McKinley Dividend Growth Portfolio, “Direct” Dividend Investing

July 1, 2010

McKinley Capital is a  Global Growth Specialist  with a quantitative focus.

Overview

In this paper we discuss a research based expertise we have gained over nearly 20 years of managing money for institutional and private clients that can be harvested into alternative product categories separate and apart from McKinley Capital Management, LLC’s (“McKinley Capital”) traditional portfolios.  Specifically, we will outline the benefits of an investment strategy where the dividend is stripped from the underlying equity creating an improved risk/return profile in relation to a straight equity investment.  

{This strategy, through the controlled use of derivative instruments, strips away the dividend from the underlying equity leaving an ownership in a stream of income with a better risk/return profile than most equity or equity/income investments including a low correlation to other asset classes.}

Historically, investors bought the equity of a company in order to receive a steady stream of income in the form of a dividend. Currently, there is an opportunity to trade company dividends independent from their corresponding equity securities. The characteristics of which suggest an independent or sub-asset class with different return and volatility profiles relative to equity investing.  Dividends provide an inflation hedge while not suffering from multiple contraction and future risk premium associated with equity pricing. Dividends exhibit low correlation to commodities, short term bond rates, and corporate bonds. In consideration of capturing these benefits, we discuss the creation of the McKinley Dividend Growth Portfolio, which, in large part, could hold dividends directly as opposed to holding equities that pay dividends but suffer from PE multiple contraction/expansion.

The Expertise

Since the founding of the firm in 1990, McKinley Capital has created a comprehensive research repository based on fundamental and quantitative security characteristics. Today, we cover more than 40,000 companies globally in nearly 60 countries across developed, emerging and frontier markets. Additionally, we gather earnings forecast data from nearly 11,000 securities analysts from more than 70 firms worldwide. On a weekly basis, we produce more than 250,000 independent calculations for proprietary statistics and variables and update standard external fundamental data to the most recent period. We also monitor earnings reports and related “flash” data on a daily basis. The net result of this research and analysis is a global growth specialty with a significant quantitative bias used to create equity portfolios with a specific mathematical and factor exposure footprint. This footprint enables our clients to offset other manager exposures within their overall asset allocation strategy which should provide a smoother risk/return profile. All McKinley Capital product extensions use the same disciplined quantitatively based investment process, risk exposures and investment personnel.

Unfortunately, a large proportion of the research and data we collect and calculate weekly goes unused. Of the 40,000 stocks in our investment universe, roughly 1,000 names pass our stringent quantitative criteria and only a few hundred are actually purchased for the portfolios. In other words, much of the knowledge gleaned is not used to its fullest extent. As a result, we created McKinley Alternative Investments (MAI) to take advantage of this opportunity and use our research based expertise to create portfolios that are “alternative” to our traditional portfolios.  We have identified three specific areas of core competency from McKinley Capital Management, LLC that will be expanded by MAI: 1) Qualitative: using proprietary behavioral analysis to analyze earnings forecast and surprise data which in turn are used to make predictions of earnings, cash flow, revenues and/or corporate dividends that differ from Street consensus; 2) Portfolio Optimization and Risk Control Technique: allows baskets of securities to be constructed in a manner that matches risk exposures relative to another basket of securities or index; 3) Quantitative: screening capability on variables, both common and proprietary. Going forward, we expect MAI to create new portfolios in these three areas subject to our stringent product launch criteria.

The contents of this paper focus on the first category called Qualitative. Our ability to identify companies that report earnings surprise with a high degree of accuracy (see Earnings Scorecard data in the Appendix) should support the opportunity to coincidently predict stable to rising dividends over time. With dividend payout ratios fairly constant at 20% to 35%, strong knowledge of earnings levels will allow better visibility to dividends paid. This, in turn, may allow investors an opportunity to benefit from a dividend only investment.

