October 2017 Letter to Investors

October was a reminder for us of why it’s important to diversify. Apple (AAPL) had a fantastic quarter on expectations of strong iPhone sales, and as I write this, the company is within striking distance of being the first trillion-dollar company by market cap.

I’ve been expecting this for a long time, and it’s nice to see an investment thesis executed as expected.

General Motors (GM), also had a great month though it ended on a sour note with negative comments from Goldman Sachs prompting investors to take profits.

But these successes notwithstanding, October was a difficult month for many of my favorite sectors. Our MLPs, REITs and alternative investment managers such as Blackstone (BX) and KKR (KKR) didn’t react well to certain aspects of President Trump’s tax reform proposals. Specifically, companies that routinely use a lot of debt in their capital structures – and MLPs, REITs and private equity firms all most certainly do – might see their ability to write off interest expense curtailed.

Weakness in these sectors dragged down the Dividend Growth portfolio’s performance in October, and we finished the month down 0.4% after all fees and trading costs.

I’m not particularly concerned about the proposed tax reforms. To start, these are proposed reforms, and there is still a lot of deal making left to be done. And while our government has a long history of making very poor decisions, I don’t think they are dumb enough to pass a tax reform law that will do serious damage to the real estate market, as a cap on interest expense write offs most certainly would.

In fact, I expect that tax reform will actually help most of these companies, which was one of the reasons I overweighted them in the portfolio this year.

I’m not alone in that belief. Writing for Barron’s, Crystal Kim quoted Credit Suisse analyst Craig Siegenthaler as saying it was probable that tax reform incentivizes Blackstone, KKR and other alternative managers to ditch their complex partnership structures and reorganize themselves as C-corporations. This, in turn, would likely lead to significantly higher valuations, as institutional investors would then be more likely to embrace the sector.

Even if tax reform doesn’t happen or if it fails to compel the alt managers to reorganize, these are still very attractive companies to own at this stage of the cycle. Due to the back-ended nature of private equity returns, we should see very healthy earnings and dividend growth for several quarters to come.

Interestingly, Barron’s – which is usually quite critical of MLPs – also had very flattering things to say about Enterprise Products Partners (EPD) late last month, saying that at current prices, EPD offered both growth and income.

I would vigorously agree.

Enterprise had a disappointing quarterly earnings release and raised its distribution by less than what investors expected, leading the shares to sell off. I’m viewing this as a buying opportunity. Frankly, I know of few places you can get a 6.7% yield without taking vastly more risk.

The Barron’s article noted that the ownership structure of MLPs is changing, getting more institutional. That’s unambiguously a good thing, as the MLP sector was notorious for its gun-slinging cowboy culture of aggressive growth via debt issues and equity dilution.

November marks the beginning of the seasonally most-favorable time of the year. As bond yields continue to ease, I’m expecting a very solid end to 2017.

Until next month,

Charles Lewis Sizemore, CFA

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