3q 2016 review and outlook - constant...

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October 2016

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3Q 2016 Review and Outlook

Dividend Trade? It’s Not a Trade, It’s a Philosophy

Q: What are Bahl & Gaynor’s macro thoughts regarding recent press and the “Dividend Trade?”A: We cringe at the phrase “Dividend Trade.” The word “trade” implies an invest-ment theme that is characterized by a lack of permanence. Incrementally, it also implies the concept of a zero-sum outcome. We emphatically disagree with the characterization of transience and the notion that dividend growth investing is a zero-sum game.

For 26 years, Bahl & Gaynor has been singularly committed to a dividend growth equity approach in investing client capital. The outperformance of dividend paying companies on an absolute and risk-adjusted basis, we believe, highlights the enduring merit of this approach and places it at the core of our client portfolios.

At Bahl & Gaynor, we do not “trade” or “make bets” on the short-term relative out/under-performance of the companies that fit our investable universe. We take an intermediate-term outlook, generally 3 to 5 years, and seek to populate client portfolios with companies that grow their earnings and dividends at an accelerated rate over that horizon and prospectively much longer. Trading and bet-making lend credence to the idea that a particular investment approach stands at one end of a binary outcome or zero-sum game. Our commitment to dividend growth investing as an investment philosophy harmonizes with our belief that “time in the market, rather than timing the market” builds wealth.

Source: Ned Davis Research, 2016.

In this issue:

Bahl & Gaynor Economic Outlook “Dividend Trade?”

Market Review 5

Income Growth Update 6

Quality Growth Update 13

Introducing smig® SmallMid Cap Income Growth 19

Small Cap Growth Update 26

You Can't Make This Stuff Up! 32

Disclosure 34

www.bahl-gaynor.com1

A: There is no argument that global risk-free yields near 0.0% have caused distortions in the valuation of practically every asset, but some empirical evidence suggests broad equity market valuations are supported by the interest rate and inflation rate environment currently observed. As of 8/31/2016, the S&P 500 trades at approximately 18.1x LTM EPS, in-line with the current inflationary environment pictured in the chart at right. Further, the equity asset class looks more favorably valued relative to several fixed-income alternatives using the same P/E calculus for bonds as for stocks illustrated in the table below:

P/E Ratio Comparison Among Asset Classes

Security Current Yield P/E (sorted)

10-yr USTN 1.56% 64.1x

10-yr AAA Corp 2.20% 45.4x

30-yr USTB 2.21% 45.2x

20-yr AAA Corp 2.98% 33.6x

S&P 500 2.10% 18.1x

Source: ValuBond, 2016; data as of 9/2/2016.

Q: Are you concerned about the valuation of the overall equity market? How does this square with the valuation of other asset classes?

Source: Strategas, 2016.

Q: Are you concerned about the valuation of dividend-paying companies? Are there any categories or types of dividend-paying companies you are avoiding?We are concerned about the valuation of stocks we would consider “bond proxies.” Bond proxies look like bonds in that they typically offer a higher yield, low or no income growth and stagnant principal value, but are accompanied by equity-like risk – not a great combination for the long-term investor. As can be seen in the table below, the highest-yielding quintile of dividend-paying companies has rocketed ahead of other quintiles with a +15.6% total return YTD as of 8/31/2016.

S&P 500 Performance by Yield Quintile (cap weighted)

Yield Quintile Total Return YTD

Highest-yielding Quintile (>3.40% yld.) +15.6%

Quintile 2 (2.7% to 3.4% yld.) +10.1%

Quintile 3 (2.0% to 2.7% yld.) +7.3%

Quintile 4 (1.3% to 2.0% yld.) +5.4%

Lowest-yielding Quintile (>0% to 1.3% yld.) +3.1%

Non Dividend Companies +3.5%

S&P 500 (2.1% yld.) +7.8%

Source: Factset, 2016; data as of 8/31/2016.

