compared to its multialternative competitors. In fact, risk, as measured by standard deviation and maximum drawdown have all been smaller than its category average (multialternative) over the same 5-year period.
Commodities (broad basket):
Our commodities exposure in 2019 with the PIMCO Commodities PLUS Fund (PCLAX) was nothing less than spectacular. Our investment here was the highest rated mutual fund investment of all our holdings in 2019, with PCLAX ranked in the second percentile of its class and a return just north of 19%. Given the portfolio’s heavy weighting (over 50%) in energy, the fund was able to produce such a stellar return in part due to West Texas Intermediate Crude and Brent Crude oil prices gaining 35% and 23% per barrel respectively over the course of the year. Although the fund has a smaller weighting in the precious metals areas at 8.63%, sharp increases in gold (18.9%), silver (15.3%) and platinum (21.6%) in 2019 were able to bolster the fund’s returns. The fund has a unique strategy in the commodity space by overlaying commodity-linked derivative instruments with an actively managed, low-volatility portfolio of fixed income instruments. PCLAX is a core holding at Synergy Capital with no plans to deviate from this exceptional commodities offering.
Global real estate was another dramatic gainer for investor’s in 2019. Our holding here, the BNY Mellon Global Real Estate Securities Fund (DRLIX), had its best performance since 2012, returning an even 23% last year. Arguable whether real estate should be included in the US equity space vs alternative holdings, the DRLIX long-term track record speaks for itself: only twice over the past ten years has the fund produced negative returns (2011 at -5.41% and 2018 at -4.66). The fund’s largest holding is Prologis Inc. which, at almost 6% of the portfolio, returned over 50% in 2019. With almost half the portfolio invested outside of the United States, the investment offers great global diversification in the REIT space. With domestic and interest rates expecting to hold steady in 2020 and global economic growth continuing to push forward, we will gently increase our weightings in global real estate from 5% to 7.5% this year.
Near the end of 2019 we added a new product to our investment mix with the Wells Fargo Precious Metals Fund (EKWAX). There are a couple reasons why an exposure to common shares in gold miners are a prudent investment holding in our portfolio at this time. First, with interest rates declining in the US and globally (some countries are even in the ‘negative’ interest rate environment) the price of gold and commodities in general tend to perform well. This is due to their non-interest paying return. Second, with global political unrest (Iran, Argentina, Venezuela to name a few and the US/China trade situation) gold tends to act a safe haven when turmoil strikes. As such, we have initiated a weighting of 5% in the Wells Fargo Precious Metals Fund which comes with a very low expense tag (1.09%) and a lead manager who has been at the helm since 2007.
As always, if there are any questions or concerns, please let me know.
All the best,