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Edited Transcript of ADX earnings conference call or presentation 24-Jul-19 6:00pm GMT

Half Year 2019 Adams Diversified Equity Fund Inc Earnings Call

BALTIMORE Jul 26, 2019 (Thomson StreetEvents) -- Edited Transcript of Adams Diversified Equity Fund Inc earnings conference call or presentation Wednesday, July 24, 2019 at 6:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Brian S. Hook

Adams Diversified Equity Fund, Inc. - VP, CFO & Treasurer

* Lyn Walther

Adams Diversified Equity Fund, Inc. - Director of Shareholder Communications

* Mark E. Stoeckle

Adams Diversified Equity Fund, Inc. - President, CEO, Senior Portfolio Manager & Director

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Presentation

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Operator [1]

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Good afternoon, and welcome to the Adams Diversified Equity Fund semiannual conference call. (Operator Instructions)

Please note, this event is being recorded.

I would now like to turn the conference over to Lyn Walther, Director of Shareholder Communications. Please go ahead.

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Lyn Walther, Adams Diversified Equity Fund, Inc. - Director of Shareholder Communications [2]

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Good afternoon, and thank you for joining us today as we discuss the results for Adams Diversified Equity Fund for the first 6 months of 2019.

With me today are Mark Stoeckle, the fund's Chief Executive Officer; Brian Hook, our Chief Financial Officer; and Janis Kerns, our General Counsel.

This conference call contains statements which are considered forward-looking statements within the meaning of the U.S. Securities Act. These statements reflect fund management's current views with respect to future events and the fund's financial performance over the past 6 month and 12 months and are not guarantees of our future performance. Although forward-looking statements made today are based on what management believes are reasonable assumptions, these statements are subject to risks, uncertainties and other important factors that could cause our actual performance, returns or investment decisions to be materially different from what we project. We assume no obligation to revise, correct or update these statements.

I will now turn the call over to Mark Stoeckle for his remarks.

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Mark E. Stoeckle, Adams Diversified Equity Fund, Inc. - President, CEO, Senior Portfolio Manager & Director [3]

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Thanks, Lyn, and thanks, everyone, for joining us today to talk about the first 6 months of '19. I'm going to give some brief remarks, talk a little bit about what moved the fund in the first 6 months and then turn it over to Brian to give some details on performance, and then we will take your questions.

After a steep sell-off at the end of '18, the stock market did reverse course in the first half, despite several economic and geopolitical headwinds. While there were signs of slowing in manufacturing, both domestically and globally, the overall U.S. economy remains relatively strong with unemployment at historic lows and inflation under control.

If you remember, we began the year with a government shutdown, which ended in late January, making it the longest shutdown on record. We also saw trade negotiations with China break down and the U.S. threatened to raise tariffs on $300 billion of Chinese imports. Tensions also escalated in the Middle East. All of this began to take a toll in May. However, in June, the Federal Reserve reassured the market that it would be accommodative if economic growth were too slow, which calmed markets and had investors wondering how many times the Fed might cut rates before the end of the year.

With this as a backdrop, the S&P 500 increased 18.5%, its strongest first half return since 1997. We are very pleased with our performance, which exceeded our benchmark by 1.4%. Our fund generated 19.9% return driven by strong stock selection across several sectors. The strength in the market was broad-based with all sectors generating positive returns. The strongest contributors to our performance came from technology, health care and consumer staples. Our technology investments increased 28%. Our holdings in Microsoft and Adobe Systems were standouts and continued to benefit from enterprise spending on cloud computing.

Another key trend in the technology sector is the migration from cash to plastic driven by e-commerce growth. Our holdings in Visa and MasterCard benefited from this trend. Health care was an interesting combination of what we owned and what we didn't own. We were underweight biotechnology, which was a very good decision, but also had one position in the best-performing stock in biotech, Alexion Pharmaceuticals. Two of the worst-performing stocks in biotech were AbbVie and Biogen, down 19% and 22%, respectfully -- respectively, where we had very little to no exposure, which also contributed to performance.

And we had much the same situation in the pharmaceutical industry group, where we were also underweight, contributing nicely to performance. Zoetis, an animal health company, was a standout stock we owned, up over 20% for the 6-month period.

Investors seemed to favor defensive sectors in the first half, such as consumer staples, which increased 21.2%. Our holdings in Costco and Mondelez were standouts. Dave Schiminger, our staples analyst, had done a really nice job identifying companies with good business models in a sector where there are few and far in between.

As we look to the second half of the year, we remain constructive in our outlook on the market. While the economy is showing some signs of slowing, the consumer does not appear to be. Given that consumer spending accounts for 2/3 of GDP, we do not expect a meaningful slowdown. The early returns from companies reporting their second quarter results has been encouraging. Just last night, we heard from portfolio holdings: Chipotle Mexican Grill; Texas Instruments; Edwards Lifesciences; and AT&T, which reported better-than-expected results. We have a long way to go to get through all their earnings, but we are certainly off to a good start.