Even though the highest-yielding quintile has enjoyed the most impressive returns YTD, the issue of valuation should be considered relative to the growth rates offered by companies populating this quintile. As can be seen in the table on the next page, some of the highest-yielding sectors of the S&P 500 have some of the highest price-to-earnings growth ratios currently and these figures are elevated relative to history (1/1/2003-7/31/2016). The most notable examples include the Telecommunications sector with a 3.54x absolute PEG (1.26x relative to history) and the Utilities sector with a 3.55x absolute PEG (1.18x relative to history).

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PEG Ratio Comparison Among S&P Sectors

Sector Current Yield PEG Historical

Average Ratio

Staples 2.6% 2.60x 1.95x 1.34

Telecom 4.5% 3.54x 2.81x 1.26

Industrials 2.3% 1.88x 1.53x 1.23

S&P 500 2.1% 1.77x 1.46x 1.21

Utilities 3.5% 3.55x 3.01x 1.18

Materials 2.2% 1.89x 1.69x 1.12

Financials 2.2% 1.70x 1.51x 1.13

Health Care 1.7% 1.56x 1.47x 1.06

Technology 1.6% 1.37x 1.45x 0.94

Discretionary 1.6% 1.10x 1.36x 0.81

Energy 2.7% N/A 1.18x -

Source: Strategas, 2016; data as of 7/31/2016, yields as of 8/31/2016.

We would note that, as illustrated below, our Quality Growth and Income Growth portfolios are positioned on a sector allocation basis according to where we believe the greatest potential for future dividend growth will be, not where absolute yield is most prevalent. These sectors include Consumer Discretionary, Financials, Health Care, and Information Technology and occupy the lower end of the valuation range on a PEG basis illustrated in the previous table.

Income Growth & Quality Growth Sector Allocation

Sector Income Growth

Quality Growth

Discretionary 7.0% 11.2%

Consumer Staples 14.0% 13.2%

Energy 5.9% 4.1%

Financials 20.7% 20.5%

Health Care 13.4% 17.4%

Industrials 10.7% 12.5%

Technology 17.0% 17.1%

Materials 1.5% 1.2%

Telecommunications 0.0% 0.0%

Utilities 6.9% 5.1%

Money Market 2.9% 2.6%

Source: Bahl & Gaynor, 2016; data as of 6/30/2016.

Companies of the bond proxy variety have appreciated significantly and appear to have done so more as a result of their relationship to broad market interest rates (like bonds) rather than any change in future earnings or dividend growth expectations. The core tenet to our investment philosophy is dividend growth, not absolute yield. Our portfolio companies have exhibited significant dividend growth over the past five years as shown in the allocation of our Income Growth strategy below:

5-Year Annualized Dividend Growth Rate of Income Growth Holdings

>3% 100% of holdings

>5% 97% of holdings

>7% 85% of holdings

>10% 54% of holdings

5yr Inflation Avg. (Core PCE) 1.60%

Fed Inflation Goal 2.00%

Long-Term Neutral Fed Funds (R*) 3.00%

Source: Bahl & Gaynor and Strategas, 2016; data as of 6/30/2016.

The greatest destroyer of purchasing power is inflation. Fully 100% of our holdings have dividend growth rates 2.0x higher than the 5-year inflation average and 97% of our holdings have dividend growth rates 3.0x higher than the 5-year inflation average! While one can debate the downward skewness of inflation measures, these dividend growth characteristics compare very favorably to the long-term neutral Fed funds rate (R*) recently defined by Fed officials.

By definition, conventional bonds do not provide coupons that grow. Our Income Growth strategy over its 10.5-year history has provided a compounded annual growth rate of +6.9% for the income stream, resulting in a cumulative income increase of nearly 100%.

So, while there may be periods of interest rate-related noise, we are confident the growth characteristics of our portfolio will be the primary driver of long-term performance.

