Download Small Cap Dividends: A Potential Path to

INVESTMENT MANAGEMENT CORPORATION
Small Cap Dividends: A Potential Path to Superior Returns
By: Andrew Bass, Director of Research at North Star Investment Management Corporation
Vanguard Dividend iShares Select
Appreciation
Dividend ETF
(VIG)
(DVY)
Market Cap
(000’s)
SPD® S&P
Dividend ETF
(SDY)
North Star
Dividend Fund
(NSDVX)
$450,000
$350,000
$250,000
$150,000
$50,000
$(50,000)
Average
Market Cap:
$25.4B
Average
Market Cap:
$30.8B
Average
Market Cap:
$36.9B
Average
Market Cap:
$0.4B
North Star Investment Management believes that
small capitalization dividend stocks (defined as
dividend- paying stocks with market capitalizations of
less than $1 billion) offer investors the best of both
worlds, superior returns and lower risk. Since 2010,
the North Star Dividend Fund (NSDVX) is one of the
few mutual funds that provides investors with the
opportunity to invest in a basket of dividend-paying
small cap stocks. Dividend payments for high quality
small cap companies can provide a return component
less volatile than the capital appreciation component,
there is an opportunity for superior long-term price
appreciation that can be associated with the small
cap stocks, and there may be some risk mitigation
when companies pay out a portion of their free cash
flow in the form of dividends.
Volatility and Dividend Payers
Long-term return data tells us that dividend-paying stocks enjoy lower volatility versus non-dividend paying
stocks. For example, from 1927-2014 non-dividend payers had a 30.1% standard deviation while dividend
payers had an 18.3% standard deviation (Source: Forbes). The same trend of lower volatility can be seen in the
North Star Dividend Fund with a standard deviation of 16.4% since fund inception in 2010 versus 20.4% for the
Russell 2000 Total Return Index.
One can see that part of the general explanation for lower
standard deviation lies in the stability of return that is derived
from dividend payments. For example, according to Standard
& Poors, dividends contribute more than one-third of historical
equity returns from 1926 to 2012. When adjusting for market
conditions, dividend yield contributed an average of 13.5%
of the total return during bull markets and 34.7% of the total
return during bear markets. So, though share price returns can
be negative and quite volatile, dividends provide consistent
positive equity return contributions, especially during periods
of weak price appreciation in broad market indices.
Dividend Income as a Percent of
Monthly Total Return of the S&P 500
60%
40%
20%
0%
1940s
1950s
1960s
1970s
Source: S&P Dow Jones Indices
1980s
1990s
1926 to
Dec-2012
High Quality Small Caps…Even Better!
In addition to the stability of returns that comes with dividend payments, the North Star Dividend Fund also seeks to
invest in higher quality businesses, which we define through lower than average leverage ratios as well as higher
than average ROEs. As of January 20, 2016, the Fund’s Debt to Equity
ratio is 0.86x versus 1.90x for the Russell 2000, and the Fund’s average
Quality
Portfolio Returns
ROE, excluding negatives, of 11.4% versus 7.5% for the Russell 2000.
(1985-2014)
Higher ROEs provide for higher long term price return potential in addition
to the dividend component of the Fund as studies have shown that higher
Russell
quality businesses tend to outperform lower quality businesses over long
3000®
Index:
periods of time. A study from 1985 to 2014 that compared a portfolio made
11.3%
up of High Quality stocks versus a portfolio of Low Quality stocks showed
that the High Quality portfolio outperformed by a wide margin. In addition
to lower than average leverage ratios and higher than average return
on equity ratios, the North Star Dividend Fund primarily seeks to invest
in stocks whose characteristics are inherently stable, which we think is
synonymous with quality in a dividend portfolio. For example, 15.7% of the
Fund’s exposure was to the Utility space.
Source: Atlanta Capital Investment Managers
Dividends as Potential Protection
A history of dividend consistency as it relates to dividend policy is another important condition that we look for
when investing through the North Star Dividend Fund. We generally find that corporations that have a long history
of paying dividends may be more attentive to managing capital structures appropriately in order to maintain
dividend payments. In the North Star Dividend Fund, for example, the average company has had a consistent
dividend policy for over 15 years with one portfolio company in particular, The York Water Company, 1.7% of the
portfolio as of 12/31/15, having paid a dividend since 1816!
The primary objective of the Fund is to generate dividend income, however income is not assured.
Our Formula Matters
We stick to a few basic principles that drive long term performance in the North Star Dividend Fund including
finding stocks whose market capitalizations are under $1 Billion, businesses whose capital structures support
long term dividend payment and growth potential, management teams whose interest align with shareholders,
and business models that generate high returns on equity. These characteristics combine to provide return
characteristics that generate lower volatility in a volatile market.
