Yield-at-Cost: Seeing the Whole Picture

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1 Yield-at-Cost: Seeing the Whole Picture Market Commentary January 2019 PHOTOREALISTIC PORTRAITS BUILT UP OF TINY DOTS of color make little sense from a vantage point very near the canvas; the isolated color globes seem random and chaotic. Seeing the whole picture requires stepping back and taking in all of the details as a unified work. In a similar manner, we believe investors are well advised to step back and approach dividend-oriented portfolios from an integrated, total return perspective considering both income and capital gains over the long-term. We believe many investors have become overly focused on the tiny dots of today s current yield. Current Yield: The Basics Current yield is a snapshot in time of a company s annual dividends per share divided by its current stock price per share. The resulting data from multiple securities can then be averaged to arrive at the overall current yield of a portfolio. While we view current yield as an important variable to consider, we believe it has become far too common to rely on it as a sole or even a primary measure of a dividend-oriented portfolio. Part of this trend may be driven by simplicity; current yield is a data point that is readily available among the information tools used today. As is so often the situation, however, this simplicity can come at a cost in this case, potentially lower long-term total return. CURRENT YIELD = Current Annual Dividends Per Share Current Stock Price Per Share The key danger in overly focusing on current yield, in our view, is that investors can be led to overlook companies that have enjoyed such success that they have been rewarded with stock price increases that equal or outstrip the growth of their rising dividend. That is to say, if the denominator of a company s stock price appreciates at an equivalent or faster rate than the numerator of its dividend, such a situation may put downward pressure on that company s current dividend yield, even if the dividend is growing respectably. We find it detrimental to eliminate positions from a portfolio or exclude companies from research coverage merely due to low current yield. By placing too much emphasis on current yield, we feel total return over the long-term could be compromised due to comparatively weak capital gains. Yield-at-Cost: Providing Some Perspective Given our long-term approach to investing and our partiality to companies with consistent dividend growth, we believe a more effective way to analyze yield is not by NOT FDIC INSURED NO BANK GUARANTEE MAY LOSE VALUE

2 utilizing the current yield but rather the yield-at-cost of a portfolio. Yield-at-cost divides a company s current annual dividends per share by the original cost per share basis at which the company was brought into a portfolio. This calculation takes a company s dividend growth into account and doesn t penalize a company for stock price appreciation. From our perspective, one of the key insights of a yield-at-cost analysis is that healthy dividend growth may accompany or even lead to stock price appreciation. YIELD-AT-COST = Current Annual Dividends Per Share Original Cost Basis Per Share A Real-World Company Example Exhibit 1 chronicles an example of a high-yielding company and a dividend growth company. Company A represents a high-yielding, flat dividend payer, while Company B represents a relatively low-yielding, but strong dividend growth company. Exhibit 1: Relationship Between Dividend Growth and Stock Price Company A: Dividend Yield Company Dividend Payment Yield-at-Cost Dividend Yield $ % Dividend Payment ($) $0.80 $0.70 $0.60 $0.50 $0.40 $0.30 $0.20 $ % 4.8% 5.1% 4.9% 5.0% 4.0% 3.0% 2.0% 1.0% ANNUALIZED Dividend Growth: 1% Price Return: 1% Total Return: 6% $ % Company B: Dividend Growth Company Dividend Payment Yield-at-Cost Dividend Yield $ % 5.0% Dividend Payment ($) $3.50 $3.00 $2.50 $2.00 $1.50 $1.00 $ % 3.0% 2.0% 1.0% ANNUALIZED Dividend Growth: 27% Price Return: 27% Total Return: 29% $ % Data source: FactSet, from 1/1/13-12/31/18. While the data above is based on two actual companies, the examples shown are provided for illustrative purposes only and do not intend to represent an actual security held in the Santa Barbara Asset Management Dividend Growth portfolio. Other methods and market conditions may result in significantly different outcomes. Dividend yield is one component of performance and should not be the only consideration for investment. Dividends are not guaranteed and will fluctuate. Past performance is not indicative of future results. 2

3 An investor focused solely on yield will likely prefer Company A for its very high yield. While the company may provide an attractive level of current income on an annual basis, the dividends paid out by the company remain static, coinciding with relatively little capital appreciation. An investor in Company A may receive bond-like returns while experiencing equity-like risk. Company B would likely be overlooked by that yield-seeking investor, because its current dividend yield never once surpasses 2%. However, this is not the result of a static dividend payment in fact, the company increased its dividend by 27% annually since Its consistently low yield can be attributed to the similarly strong capital appreciation in the company s stock price, which grew by 27% annually over the same time period. We believe this example accentuates the limitations of focusing on a company s yield as a means of security selection and as an analytical device. A company with a low yet growing dividend may offer an investor greater total return potential due to the strong relationship between dividend growth and price appreciation. Santa Barbara's Approach to Applying Yield-at-Cost We believe a yield-at-cost perspective can help add value for our clients by providing us with tools to retroactively evaluate companies in the portfolio that may be growing dividends while simultaneously appreciating in value. The chart in Exhibit 2 shows a generally widening gap over time between the current portfolio yield and the portfolio yield-at-cost of the Santa Barbara Dividend Growth portfolio. We believe this example illustrates a portfolio that has benefited over time from both dividend growth and capital appreciation. We find the portfolio s yield remained competitive throughout this period, but by avoiding what we would view as overreaching for yield, we were able to maintain exposure to select companies that benefited from stock price gains. Exhibit 2: Santa Barbara Dividend Growth Model Portfolio (5 Year Quarterly Yields from January 1, 2014 December 31, 2018) Average Current Portfolio Yield 5% Average Portfolio Yield-at-Cost 4% 3% 2% Data source: FactSet, from 1/1/14-12/31/18. Data is based on the securities held in the Santa Barbara Asset Management Dividend Growth model portfolio during the period shown. Holdings of individual accounts may differ from this model; model holdings and weights are subject to change without notice. Dividend Growth inception date is April 1, Dividend yield is one component of performance and should not be the only consideration for investment. Dividends are not guaranteed and will fluctuate. Past performance is no guarantee of future results. 3