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A: Ultimately, dividend growth and sustainability are a function of free cash flow and earnings. Unless we see rapid deterioration in these fundamental characteristics, we are unlikely to see widespread dividend cuts. While dividends have increased at a faster rate than free cash flow or earnings since the financial crisis, this growth has occurred starting from a very low base. Viewed through a longer-term lens, the current S&P 500 dividend payout ratio of approximately 51.0% resides below the long-term average of 57.2% since 1926.

However, sectors that are exposed to volatile inputs, such as Energy, have been in the crosshairs of capital markets recently and many companies have been forced to reduce their capital outlays, including dividends, to ensure corporate viability. Within those sectors, we are extremely focused on balance sheet quality to ensure that during periods of stress, the companies in which we invest have access to capital markets and the capacity to pay and potentially grow their dividends. Concerns regarding access to capital or capacity to pay dividends are primary sell criteria for our Investment Committee. We err on the side of caution versus presenting our clients with the prospect of a substantial income cut or principal impair-ment. There are old pilots and bold pilots, but no old, bold pilots!

Q: Dividend payout levels have increased over the past five years. Is that increase unsustainable? Are certain dividend growth companies predisposed to cuts?

Source: Ned Davis Research, 2016.

Q: How is Bahl & Gaynor’s Income Growth strategy positioned versus other popular dividend-oriented strategies?A: There are many income strategies available today that tout a dividend focus. Bahl & Gaynor’s strategies are characterized and differentiated by our diversification of both capital and income and lack of relative concentration in bond proxies. This is evidenced in the table below where the Income Growth strategy has generated performance that trails absolute-yield strategies like

the PowerShares High Dividend/Low Volatility and iShares High Dividend ETFs, but has much less exposure to sectors like Utilities and Telecommunications that we have previously established are richly valued relative to the growth prospects they offer and contain a disproportionately large number of bond proxies.

Fund TickerYTD Total

Return (net, sorted)

Utility Weighting

Telecom Weighting

Total Utility & Telecommunications

PowerShares High Dividend/Low Volatility SPHD +20.4% 18.4% 6.9% 25.3%

iShares High Dividend HDV +13.4% 10.8% 7.3% 18.1%

AAM Bahl & Gaynor Income Growth I AFNIX +10.4% 6.0% 0.0% 6.0%

S&P 500 +7.8% 3.2% 2.7% 5.9%

Source: Morningstar and Bahl & Gaynor, 2016; data as of 8/31/2016. continued >


Bahl & Gaynor constructs portfolios with an emphasis on diversification of income source. For example, our Invest-ment Committee will not allow a single security held in the Income Growth strategy to contribute more than 6.0% to overall portfolio income. We seek diversification not only by

company, but also by sector. That diversification discipline results in our clients’ portfolios having many “oars in the water” and avoids over-indexing to sectors, industries and companies with fundamental characteristics in secular decline or at risk of sudden deterioration.

Q: Can you provide examples of sectors in which you are investing that are less traditionally considered in many dividend-oriented strategies?

Q: Any concluding comments on the “Dividend Trade”?

A: We differ from many of our peers by virtue of our substantial allocation to Financials and Information Technology companies.

Within the Financial sector, we have strong conviction in the merits of owning domestic banks. While these companies do not typically exhibit as much downside protection as other sector holdings, like REITs, their role in our strategies are justified because these securities exhibit:

• High current yields with a strong recent history of dividend growth;

• Low payout ratios with the capacity and regulatory support to increase dividends;

• Significant regulatory oversight regarding capital levels and risk-taking;

• Historically cheap valuations on an absolute and relative basis;

• Positive leverage to rising short-term and long-term interest rates or a reflationary trade;

• Demonstrated ability to operate well in the current low-rate environment.

Our exposure in the Information Technology sector also cuts against the typical positioning of strategies in the equity income space. Over the past decade, more and more companies in this sector have realized the benefits of rewarding shareholders with a growing dividend. Moreover, the fundamental dynamics many of these businesses enjoy positions them quite well to execute a growing capital return program. We are focused on investing in sector constituents with durable and defensi-ble competitive advantage (usually illustrated by high and stable returns on invested capital), significant recurring revenue streams that are less sensitive to the business cycle, strong balance sheets and excellent conversion of earnings to free cash flow.