The Opportunity

Recently, there has been an explosion in supply and development of derivatives vehicles used to strip dividends from the underlying equities to which they are associated. This growth relates to investment banks and the creation of structured products and related returns. In addition, there is reason to believe that an investor that holds large amounts of equities may be willing to separate dividend growth from price growth and sell one or the other for a current net present value. We believe the supply of dividends stripped from equities is likely to grow exponentially in the coming years. In Q2 2009, several markets in Europe added exchange traded futures contracts on dividend indexes and we expect more on the way. Our expertise in forecasted acceleration allows us to capitalize on this new investment opportunity. Our ability to identify earnings surprise of securities means we can also estimate dividend payments. Given the large supply of stripped dividends hitting the market, prices have accordingly been pushed down to unsustainable levels. Thus, there arises a situation where implied dividends can be purchased at a discount from both consensus as well as Smart Analyst predictions and we believe, in some cases, those dividends understate the actual dividend stream that may be realized over time.

The following sections of this paper address the viability and construction of this specific investment strategy within an overall portfolio asset allocation strategy, and describe it as a sub-asset class to equities. Because this strategy is relatively new, the following information differs from a traditional McKinley Capital whitepaper; proving a concept in a statistical manner with excess returns measured and described using back-tested data. The dearth of historical data and the inability to provide specific statistical analysis requires this type of strategy to be described and return/volatility patterns reviewed on a more anecdotal basis.

Characteristics of Dividends as a Stand Alone Product
Dividends vis-à-vis Prices

The return from owning stocks depends in large part on the level of stock prices when the securities are bought relative to the level of stock prices when they are sold. However, price level depends heavily on the state of confidence in future earnings, or long-term expectation, as opposed to what the company is earning at the date of purchase. Many investors base their investment decisions on the price levels at which they expect to sell stocks in the future. Therefore, they believe that the price the market is willing to pay for a dollar of dividends (earnings) at some point in the future will be as high as or even higher than at the time of purchase. Indeed, it is not possible to predict this without knowing what future growth rate of dividends(earnings) the market is assuming and what risk premium or expected rate of return the market is requiring (the simple Gordon growth model).

Stock versus Dividend Trading – Risk

Dividends are driven largely by earnings growth, payout ratios, and cash availability. While stock prices are also partially driven by earnings growth, other factors also play a role, such as changes in P/E multiples, and expectations about a company’s future earnings stream including earning streams falling outside of the period to which the dividend payout applies. Accordingly, there are more sources of potential risk in trading stocks versus trading the dividends of stocks.
Historically dividends have been less volatile than either earnings or stock prices (See Figures 1, 2 and 3).


1007 Dividend -01 Fig1 (1)

1007 Dividend -02 Fig2

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Dividends vis-à-vis Earnings

The regression in Figure 4 below, of dividend growth versus the previous year’s index return captures many of the characteristics observed for dividend returns over the last 18 years.

Figure 4. Regression of European Dividend Growth versus the Index Return in the Previous Year

1007 Dividend -04 Fig4Dividends tend to lag earnings. Companies generally do not pass through all profit increases immediately to shareholders and similarly do not cut dividends immediately following a period of weaker earnings. Companies tend to smooth dividends by changing the proportion of earnings that they pay as dividends (the payout ratio, or dividend per share / earnings per share). Dividends tend to grow more slowly and with more of an upward bias than company earnings given the reluctance of management to cut their dividends, thus sending a negative signal about future prospects to shareholders. This is reflected in the fact that the y intercept in the above regression chart is above zero. Dividends exhibit positive alpha over equities as seen in Figure 4.

Holding a dividend portfolio should be less exposed to downward revisions in earnings estimates when market sentiment becomes more bearish and explains why the downside risk for dividends tends to be more limited than that for equities. Further, dividend growth tends to be a muted version of earnings growth, typically showing lower volatility as demonstrated in Figure 5, which displays the dividends versus earnings volatility in Europe.

There is no doubt that dividends and earnings are cyclical. However, it is also apparent from the graphs below that dividends tend to lag earnings and tend to be less volatile.