One of the overhangs in our view is our concern about the impact of ongoing trade disputes and escalating global tensions might have on the market. We will be watching this at the company level very closely.

I will now turn it over -- the call over to Brian to provide some details on our performance.

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Brian S. Hook, Adams Diversified Equity Fund, Inc. - VP, CFO & Treasurer [4]

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Thanks, Mark. For the first 6 months of 2019, the total return on the fund's net asset value with dividends and capital gains reinvested was 19.9%. This compares to an 18.5% total return for the S&P 500 and a 17.7% total return for the Lipper Large-Cap Core Funds Average over the same time period.

The total return on the market price of the fund's shares for the period was 23.3%. For the past 12 months, the fund's total return on net asset value was 13.7%. Comparable figures for the S&P 500 and Lipper Large-Cap Core Funds Average were 10.4% and 9.3%, respectively. The fund's total return on market price for that same time period was 15.0%.

During the first half of 2019, the fund bought back $7.2 million worth of its shares at a weighted average discount to net asset value of 13.7%, resulting in a $0.01 increase in net asset value per share.

Also during the period, the fund distributed $10.6 million to shareholders from distributable earnings. Even with these shareholder payouts, the net assets of the fund increased by $294 million.

As we move into the third quarter, ADX declared a distribution on July 18 of $0.05 per share from net investment income. This distribution will be paid on August 30 to shareholders of record on August 16. This represents the third payment this year toward the fund's annual 6% minimum distribution rate commitment.

That concludes our prepared remarks. We would now like to begin the Q&A portion of our call. Operator?

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Questions and Answers

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Operator [1]

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(Operator Instructions)

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Lyn Walther, Adams Diversified Equity Fund, Inc. - Director of Shareholder Communications [2]

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Okay. Our first question regarding health care. How are you positioning your health care holding, given the political environment and the potential for Medicare for All?

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Mark E. Stoeckle, Adams Diversified Equity Fund, Inc. - President, CEO, Senior Portfolio Manager & Director [3]

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It's a really good question, and frankly, a timely question. As I mentioned previously, we've been underweight biotechnology and pharma for quite some time now. And the real reason for that is the difficult political environment. As we -- as you know, we've also -- I'm sorry, we've also been underweight in managed care and that really speaks to the issues around Medicare for All as some people who are running for -- some candidates running for President would like to get rid of all managed-care companies, all the insurance companies. It's something that we keep a careful eye on.

It's very clear to us that there was going to be a pretty substantial headwind on pricing, both -- which seems to be pretty bipartisan, both Democrats and Republicans are keenly interested in reducing drug pricing. So we have, as I mentioned, been underweight both biotech and pharma. And as I mentioned in my prepared remarks, it certainly benefited the fund. The fact that we are underweight both and the stocks that we owned in them -- in those industry groups were most standouts, really significantly helped performance. So it's something we keep a careful eye on. At some point, biotechnology is going to get too cheap, and we will look to get back in. Pharma would get too cheap. But for now, it's something that we feel very comfortable with, about the underweights in biotech, pharma and managed care.

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Lyn Walther, Adams Diversified Equity Fund, Inc. - Director of Shareholder Communications [4]

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Okay. Thanks for that. Our next question. You mentioned technology, health care and consumer staples as standouts. Are there any other sectors that performed particularly well in the first half of the year?

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Mark E. Stoeckle, Adams Diversified Equity Fund, Inc. - President, CEO, Senior Portfolio Manager & Director [5]

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Yes. I think it's important to point out the materials sector. Materials is actually less than 3% of the S&P 500 weight, but it contributed a significant amount to the fund's returns in the first half. And that really was a result of owning the 2 best-performing stocks in materials, Ball Corp, which was up 53%, and Air Products, industrial gas company, up 43%. The term we use around here is, materials has significantly punched above its weight because it is so small. But the benefit to the fund from such a small sector doesn't happen very often, which is really a good reason to call out how well it's done.

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Lyn Walther, Adams Diversified Equity Fund, Inc. - Director of Shareholder Communications [6]

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Okay. The next one is regarding energy. Oil prices have been fairly volatile this year, how has the energy sector performed?

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Mark E. Stoeckle, Adams Diversified Equity Fund, Inc. - President, CEO, Senior Portfolio Manager & Director [7]

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The S&P energy sector was up 13.1% and so it underperformed the S&P 500. About 40% of our energy exposure comes from Adams Natural Resources Fund and that was up 13.9% for the period. So we were able to perform -- outperform energy. The performance was helped in a pretty significant way by an M&A transaction that happened in the sector. Anadarko Petroleum was approached by Chevron to be acquired. And after that happened, Occidental Petroleum came in and trumped their bid, which really took Anadarko's stock price up significantly. So we benefited a lot by that. We were pretty troubled by the -- well, we were happy about the fact -- what it did to Anadarko. We were really troubled by the extent to which Occidental went to get the company, to get Anadarko. They outbid -- effectively outbid themselves because Chevron only bid once.