By pairing exposure in such sectors possessing great ability and propensity to grow dividends with more tradi-tional income sectors like Consumer Staples and Health Care, we are able to strike a harmonious balance between current yield and growth of income, affording our clients downside protection and favorable risk-adjusted returns over a full market cycle.

A: In Bahl & Gaynor’s strategies, we focus on the ability of held companies to pay and grow dividends. While macro events, such as a potential rising interest rate cycle, may have some tangential impact on the investing climate, they do not represent “make-or-break” outcomes to our investment thesis.

The ability of a company to grow its dividend is the critical component to our investment approach. In our macro research, we seek to identify long-term trends either unappreciated or misunderstood by the market to help guide and confirm our individual company selection.

The prevailing low interest rate environment has created much interest in any strategy that has a high current yield. We conclude that strategies structured for absolute yield and not growth of income should be reconsidered by investors due to valuation risk. We reiterate that the long-term success of our strategies will be measured by the ability for our companies to grow their earnings and dividends.

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Market Review: Observations from the quarter just endedEntering 3Q16, investors anticipated a spillover impact from the surprise results of the Brexit vote on June 23. What impact the vote might have near or long-term was not immediately clear.

Would it be positive or negative for global capital markets? The jury is still out on a definitive answer with political-ly-generated bumps in the road the only certainty between now and full UK independence. The vote outcome and the corresponding capital market volatility has frayed investor nerves with the quarter beginning on an unsettled note and an elevated degree of investor caution observed regarding the global outlook.

A combination of other economic metrics provided a relatively stable overlay during 3Q16. These metrics suggest an environment that provides modest but per-sistent firming of the economic backdrop in select, but not all elements, of the macro growth puzzle. Oil prices in recent months seemed to find the bottom end of a 2-year trading range, supporting more cyclical sectors of equity markets such as Industrials. This effect was observed in relative performance of our strategy holdings in the sector. In the YTD period, oil and the S&P 500 have been highly correlated as higher oil prices have served as a catalyst and market driver via an enhanced investor risk appetite. While it is far too early to declare an end to dramatically lower oil prices, we have witnessed a floor forming since November of 2014. This floor is likely to serve as a tailwind for several non-Energy equity sectors.

Domestically, interest rates as measured by the 10-year Treasury Note, remained well-behaved with a modest upward bias as Brexit-based recession fears faded in the rearview mirror and firming employment and inflation trends (both current and anticipated) are increasingly apparent. As such, the U.S. Federal Reserve is forecasted to raise the Federal Funds rate in the months ahead. We do note that higher-yielding areas of the equity market were unnerved by the prospect of a September 2016 Fed rate hike. We anticipate this concern to unfold in a similar manner as the Fed contemplates and very well imple-ments a benchmark rate increase in December.

While modestly higher US-based interest rates are perhaps on deck, very low interest rates and growth trends remain entrenched and operative in economically significant geographies such as Europe and Japan. Accordingly, as both economic growth and central bank policy are linked globally, this reality suggests a deliberate trajectory to any Fed-driven efforts to lift US rates in the years ahead. Lower for longer is alive and well.

As pumpkins, college football and goblins make their October introduction; investors begin to assess company earnings for both 4Q16 and the year ahead. The significant variability in oil prices continues to dramatically influence the earnings outlook for the entire S&P 500. It is possible 3Q16 could represent the first batch of earning releases that will yield a positive YoY trend in aggregated earnings. This would be the first such observed occurrence in 5 quarters.