Figure 5. Volatility of Dividends and Earnings 

1007 Dividend -05 Fig5

Dividends and Inflation

Historically, dividends have provided an inflation hedge. Dividends in commodity related sectors in particular may provide the best inflation protection. The strong relationship between dividends and inflation and nominal GDP gives rise to the potential to use dividend investing as an alternative to equities and bonds in efficient portfolio allocation. Dividends tend to be less volatile than equities, yet can provide similar growth rates, thus providing a better risk-adjusted inflation hedge {see Figure 6 for inflation versus dividends in the United States during periods of sharp changes in inflation}.

Figure 6.  U.S. Annual Inflation Rate and S&P500 Dividend Growth – 70’s versus 80’s 

1007 Dividend -06 Fig6

Even over longer periods as demonstrated in Figure 7, earnings and dividends are nominal concepts and generally keep pace with inflation.

Figure 7.  U.S. Dividend Growth and Inflation

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Dividends vs. Other Asset Classes

McKinley Capital constructed an implied dividend index. The index consists of the forward 1 year implied dividend rolled over every year on January 1st for the time-period March 2003 through July 2009. Note that implied dividends were only trading over-the-counter (OTC) until 2008; therefore daily volatility before 2008 is likely underestimated. Historically, dividend swaps were not re-priced as frequently as they are now, therefore daily dividend swap data has not always been available. Accordingly, the use of daily returns may also underestimate the correlation between dividend swap returns and equity market returns. Nevertheless, a comparison with several other asset classes can still be relevant for the purpose of exploring correlations and returns.

In order to demonstrate a complete picture of the correlation between dividends and other asset classes, we used daily, weekly and monthly data to provide a comprehensive picture for implied dividends in comparison to these other asset classes. The data will show that within the timeframe of the analysis, dividends provide low correlation to other asset classes as well as a better risk/return profile when compared to equities. We used Bloomberg and other sources in our analysis. We believe that while dividends are partially correlated to equities, the variance of their returns may not be explained by the variance of other asset classes and therefore dividends may complement a multi-asset investment strategy. In comparing a simple dividend strategy with an equity strategy, the portfolio consists of the forward 1 year implied dividend rolled over every year on January 1st. The following chart shows that an implied dividend strategy would have beaten the price index since 2003. In addition, the lagging effect of that dividend strategy in 2003 and in 2009, in both instances, occurred when the market was emerging from a recession.

Figure 8. Relationship between Implied Dividends and DJ EURO STOXX 50 (2/14/2003-7/16/2009)

1007 Dividend -08 Fig8

Moreover, since a dividend swap requires no principal investment (apart from margin), including an additional conservative return of LIBOR on deposited funds would provide further outperformance versus an equity market total return (see Table 1).

Table 1.  Rolling 1-Year Forward Euros Stoxx 50 Implied Dividend Returns versus Equity Market Returns 

1007 Dividend -09 Tab1

Using a strategy consisting of acquiring the dividend term structure (5 year maturities) would have produced superior results compared to a 1 year forward rolling strategy. This is due to the higher risk premium linked to longer maturities, as higher returns associated with future contracts are justified due to higher uncertainty and carry risk linked to longer expirations.  This means (as shown in Figure 9) that the dividend term structure investment has beaten the 1 year forward investment, both of which have beaten the equity market.

1007 Dividend -10 Fig9

Correlation analysis provides a view of dividends in comparison to other asset classes, based on daily, weekly and monthly returns.

Table 2 shows the low correlation between implied dividends and inflation linked bonds (EMTXIGC), Euribor 3 Months (EUROO3M), corporate bonds (IB8A), and commodities (SPGSCITR) while, as expected, the correlation is slightly higher to equity indices (SX5E and SX5T).

Table 2. Correlation Based on Daily Returns (2/2003 – 9/2009)

1007 Dividend -11 Tab2

Thus, using daily returns, a dividend strategy would have produced a better risk/return trade-off than an equity strategy not only for the 2003 to 2009 period, but also for other sub-periods as illustrated in Table 3.