ANNUALIZED RETURNS OF FUND unaudited (net of fees)
North Star Dividend Fund
Russell 2000 TR
12/31/15
1-YR
3-YR
5-YR
Inception
-2.8%
-4.4%
10.4%
11.7%
9.6%
9.2%
12.5%
12.6%
*The Russell 2000 Index measures the performance of small-cap segment of the U.S. equity universe.
Past performance is not indicative of future results. Current performance may be lower or higher than the performance data quoted
above. For performance information current to the most recent month-end please call toll-free 855-580-0900. Performance shown
before June 1, 2013 is for the Fund’s predecessor limited partnership (North Star Dividend Fund, LP). The prior performance is net
of management fees and other expenses, but does not include the effect of the performance fee. The Fund has been managed in the
same style and by the same portfolio manager since the predecessor limited partnership’s inception on February 1, 2010. The Fund’s
investment goals, polices, guidelines and restrictions are, in all material respects, equivalent to the predecessor limited partnership’s
investment goals, polices, guidelines and restrictions. From its inception on February 1, 2010 through the date of this prospectus the
predecessor limited partnership was not subject to certain investment restrictions of the 1940 Act of the Code, which if they had been
applicable might have adversely affected its performance.
The Vanguard Dividend Appreciation ETF (VIG) seeks to track the performance of a benchmark index that
measures the investment return of common stocks of companies that have a record of increasing dividends
over time. This ETF is subject to Stock Market Risk, Investment Style Risk and the target inded may become
concentrated in a particular market sector subjecting it to additional risk. The annual fee for this ETF is 0.10%.
The iShares Select Dividend ETF (DVY) seeks to track the investment results of an index composed of
relatively high dividend paying U.S. equities. This ETF is subject to Asset Class Risk, Authorized Participant
Concentration Risk, Concentration Risk, Consumer Discretionary Sector Risk, Consumer Goods Industry Risk,
Consumer Staples Sector Risk, Dividend-Paying Stock Risk, Energy Sector Risk, Financials Sector Risk, IndexRelated Risk, Management Risk, Market Risk, Risk of Secondary Listings, Secondary Market Trading Risk, MidCapitalization Companies Risk, Passive Investment Risk and Utilities Sector Risk. The annual fee for this ETF
is 0.39% The SPDR® S&P® Dividend ETF (SDY) seeks to provide investment results that, before fees and
expenses, correspond generally to the total return performance of the S&P® High Yield Dividend AristocratsTM
Index. This ETF is subject to Sector Risk, Market Risk, Index Tracking Risk, Dividend Paying Securities Risk,
Equity Investing Risk, Financial Sector Risk and Non-Diversification Risk. The annual fee for this ETF is 0.35.
The primary investment objective of the North Star Dividend Fund (NSDVX) is to generate dividend income and
the secondary objective is to seek capital appreciation. The Fund seeks to achieve its objective by investing in
a diversified portfolio of dividend paying securities with market capitalizations under $1 billion. The sales charge
(load) for purchases of the North Star Dividend Fund is 1.38%. You should carefully review the prospectus
for each ETF identified and understand all risks.
*The S&P 500® is widely regarded as the best single gauge of large cap U.S. equities. The index includes 500
leading companies and captures approximately 80% coverage of available market capitalization.
*The Russell 2000 Index measures the performance of the small-cap segment of the U.S. equity universe.
The indices shown are for informational purposes only and are not reflective of any investment. As it is not
possible to invest in the indices, the data shown does not reflect or compare features of an actual investment,
such as its objectives, costs and expenses, liquidity, safety, guarantees or insurance, fluctuation of principal or
return, or tax features. Past performance is no guarantee of future results.
Mutual Funds have investment risks including loss of principal. There is no guarantee the fund will meet its
objective. The risk that the securities of small-cap and micro-cap companies may be more volatile and less liquid
than the securities of companies with larger market capitalizations. These small-cap companies may not have
the management experience, financial resources, product diversification and competitive strengths of large- or
mid-cap companies, and, therefore, their securities tend to be more volatile than the securities of larger, more
established companies.
Investors should carefully consider the investment objectives, risks, charges and expenses of the North
Star Funds. No-Load Mutual funds are sold without sales charge; however, they have ongoing expenses,
such as management fees. This and other important information about each of the Funds are contained
in the prospectus, which can be obtained at www.nsinvestfunds.com or by calling (855) 580-0900. The
prospectus should be read carefully before investing. The North Star Funds are distributed by Northern
Lights Distributors, LLC member FINR/SIPC. North Star Investment Management Corporation is not
affiliated with Northern Lights Distributors, LLC.
4131-NLD-2/10/2016