The S&P 500 is likely to record flat full-year 2016 earnings relative to 2015 results. At this time, Wall Street analysts collectively forecast +12.0% to 14.0% earnings growth for FY2017, a projection Bahl & Gaynor believes is too optimistic. However, should oil prices remain firm and US consumers continue to contribute via employment and wage gains, modest earnings improvement in the quarters ahead is likely. Further, a resolution to the inhabitant of 1600 Pennsylvania Avenue over the next four years, regardless of party affiliation, could lend stability to the broad equity market multiple.

As always, Bahl & Gaynor’s strategies focus on the ability of held companies to pay and grow dividends. While macro events, such as a potential rising interest rate cycle, may have some tangential impact on the investing climate, they do not represent “make-or-break” outcomes to our invest-ment thesis. The ability of a company to grow its dividend is the critical component to our investment approach.


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On a month-by-month basis, the strategy lagged the index in July (+2.44% gross / +2.39% net vs. S&P 500 +3.69%), August (-0.54% gross / -0.58% net vs. S&P 500 +0.14%) and September (-0.50% gross / -0.51% net vs. S&P 500 +0.02%).

The strategy’s objectives, according to priority, are restated below:

Income Growth Objectives:

1. Income Growth2. Downside Protection3. Capital Appreciation

Growth of income is the primary objective of the Income Growth strategy. Bahl & Gaynor believes it can position the strategy to deliver between +6.0% and +8.0% annual growth in the income stream each year. This growth, combined with a high current yield (3.0% at quarter-end) provides clients with a differentiated (relative to the Morningstar large cap core peer universe average dividend yield of 2.2% at quarter-end) absolute yield and real purchasing power accretion, as the income growth rate has generally exceeded the inflation rate since the strate-gy’s inception. During the quarter, the strategy’s income stream grew by +2.11% which amounts to +6.20% growth in income for the YTD period.

As in previous quarters, we provide commentary below highlighting our bottom three and top three performing companies held in Income Growth.

We begin by reviewing the three greatest detractors from performance during the quarter: Wisconsin Energy (WEC), Crown Castle (CCI) and Altria Group (MO).

WEC Energy Group (WEC)WEC Energy Group is featured again this quarter after the company’s first appearance as a top contributor in our 3Q15 correspondence and again in our 1Q16 note.

WEC now finds itself among the Income Growth strategy’s greatest detractors. This has more to do with broad en-vironmental factors of the current investment landscape than changing fundamentals at the company.

In the past, we have highlighted WEC as the largest Midwest utility after its combination with Chicago-based Integrys Energy Group in 2015. A majority of the compa-ny’s earnings are generated in the favorable regulatory environment of Wisconsin with opportunities for growth by investing in infrastructure projects within the Integrys footprint.

WEC is one of the highest-quality companies within its peer group, maintaining a strong balance sheet, stable earnings sources and a dividend policy that has not deviated from management guidance. WEC has grown its dividend at a +13.7% annualized rate over the last five years, far ahead of many slower-growth peers and attractive relative to the objectives of the Income Growth strategy.

Poor performance of the shares in the quarter just ended had more to do with fears of rising benchmark interest rates being announced after the Federal Reserve’s September confab than fundamental deterioration of the company’s operations. Although rates were maintained at current levels following the Fed meeting, higher-yielding securities like WEC tend to be pressured as concerns among investors mount leading up to a Fed decision. Although this is painful to experience, it is likely to be the case surrounding future Fed meetings. However, the attractive dividend growth the company is able to produce does justify ownership in the strategy.

During the quarter, Bahl & Gaynor’s Investment Commit-tee elected to trim the strategy’s position in WEC based on valuation. As we have often stated, the Income Growth strategy’s objectives, in order of priority, are growth of in-come, downside protection and capital appreciation. WEC has continued to deliver excellent growth of income, but valuation resides in a range above long-term observed av-erages. Shares currently trade at 19.7x trailing 12-month earnings with earnings expected to advance +4.1% YoY, representing a 4.8x PEG ratio. Shares were trimmed in favor of initiating a new position in Amgen (AMGN), which trades at 15.1x trailing 12-month earnings and is expected to deliver dividend growth similar to or ahead of WEC in the future.