Table 3.  Sharpe Ratio Based on Daily Returns  

1007 Dividend -12Tab3

Correlation Based On Monthly Returns:

Because of the static nature of dividends in the time series, daily changes might underestimate the true correlation. This is particularly true given that swaps weren’t priced on a daily basis until just a few years ago. Because daily returns are currently available, more recent periods of analysis should reflect daily not monthly analysis.
In the following tables, correlations based on monthly returns were broken down between different time periods. As expected, dividends are consistently correlated with equities at more than 50% during the time frame of the analysis. This is a more realistic outcome compared to the previous daily return analysis as dividends depend on earnings and earnings growth traditionally translates into dividend growth.

In the period between 2003 and 2009 dividends were only mildly correlated with short-term rates (EUROO3M), commodities (SPGSCITR), corporate bonds (IB8A) and inflation linked government bonds (EMTXIGC). It is only within the last two years that the correlation has increased. In the period between 2005 and 2007 only commodities were mildly correlated at less than 30% while bonds and short term rates were negatively correlated.

Table 4. Correlation Based on Monthly Returns

1007 Dividend -13 Tab4 (1)

In Table 5 below, risk/return trade-offs are calculated based on monthly returns. In this example, the dividend strategy would have outperformed the equity strategy during the bull market period from 2003 to 2007 and would have underperformed during the bear market period from 2007 to 2009. Monthly returns for the 2007 to 2009 period understate the stock index volatility, and we would like to emphasize that since early 2008, dividend swaps have traded on the futures exchange and therefore, daily returns and volatility are more relevant than for the period when they traded exclusively over-the-counter; therefore the Sharpe ratios appear to favor an equity strategy. Nonetheless, we display both the daily and the monthly data for the purposes of full disclosure.

Table 5. Sharpe Ratios Based on Monthly Returns

1007 Dividend -14 Tab5

As a compromise between monthly returns which understate recent periods, and daily returns which weren’t necessarily relevant over the whole period, we have included weekly risk/return trade-offs as well.

As evidenced below in Table 6, weekly returns reflect higher Sharpe ratios for the dividend strategy across all time series and most of the sub-periods.

Table 6. Sharpe Ratios Based on Weekly Returns

1007 Dividend -15 Tab6

Figure 10 depicts two regressions between implied dividends (.ID1FROLL) and the DJ Euro STOXX 50: one period is between 2003 and mid 2009 and a second period is between 2003 and mid 2008. It is also instructive to see the increase in correlations visually when including the most recent period. This period has been one of the most volatile in the history of capital markets and should give investors an idea of dividend correlations in times of duress.

Notice that R^2 (coefficient of determination) is higher once the last 12 months of prices are included. As expected, correlation has increased in the past year however both periods show positive alpha.

Figure 10. Regression of 1-Year Forward Dividend Rolling (.ID1FROLL) and The Dow Jones EURO STOXX 50 (Price) Index (SX5E) Using Weekly Returns

1007 Dividend -16 Fig10

In addition, to the correlation to equities in Europe, in Figure 11, we compare implied dividends (.ID1FROLL) against the IBOXX Liquid corporate index, a benchmark for liquid corporate bonds euro denominated. Correlation close to zero indicates that dividends may complement a corporate bond strategy. Again, this analysis is more powerful presented visually.

Figure 11. Regression of 1 Year Forward Dividend Rolling (.ID1FROLL) and (IB8A) IBOXX € LQD CRP TR Liquid Euro Corporate Bonds Using Weekly Returns

1007 Dividend -17 Fig11

The S&P GSCI (SPGSCITR) is widely recognized as the leading measure of general commodity price movements. Low correlation until mid 2008 between implied dividends and commodity prices has dropped to almost zero indicating that implied dividends may complement a commodity strategy (Figure 12).

Figure 12. Regression of 1-year forward dividend rolling (.ID1FROLL) and (SPGSCITR) commodity index using weekly returns

1007 Dividend -18 Fig12

Finally, inflation linked European government bonds also display very low correlation through mid 2008 and no correlation at all through 2009 with implied dividends (Figure 13)

Figure 13. Regression of 1-Year Forward Dividend Rolling (.ID1FROLL) and Euro MTS Inflation Linked Index Level Closed Fixing (EMTXIGC) Using Weekly Returns

1007 Dividend -19 Fig13

The Market for Dividends

Institutions such as investment banks may end up being long dividends as a direct result of the structured products they create, e.g. capital guaranteed bonds, which offer exposure to the upside of equity markets. Essentially, these products are written in terms of capital gains, which result in the issuers holding the dividends. Institutions sell the dividend exposure through dividend swaps (or futures). These transactions are similar to a plain vanilla rate swap.