4 Conclusion Ultimately, we believe the increase or decrease in a security s current yield shouldn t be of chief importance; rather, we believe emphasis should be placed on the total return that has been produced as a result of owning high-quality companies that possess the financial flexibility to increase dividends while also appreciating in value with time. We view a yield-at-cost perspective as a much more helpful framework for determining portfolio success than simply looking at current yield. In our view, seeing the whole picture in this manner is likely to provide real value for clients over the long-term. DIVIDEND GROWTH ADVISOR SPONSORED COMPOSITE PERFORMANCE AND RESULTS EXPLANATION Total Firm Period Assets U.S. Dollars % Non-Fee Number of Composite Composite S&P 500 Russell 1000 Composite Composite S&P 500 Index Russell 1000 Index End (millions) (millions) Paying Accts Accounts Gross** Net Index Index Dispersion 3 Yr St Dev (%) 3 Yr St Dev (%) 3 Yr St Dev (%) ,131 1,313 < 1% 4, % 17.48% 21.83% 21.69% 0.2% 10.0% 9.9% 10.0% , _ 3, % 9.12% 11.96% 12.05% 0.4% 10.7% 10.6% 10.7% ,721 1,267 _ 4, % -5.25% 1.38% 0.92% 0.2% 10.4% 10.5% 10.5% ,762 1,255 _ 3, % 10.93% 13.69% 13.24% 0.3% 8.6% 9.0% 9.1% ,467 1,099 _ 2, % 23.35% 32.39% 33.11% 0.3% 11.0% 11.9% 12.3% , _ 1, % 10.59% 16.00% 16.42% 0.3% 14.6% 15.3% 15.6% , _ 1, % 3.10% 2.11% 1.50% 1.0% 17.7% 19.0% 19.2% , _ % 13.35% 15.06% 16.10% 0.4% _ , _ % 14.24% 26.46% 28.43% 0.6% _ , _ % % % % N.M. _ , % % 9.86% 5.49% 5.77% 0.2% _ , % % 16.23% 15.79% 15.46% 0.5% _ , % % 4.74% 4.91% 6.27% N.M. _ 2004* 2,056 < 1 _ Five or Fewer 12.37% 9.95% 9.04% 9.32% N.M. _ *Results shown for the year 2004 represent partial period performance from April 1, 2004 through December 31, **Beginning 4/1/08, pure gross returns do not reflect the deduction of any expenses including transaction costs and are supplemental to net returns. N.M.- Information is not statistically meaningful due to the composite including five or fewer portfolios for the entire year. Dividend Growth Advisor Sponsored Composite incepted on April 1, 2004; the composite creation date is April The composite contains all fully discretionary Dividend Growth Advisor Sponsored accounts. The strategy primarily invests in dividend-paying common and preferred stocks with the potential for future dividend growth and capital appreciation. The strategy may invest in small-, mid- and large-cap companies. Dividend Growth generally invests in U.S. companies, although investment in non-u.s. companies is permitted in the form of ADRs. For comparison purposes, the composite is measured against the S&P 500 and Russell 1000 Indices. The firm, Santa Barbara Asset Management, LLC is a registered investment adviser and subsidiary of Nuveen, LLC. Registration does not imply a certain level of skill or training. The firm maintains a complete list and description of composites, which is available upon request. Santa Barbara Asset Management, LLC claims compliance with the Global Investment Performance Standards (GIPS ) and has prepared and presented this report in compliance with the GIPS standards. Santa Barbara Asset Management, LLC has been independently verified for the periods July 1, 1988 through December 31, The last firm verification was performed by ACA Performance Services, LLC. Verification assesses whether (1) the firm has complied with all the composite construction requirements of the GIPS standards on a firm-wide basis and (2) the firm's policies and procedures are designed to calculate and present performance in compliance with the GIPS standards. The Dividend Growth Advisor Sponsored composite has been examined for the periods April 1, 2004 to December 31, The verification and performance examination reports are available upon request. Results are based on fully discretionary accounts under management, including accounts no longer with the firm. Effective January 1, 2012, Santa Barbara Asset Management, LLC retroactively redefined discretionary assets for GIPS purposes; Unified Managed Account (UMA) assets are excluded from total firm assets. Effective November 2016, $0.5 billion in discretionary assets converted to UMA assets. As of December 31, 2017, UMA assets were approximately $6.5 billion. The U. S. Dollar is the currency used to express performance. Returns are presented gross and net of fees and include the reinvestment of all income. Accounts in the composite will pay a bundled wrap fee based on a percentage of assets under management. Other than portfolio management, the bundled wrap fee includes brokerage commissions, consulting services, custodial services and other expenses that may be associated with the management of the account. The highest wrap fee may change over time. Net of fee performance was calculated using the highest applicable annual fee of 3.00%. For the period April 1, 2010 forward, net of fee returns have been calculated by reducing the pure gross of fee return using the highest applicable fee on a monthly basis. For the period from April 1, 2008 to April 1, 2010, net of fee returns were calculated by reducing the pure gross return using the highest applicable fee on a quarterly basis. Performance results prior to April 1, 2008 are that of the Dividend Growth Composite and are net of transaction costs. Prior to April 1, 2008 net of fee returns were calculated by reducing the gross return using the highest applicable fee on a quarterly basis. The wrap program may charge an all-inclusive fee as high as 3.00%. Wrap fees are available upon request from the respective wrap sponsor. Actual investment advisory fees incurred by clients may vary. Internal dispersion is calculated using the asset-weighted standard deviation of the annual pure gross returns of all portfolios included in the Composite for the entire year. Bundle fee portfolios make up 0% of composite assets prior to March 31, 2008 and 100% of composite assets beginning April 1, The Composite performance is presented net of non-u.s. taxes withheld on dividends, interest income, and capital gains. Composite returns represent investors domiciled primarily in the United States. Policies for valuing portfolios, calculating performance, and preparing compliant presentations are available upon request. Prior to April 1, 2006, balanced portfolio segments were included in this composite. Cash was allocated to equity segments using a set percentage. As of December 31, 2005, 18% of composite assets are comprised of carve-out segments. The returns are compared to the S&P 500 Index, which is a market-capitalization weighted index. The S&P 500 Index is a widely used gauge of large-cap U.S. equities. The S&P 500 4