Income Growth Update: +1.37% for 3Q16. 3.0% dividend yield as of 9/30/2016.The Income Growth strategy lagged the S&P 500 during the quarter (+1.37% gross / +1.28% net vs. +3.85% S&P 500).


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Income Growth Continued

Crown Castle (CCI)Crown Castle was first featured in our 2Q16 newsletter as a top contributor to the Income Growth strategy’s performance during that quarter. As with WEC, environmental factors have led to CCI shares being pressured of late.

CCI is the second-largest wireless communication tow-er operator in the United States, behind international competitor American Tower (AMT). CCI owns more than 40,000 macro towers that span the geography of the US in addition to owning an array of distributed antenna systems (smaller cell sites usually located in densely-populated urban areas).

CCI leases space on its tower sites to any of the four nationwide wireless carriers operating in the US: AT&T, Sprint, T-Mobile or Verizon. It is almost always cheaper for a specialized tower company, like CCI, to own and operate the tower than the national carrier to do so internally. This is because a carrier-operated tower usually only carries a single antenna array of the owner-carrier (whereas tower operators can serve multiple tenants – thereby leveraging fixed costs). Further, national carriers are taxed as C-corps, whereas CCI is not taxed at the corporate level due to its status as a real estate investment trust (REIT), so tax efficiency represents a competitive/ operating advantage.

Tower operators enjoy long-term contracts with their nationwide carrier clients who lease space on towers where they place antenna equipment, usually for a period of 10 years, often with 5-year renewable extensions. Client turnover is very low, generally less than 2% of the tower portfolio annually, and rental payments are subject to inflation escalators that bring in more revenue automat-ically each year for CCI. Finally, to the extent that CCI is able to attract multiple carriers to a single tower site, the fixed costs of operating such a tower are spread over a larger base of revenue, imbuing the benefits of significant incremental margins and strengthening the cash-generat-ing characteristics of the overall tower portfolio.

The stability of CCI’s business, longer-term nature of its contracting and attractive current yield does leave the company’s shares sensitive to the interest rate environ-ment. As with WEC, investor concern about a potential benchmark interest rate increase in September produced significant volatility among higher-yielding companies like CCI. Fundamentally, CCI’s business would not be

greatly influenced or disadvantaged by an interest rate increase contemplated by the Fed. In fact, the combination of contractual rental escalators (~+3.5% annually) and growth of the company’s tower portfolio (~+3.5% annually) supports overall cash flow growth of approximately +7.0% annually for the foreseeable future. This dynamic should be a better long-term predictor of share performance than any particular change in benchmark interest rates.

CCI trades at approximately 19.6x trailing 12-month funds from operations (FFO is a proxy for cash flow among RE-ITs). A price-to-FFO-growth of 2.5x on a company yielding 4.0% with incredibly stable operating results fits nicely with the objectives of the Income Growth strategy.

Altria Group (MO)Altria Group is the parent of Philip Morris USA, John Middleton, US Smokeless Tobacco, Philip Morris Capital, Chateau Ste. Michelle Wine Estates and will hold a 10.5% stake in the world’s largest brewer when the merger between Anheuser-Busch InBev and SABMiller closes in late 2016. The company enjoys leading market share in cigarettes and smokeless tobacco in the US and is #2 in machine-made cigars.

Marlboro is the company’s dominant and most recog-nizable brand that controls approximately 44% of the US cigarette market, up from 38% in 2003. Smokeless tobacco brands Skoal and Copenhagen together control approximately 50% of that growing market as more existing tobacco consumers try smokeless products. The oligopolistic nature of the US tobacco industry (the top three competitors in this industry control 90% of the market) and extremely restrictive marketing regulations ensure sizeable barriers to entry – a boon to incumbents.