Equity returns are a function of:
1007 Dividend -20 Equity Returns

What Is A Dividend Swap?

A dividend swap is an over-the-counter (OTC) derivative contract that enables an investor to bet on the dividends that will be paid out by a chosen security or basket of securities (like the constituents of an equity index) in a predetermined time period, usually one year.

The seller agrees to pass through the dividend at whatever value is paid by the company or basket of companies and the buyer agrees to pay a fixed amount in realized index dividend points (see Figure 14 below).

Figure 14. Description of a Dividend Swap

1007 Dividend -21 Fig14

The realized dividend is the cash flow actually received by the purchaser of the swap.

Figure 15 below shows the dividends paid over the period, and clearly indicates growth up until 2008, when the level of dividends declined as a result of the credit crisis.

Figure 15. Euro Stoxx 50 Realized Dividends Between 2005 and 2009

1007 Dividend -22 Fig15

Implied Dividends

Market-implied dividends for a particular year are driven by dividend growth expectations and the perception of risk to dividends. These dividends are implied given the price paid now to gain these payments over time. An opportunity is created when implied dividends understate potentially realized dividends. More recently in Europe, a market for dividend futures has developed to augment the swap market. A swap and a future offer the same exposure while the latter does not carry counterparty risk.

SX5E Dividend Futures Pricing Date 04/24/09 Sort by Expiration

1007 Dividend -23 SX5E

For example, while somewhat technical in nature, the price of the swap is derived from using the options spot market for a given security or basket of securities.

The implied pricing of Dow Jones EURO STOXX 50 Index dividend swaps can be calculated by using Eurex Dow Jones EURO STOXX 50 Index Options prices. From put/call parity for dividend paying stocks we know that:

1007 Dividend -24 Basic Mech

A Dow Jones EURO STOXX 50 Index dividend swap is a forward contract which represents an annual dividend payout to December each year.

Expected/predicted dividends can be derived from external sources such as IBES; Markit; sell side fundamental analysts; sell side macro analysts and proprietary research. In other words, proprietary McKinley Capital analysis of earnings and payout ratios can give us a unique expectation of dividend payments. We then have the opportunity to buy those dividends, based on our expectations, at the implied price. It should be noted that, implied dividends tend to trade at a discount versus expected dividends. In essence, the implied dividend is equal to the dividend-risk premium adjusted prediction of the future and therefore, the implied dividend is actually the dividend-risk-premium adjusted market prediction of dividend payments.

Figure 16. Implied Dividends are the Dividend Risk Premium Adjusted Expected Dividend

1007 Dividend -25 Fig16

This dividend risk premium is the amount of discount investors are demanding to take the risk that the market expectations for dividends come to pass. An opportunity arises if our expectations either at least infer that the market expectations will occur or even better, if market expectations are too low. See the Appendix for a description of McKinley Capital’s expertise in this area. The risk premium and resulting return, before any unique McKinley Capital expectation is calculated, is shown in Figure 17 below.

Figure 17.  Calculation of the Dividend Risk Premium and the Resulting Return of a Fully Funded Dividend Strip

1007 Dividend -26 Fig17

What is the expected return? A 1-year forward dividend swap position should return the dividend risk premium and cash return over that period. As time goes by and the cumulative dividend is accumulated, the risk premium diminishes while the trade generates the expected return (see Figure 18).

Figure 18. Market Implied Dividend Risk Premium for 2006 EUR STOXX50 and Cumulative Dividends Paid by Constituents, January 3, 2005 to December 29, 2006

1007 Dividend -27 Fig18

The goal of any strategy that uses dividend swaps and or futures is to capture the risk premium between implied and expected dividends.  This could be done at the level of the whole market through basket futures or swaps or for individual securities where a person may have insight on the level of dividends that will be paid over time.