5 Index includes 500 leading companies and captures approximately 80% coverage of available market capitalization. The volatility of the Index may be materially different from that of Dividend Growth strategy. In addition, the holdings in the Dividend Growth strategy may differ significantly from the securities that comprise the Index. The secondary benchmark was changed in the 3rd quarter of 2008 from the Dow Jones US Select Dividend Index to the Russell 1000 Index. The change was made after determining that the Russell 1000 Index was a better representation of the Dividend Growth strategy. The Russell 1000 Index measures the performance of the large-cap segment of the U.S. equity universe. The Index is comprised of approximately 1000 of the largest companies in the Russell 3000 based on a combination of market cap and current index membership. Benchmark returns are not covered by the reports of independent verifiers. The Indices have not been selected to represent appropriate benchmarks to compare to the Dividend Growth strategy performance, but rather are disclosed to allow for comparison of Dividend Growth strategy performance to that of well-known and widely recognized Indices. Past performance is not indicative of future results. Inherent in any investment is the possibility of loss. For more information, please contact your financial advisor and visit nuveen.com or contact Santa Barbara by visiting sbasset.com. GLOSSARY Dividend Yield: For a company s stock, the ratio of the dividends paid out by the company each year per share to the share s current market price. Dividend Growth Rate: represents the percentage increase in the dividend payment since purchase. RISKS AND OTHER IMPORTANT CONSIDERATIONS This material is not intended to be a recommendation or investment advice, does not constitute a solicitation to buy or sell securities, and is not provided in a fiduciary capacity. The information provided does not take into account the specific objectives or circumstances of any particular investor, or suggest any specific course of action. Investment decisions should be made based on an investor's objectives and circumstances and in consultation with his or her advisors. The statements contained herein are based upon the opinions of Santa Barbara Asset Management and the data available at the time of printing this report. Past performance is no guarantee of future results and there is no assurance that any predicted results will actually occur. All investments carry a certain degree of risk, including possible loss of principal, and there is no assurance that an investment will provide positive performance over any period of time. Equity investments are subject to market risk or the risk that stocks will decline in response to such factors as adverse company news or industry developments or a general economic decline. Growth style investing may fall out of favor and underperform other equity investments during given periods. Certain sectors or growth stocks may shift characteristics over a long market cycle and may not perform in line with stated benchmarks. Dividend yield is one component of performance and should not be the only consideration for investment. Dividends are not guaranteed and will fluctuate. All information used reflects the most current data available. The information contained in this report has been taken from statistical services and other sources, which we believe is reliable, but not guaranteed for accuracy or completeness. Since no one manager is suitable for all types of inves tors, it is important to review investment objectives, risk tolerance, tax liability and liquidity needs before choosing a suitable investment style or manager. Santa Barbara Asset Management, LLC, is a registered investment adviser and an affiliate of Nuveen, LLC. GPE-BYCOST-0119P INV-Y-01/20 Santa Barbara Asset Management, LLC 2049 Century Park East, 17th Floor Los Angeles, CA