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July 2022

Equity Income: Remaining Relatively Resilient

Key Points

• Emphasizing dividend growth to improve inflation hedge

• Focus on downside protection to help ride out volatility over the cycle and maximize total return

• Attractive yield and compounded growth drive long-run value and potential equity price appreciation

Volatility continued to dominate market headlines in the second quarter, with losses extending and equities entering bear market status. As investors continue to look for places of safety and stability, dividend stocks have not been immune to the drawdown but have held up much better overall.

This is what we would expect to see, absent a financial crisis or exogenous shock. Because they predominantly represent established businesses, dividend stocks are inherently more defensive than non-dividend stocks. Our benchmark is overweight defensive sectors such as Utilities and Consumer Staples, and materially underweight Technology. No profitless tech here. And amid this inflationary environment, our dividend stock universe is also overweight the Energy and Materials sectors.

Within sectors, dividend stocks have also outperformed the broader market year to date – almost across the board. Rising interest rates have caused the longest duration, highest multiple stocks to de-rate. Dividend stocks are value stocks, with lower multiples and shorter duration, as more cash flows are delivered to investors via dividends in the nearer term.

As for the Equity Income portfolio itself, we have been reducing risk and cyclicality over the last year while employing our rising rate playbook of emphasizing dividend growth over yield. Annual dividend growth of +4-6% accrues to portfolio value over time, and also serves as an inflation hedge.

We believe the portfolio is well prepared for whatever lies ahead for the economy and market, but we will continue to adapt and adjust as warranted. Our focus remains on stock and dividend quality, on the stability of sales and earnings, on the resilience of cash flows and dividend income and on owning businesses well positioned to ride out the volatility inherent to the cycle.

As much as we look for opportunities for capital appreciation and growth, we also continuously evaluate downside risks to our holdings, looking to maintain confidence that pressures down the income statement are controlled, and risks to free cash flows, balance sheets and dividend payout are limited. Minimizing volatility via revenue and earnings stability, and avoiding dividend cuts, will help protect on the downside and help maximize total return over time.

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