Implementation of a McKinley Dividend Growth Strategy

A component of an investment strategy designed to capture stripped dividends could be based on the ability of the investment manager to forecast those dividends and, if possible, to buy them at a discount to the stream of income actually paid over time. Therefore, investors may profit from the mispricing of these dividends if the manager is able to forecast dividends relative to a benchmark index or at the company level for a single stock, with a higher degree of accuracy than the market. Also, investors buying dividends with long maturities will profit from the passage of time (i.e. profit from positive carry) because implied levels tend to price in high risk premiums to compensate for fundamental and mark-tomarket risks. We believe our unique perspective and comprehensive research and data collection capabilities on the broadest array of securities worldwide will provide the insight necessary to capture this opportunity and thus provide investors with exposure to dividend growth at a lower level of volatility than that expected from an equity strategy wherein dividends are only part of total return (the other part being stock price return).

The McKinley Dividend Growth Portfolio Direct component may use a combination of stock index dividend futures and/or swaps, in addition to individual company equity dividend futures/swaps, and other derivatives, to create a basket of securities/indices that can capture the earnings growth and thus dividend payouts and yields revealed by our research analysis. As evidenced by our analysis, we believe this investment strategy can create an improved risk/return profile over time, relative to an equity portfolio while also providing a low correlation to other asset classes. Our bias is towards the use of futures to eliminate the counterparty risk associated with swaps and thus suggest an investment universe closely associated with that of the EuroStoxx 50 in Europe. Given the size and speed of development of the European market, we estimate that current capacity for this component of a portfolio is US$500 million to US$1 billion which is roughly equivalent to 15% of contracts outstanding. Given that the level of contracts outstanding is increasing both in Europe and elsewhere, we expect capacity for a global version of this product to be multiples of this number. Importantly, the swaps market is global so this strategy could be considered worldwide as a way to collect a dividend stream with higher rates of return than what is now being paid to investors who buy, hold and collect dividends on those securities. By definition, this investment strategy should reduce the impact of stock price volatility and multiple expansion and contraction. While this product would have some characteristics of a fixed income investment, it would not have the claim on corporate assets associated with bonds. Nevertheless, returns may indeed be very attractive.

As an institutional investment manager, we will create fund vehicles that exhibit clear pricing schedules, full transparency and no lock-ups. Although the features of this fund are unique, the fund itself is just an alternative way of garnering a stream of income within a sub-asset class to equities. To the degree that it is compatible with client assets, the use of Delaware Trusts and UCITS Funds would be the preferred vehicles.

Risks

Any analysis of a new investment opportunity would not be complete without a description of the associated risks. We believe there are four primary risks associated with the McKinley Dividend Growth Portfolio which are as follows: 1) We may not accurately predict earnings so even if payout ratios remain consistent, it is possible we could overestimate dividends. 2) The tax regime in regard to dividends could change in the various jurisdictions of our clientele making capital gains relatively more attractive. 3) We could see further dividend cuts along the lines of those implemented in the difficult market environment of 2008. 4) This strategy has counterparty risk for the swap agreements. To address this risk, we intend to use our relationships with the largest and highest investment grade, OTC counterparties. Furthermore, where futures are available, we will use them extensively instead of swaps.