Number two, they went to Berkshire Hathaway and got what we thought was very expensive financing for the transaction. And number three, it wasn't really clear to us that the addition of Anadarko, what that was going to do for Occidental. So we significantly reduced our exposure to Occidental just after they -- it was clear that Chevron was not going to bid for the company. And one of the smartest things we did in the quarter was to reduce our exposure to Occidental because it significantly underperformed after we sold it. So we were able to benefit a couple of ways. The energy -- it's tough.

You mentioned the volatility when you asked the question, there -- it has been very volatile. And we're often asked, what is it going to take for energy to turn around? I can tell you from an investor's standpoint for probably the last 5 years or so, it has been a systematic adding of value by not being in energy. So it has really paid to ignore energy because it's underperformed by so much. And I'll give you a little statistic. In 2008, energy represented about 13.4% of the S&P 500. Today, it represents less than 5%. And you -- so you've seen significant value being destroyed. And by the way, that 5 -- less than 5% is -- you have to go before the year 2000 in order to find a period when energy represented such a small percentage of the S&P 500.

So in some respects from an investor standpoint, you don't have to be in energy. You can ignore it because it's so small. We do think that capital discipline and showing free cash flow is something that a lot of these companies, energy companies have to begin to do in order to get people interested. Because effectively, what they're doing is, energy stocks are competing with health care stocks, with technology stocks and a bunch of other sectors that are really continuing to do well, generating a lot of free cash flow. So I think we need to get there in order for technology to significantly turn around.

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Operator [8]

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(Operator Instructions)

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Lyn Walther, Adams Diversified Equity Fund, Inc. - Director of Shareholder Communications [9]

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Okay. Along those lines, there has been an increase in M&A activity this year and concern over how some of these deals were structured. You mentioned Occidental and Anadarko in energy. In health care, AbbVie agreed to buy Allergan. What are your thoughts on how these transactions were handled?

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Mark E. Stoeckle, Adams Diversified Equity Fund, Inc. - President, CEO, Senior Portfolio Manager & Director [10]

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I mean I will tell you, and I think this is a pretty important point because I believe in both cases, Occidental and AbbVie showed very, very poor judgment in corporate governance. Both transactions were specifically structured so as to eliminate the need to go to shareholders to approve the transaction. Now if this was a routine matter, it really wouldn't matter. But these were both -- are both transformative transactions that I think it's imperative that the shareholders have the ability to weigh in on them. They were -- these triggers were put in their bylaws for a specific reason. I mean AbbVie specifically said, they will issue stock up to 19.9% of the outstanding when the trigger is 20% to go to shareholders. So to me, it was a blatant disregard for good corporate governance. And it surprises me a little bit that more hasn't been made of it, whether it's print or broadcast journalists. That does surprise me. But it's something that is troublesome from an investor's standpoint, we believe.

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Lyn Walther, Adams Diversified Equity Fund, Inc. - Director of Shareholder Communications [11]

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Okay. We received this question through our website recently from a shareholder in Thailand. I have been a holder of ADX for more than 15 years and so is my 2-year-old grandson, who proudly owns 200 shares. Several years ago, you received stockholder approval to run on the side of managed portfolio for a single large client. Do you still have only one client? Or have you added additional clients? How is that side business doing?

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Mark E. Stoeckle, Adams Diversified Equity Fund, Inc. - President, CEO, Senior Portfolio Manager & Director [12]

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First, a couple of things. One, a shareholder in Thailand is pretty cool, I will have to say. Second, we appreciate your confidence in us. It's nice to have long-term shareholders like you, and we will continue to do our best for your grandson. The transaction or the relationship we had was with a company called Union Bancaire Privée, and we were running a U.S. small-cap fund for them. We had -- I had some relationships with some of the UBP folks when I was at BNP before I got here, and they had asked us to run a U.S. small-cap fund, which we did. The reality is, in Europe, where they were distributing the fund, there is almost no interest or demand for U.S. small-cap. They tried very hard to sell the product and it wasn't something that was able to be sold. So from a corporate standpoint, they made the decision to close the fund and merge it with their U.S. growth fund that has a lot more demand from European investors. So we do not have the -- that client anymore. We do still have the business open in case we are able to identify someone else that would like us to sub-advise a fund for them. But as of right now, there is no client and no fund being run.

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Lyn Walther, Adams Diversified Equity Fund, Inc. - Director of Shareholder Communications [13]

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Okay. Our next question is on our technology holding. Would there be a continuity, continued percentage of high-growth securities such as Netflix, Facebook, et cetera? And will there be some shift toward value? I think the concern is whether or not with the political spectrum as we get closer to 2020, will that have a material impact on the portfolio?

