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October 2022

Process in Action: Adapting to Higher for Longer

Key Points

Dividend stocks continue to hold up better than the broader market


Focus on downside protection and adjusting overall portfolio tilt defensively to help ride out volatility


Attractive income and compounded growth drives long-run portfolio value

Despite starting with a rally, the third quarter saw the bear market strengthen and lengthen, making new lows shortly before quarter’s end. Dividend stocks continue to hold up much better overall, although their margin over the broader market narrowed modestly as the stocks digested new information about rates, inflation and geopolitical events, and processed the macro implications sector by sector.

As we look ahead to year-end and beyond, it is worth discussing how we incorporate observations about the evolving macro and market outlook into our process. How information is acquired and conclusions are drawn both position by position as well as through the lens of CNR’s Investment Strategy Committee. From our bottom-up, quantitative and qualitative-driven stock selection process to our more macro-informed, more top-down portfolio construction, both inform how we adapt and evolve the portfolio through a very dynamic environment.

Both combine to facilitate our goal of protecting the downside, retaining future upside, and crucially, ensuring that our portfolio of dividend income remains intact and growing throughout the economic cycle. It is a tenet of our investment philosophy that value derives from portfolio income, and that over the long term, if income grows, value will grow with it, even if temporarily dislocated from current stock prices by market volatility.

From a bottom-up basis, in addition to free cash flow, we focus on liquidity and leverage even during the best of times, and examine what could go wrong when such metrics move in the wrong direction. While balancing turnover and client tax considerations, we trim and sell stocks where we see eroding fundamentals on the horizon, most recently within the consumer discretionary and real estate sectors. And we draw from our rising rate playbook, adding more dividend growth as an offset to rates and inflation.

As macroeconomic conditions have evolved this year, leading to the CNR outlook determining that a recession has become likely over the next year, we have adjusted our relative sector exposures and tilted more defensively. Painting with a broad brush, the nearby chart shows the overall portfolio tilt since the beginning of the year, as well as for some key sectors. In response to changing conditions, the portfolio has shifted from a modest cyclical bias to a modest defensive one, while remaining balanced across exposures overall.

More from the Quarterly Update

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