References
Blees, Wietske. “Dividend Option Market Tipped for Growth.” Risk April 2008.
Brennan, Michael J. “Stripping the S&P 500 Index.” Financial Analysts Journal Vol. 54. No. 1. (January/February 2008): 12-22.
“Companies International: Trading Strategies.” Financial Times July 2007.
“Dividend Focus, Turning Cash into Value.” Goldman Investment Research September 2006.
Dividend Swap Primer Barclays Capital October 2004.
Dividend Swaps Product Note JP Morgan 18 May 2009.
Global Speculations: Dividend Delights Barclays Capital September 2005.
Hughes, Chris. “Dividends – The Accidental Asset Class.” Financial Times July 2007.
“Investing In Dividend Yield.” Equity Derivatives Barclays December 10, 2007.
“Lex Column: Dividend Swaps.” Financial Times April 2008.
Manley, R., and Mueller-Glissman, C. “The Market for Dividends and Related Investment Strategies.” Financial Analysts Journal Vol 64. 2008.
MCM Earnings Scorecard. McKinley Capital Management, LLC December 2008
Montier, James. “Asset Fire Sales, Depression and Dividends.” Mind Matters 2 February 2009.
“Pricing & Applications for the Institutional Investor.” Eurex Dow Jones EURO STOXX 50® Index Dividend Futures 2008.
Sawyer, Nick. “Uncertain Dividends.” Risk October 2007.
Shiller, Robert. “Do Stock Prices Move Too Much to Be Justified by Subsequent Changes in Dividends.” American Economic Review Vol. 71. No. 3. (June 1981): 421–436.
Shiller Robert. “Irrational Exuberance.” Princeton University Press 2000, 2005, updated.
“Where from Here?” Index Dividend Swaps Barclays Capital August 2005.

Disclaimer Statement

McKinley Capital Management, LLC (“McKinley Capital“) is a registered investment adviser. The material provided herein has been prepared for a one-on-one institutional and high net-worth client presentation and should not be further disseminated without the compliance officer’s approval. This material may contain confidential and/or proprietary information and may only be relied upon for this report. The data is unaudited and may not correspond to calculated performance for any other client or investor in the stated discipline. There is no historical performance for this discipline. McKinley Capital recently initiated a dedicated dividend growth product and any returns presented herein are extracted from named external indexes and may not correspond to quarterly or annual performance for any other client or investor in a similar discipline. This is not an offer to purchase or sell any security or service, is not reflective of composite or individual portfolio ownership and may not be relied upon for investment purposes. Investments and commentary were based on information available at the time and are subject to change without notice. Any references to specific securities are for informational purposes only, may or may not have been owned by McKinley Capital in the past, may or may not be owned by McKinley Capital in the future and may or may not be profitable. Any positive comments regarding specific securities may no longer be applicable and should not be relied up for investment purposes. No one security is profitable all the time and there is always the possibility of selling it at a loss. Active clients are provided monthly and/or quarterly portfolio profiles that include trading information for the period. Past performance is not indicative of future returns. Investments are subject to immediate change without notice.

Because McKinley Capital’s investment process is proprietary, composite returns and individual client returns may at various times materially differ from stated benchmarks. Charts, graphs and other visual presentations and text information are provided for illustrative purposes, derived from internal, proprietary, and/or service vendor technology sources and/or may have been extracted from other firm data bases. As a result, the tabulation of certain reports may not precisely match other published data. Future investments may be made under different economic conditions, in different securities and using different investment strategies. International investing also carries additional risks and/or costs including but not limited to, political, economic, financial market, currency exchange, liquidity, accounting, and trading capability risks. Fees are collected quarterly which produce a compounding effect on the total rate of return. Fund products also include administrative and other expenses which are usually charged to the shareholders. Therefore, the investor must consider total costs in arriving at a suggested rate of return. Actual investment advisory fees incurred by institutional and high net-worth clients may vary. A fee schedule is described in Form ADV Part II. To receive the firm’s ADV or a description of all McKinley Capital composites, please contact McKinley Capital Management, LLC, 3301 C Street, Suite 500, Anchorage, Alaska 99503, 1.907.563.4488 or visit the firm’s website at, www.mckinleycapital.com. All information is believed to be correct but accuracy cannot be guaranteed. Please review the references section of this report for further details on locating complete source information.

Appendix

The follow tables show the percentage of our holdings, across various portfolios that have positive earnings announcements versus consensus expectations. These numbers are consistently high. Herein is an opportunity to apply this analysis to a dividend portfolio. Consistently better earnings lead to higher dividends paid. Thus, where the market may have dividend expectations of X, we would show X plus something more.  If we can buy the market expectations at an implied price that is less AND our expectations are higher than the market, an alpha opportunity arises.

1007 Dividend -28 Appendix1

1007 Dividend -29 Appendix2

1007 Dividend -30 Appendix3

1007 Dividend -31 Appendix4