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Mark E. Stoeckle, Adams Diversified Equity Fund, Inc. - President, CEO, Senior Portfolio Manager & Director [14]

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It's a good question, especially in light of the DOJ announcing yesterday that they are going to go after some of these companies. There are a couple of things. First, we are well aware, as I know many of you are, that growth has significantly outperformed value now for years. And I will tell you that it is a topic of discussion at every single one of our portfolio management meetings. Because we do know at some point, that's going to stop. It will not continue forever. So we are very sensitive to that issue. I think it's important to know that when you talk about the traditional FANG stocks, Facebook, Amazon, Netflix and Google, we today are underweight them compared to where we were a couple of years ago. And part of the reason for that is the business models have gotten more challenged.

There is a little bit of a valuation issue as well, but the business models are a little bit more challenged. We still own bits of all of them, but we are underweight, as you can see by our filings, we're underweight Facebook, we are underweight Google. And it's something that we think is the right thing to do, especially a company like Google. The law of large numbers, you can only grow at 20% for so long, and it's one of the issues that Google is having right now. They report tomorrow night, and we'll see how they've been able to do. But it's really important for the portfolio management team of ADX that our investors know that we are aware of the issues revolve -- around these companies.

Netflix, we do own some Netflix, it's a very, very small position. And so it really is not -- even a wiggle in Netflix is not going to significantly upset the Apple cart as far as performance. But we are well aware of the challenges that some of these high growth stocks have. And I think one of the things that we have been good at, we're good at many things, but one of them is, as stocks do really, really well, we can take Microsoft as an example. Microsoft has -- had done very well. Chipotle has done very well. So these stocks that we've owned, they have continued to do really well, we will pare back our ownership of them, and it's really a risk-control mechanism.

Some funds you'll see, they'll let their winners run, and they'll end up -- Chipotle would end up being 5% or 6% of the fund. That to us is way too much risk. So when we have stocks that do exceptionally well within each sector, we have been very good at beginning to pare them back to take a careful eye toward risk and making sure that we're not leaving the fund out over the risk spectrum too much.

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Lyn Walther, Adams Diversified Equity Fund, Inc. - Director of Shareholder Communications [15]

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What is your outlook for the market? How are you positioning the fund given that we are in the 10th year of this bull market?

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Mark E. Stoeckle, Adams Diversified Equity Fund, Inc. - President, CEO, Senior Portfolio Manager & Director [16]

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We are a bit cautious. I will say, as I said earlier, trade is a real issue. Companies are -- especially as it relates to capital expenditures, companies are taking a wait-and-see attitude because they don't know which way trade is going to go. I mean we've all -- we all watch the news and read the papers, and it seems to change every week. If the trade negotiation is going well, they're not going well. We should have something soon, we're not going -- we don't have anything anytime soon. So it's really been difficult, and I think it's starting to show in management teams. So pulling back and waiting to see how things shake out before they commit serious capital expenditure dollars. So it is something that we are -- we think is a real issue and we're cognizant of.

The second is, the fact that -- we talk about a 10-year bull market. We don't really look it as a 10-year bull market. We look at it as -- I mean, it's certainly been good, but we're not good enough to know when that's going to end. But what we do think we're really good at is identifying companies that are doing good things operationally at good prices. So we believe that if -- unless there is a very fast change from growth to value or the bull market stops in its tracks pretty quickly, we believe that we should be able to navigate a change out of a real bull market pretty well, and it really ends up being just executing our process the way that we've always executed it. We're not growth managers, we're not value managers. We are really good at stock selection, and we'll continue to do that regardless of whether the bull market continues or doesn't.

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Lyn Walther, Adams Diversified Equity Fund, Inc. - Director of Shareholder Communications [17]

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Okay. I think that is all the questions we have today. Mark, do you have any closing comments?

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Mark E. Stoeckle, Adams Diversified Equity Fund, Inc. - President, CEO, Senior Portfolio Manager & Director [18]

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I do. I really want to acknowledge what I think is a very talented team that we have here at Adams. We have an experienced group of industry analysts, we have experienced portfolio managers that have been working at Adams for quite a long time, we -- which are all supported by a strong infrastructure in accounting and compliance. We are a team that takes a long-term view and incorporates a disciplined approach to investing. I do want to thank our shareholders for investing with us. We do appreciate your trust in us and do not take it for granted. We do intend to keep earning it by maintaining our focus on delivering consistent investment returns for you. And for that, we thank you.

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Lyn Walther, Adams Diversified Equity Fund, Inc. - Director of Shareholder Communications [19]

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All right. Thank you all for joining us today. We look forward to updating you on our performance in January.

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Operator [20]

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The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.