Although MO operates almost exclusively in the high-ly-regulated US tobacco market, the company has done an admirable job of positioning brands to support ongoing price increases and has diligently controlled costs, the combination of which has allowed earnings to expand despite persistent cigarette volume declines. With ap-proximately 85% of MO’s sales derived from cigarettes, future trends in this business will most directly influence company results.

The traditional cigarette business requires fairly little capital investment, and what capital investments MO does make are largely positioned in verticals and brands expected to offer future growth. Low capital needs have


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allowed MO to continue distributing 80% of its net income to shareholders in the form of dividends. The company announced an +8.0% dividend increase during 3Q16 and has grown its dividend payments at an +8.3% annualized rate over the last five years.

As has been the case with WEC and CCI, MO’s share performance during 3Q16 was largely influenced by the interest rate environment. With its 3.9% current yield, the shares are sensitive to expectations of interest rate changes and as with WEC and CCI, the underlying busi-ness is likely not materially affected by actual interest rate increases – especially of the scale being contemplated by the Fed.

Because of the consistency of operating results, shares currently change hands at 20.9x trailing 12-month earnings. This is somewhat offset by a +7.1% expected earnings growth rate in FY2017 resulting in a 2.9x PEG. The combination of stability and growth of income leaves MO well-positioned for inclusion in the Income Growth strategy.

During the quarter, the three greatest contributors to performance were: Spectra Energy (SE), Qualcomm (QCOM) and Cisco Systems (CSCO).

Spectra Energy (SE)Spectra Energy’s streak of strong performance continued in 3Q16 following top-contributor showings in both our 2Q16 and 1Q16 newsletters. This strong performance culminated in the September 6th announced stock-for-stock merger of SE with Canadian-based energy deliver company Enbridge (ENB). SE shares advanced +18.03% during the quarter, inclusive of the +11.50% merger announcement premium, and have risen +85.61% YTD. These quarterly and YTD returns have far outpaced the returns of the overall S&P 500 Energy sector: +2.25% during 3Q16 and +18.62% YTD.

As has been stated before, SE is the general partner and majority owner of Spectra Energy Partners (SEP), an MLP specializing in transmission pipelines. The company also owns UnionGas, a Canadian natural gas distributor, and DCP Midstream, a field services company.

A majority of SE’s operating earnings are derived from the firm’s ownership of SEP. The US transmission pipelines owned by SEP are contracted under fee-based terms, meaning little to no commodity or volume exposure exists,

and the average contract length exceeds 8 years, providing a stable source of cash flow to SE, the general partner.

More importantly, SE has maintained a lower proportion of debt on its balance sheet than its peers and requires less frequent access to capital markets to fund its operations.

In commentary provided by both management teams following the merger announcement, the merger is expected to be neutral to ENB’s +12.0% to 14.0% secured ACFFO per share CAGR through 2019 and strongly additive to growth thereafter. The transaction has been structured to ensure balance sheet strength and the maintenance of a strong investment grade credit rating – important reasons for which the Income Growth strategy has contin-ued to own SE’s shares through a difficult environment in the energy space. Management extended their anticipated +10.0% to 12.0% annual dividend growth guidance through 2024, which remains attractive relative to the Income Growth strategy’s growth of income objective. ENB’s MLP, Enbridge Energy Partners (EEP) and SE’s MLP, Spectra Energy Partners (SEP), are expected to remain separate publicly-traded entities for the forseeable future.

Given the favorable post-merger guidance provided on the combined company’s distribution growth expectations, and the continued preference to build balance sheet strength and limit capital market access needs – Bahl & Gaynor’s Investment Committee has elected to retain shares of the combined company and will closely monitor fundamental dynamics leading up to and following transaction closure during 1Q17.

Qualcomm (QCOM)Qualcomm is a long-time innovator in the wireless tech-nology business that through intense R&D operations has built key intellectual property portfolios around CDMA and OFDMA technologies. These technologies are accepted standards in 3G and 4G wireless communication archi-tectures. QCOM’s strongest patent portfolio relates to 3G architecture where it maintains a virtual monopoly on the most critical intellectual property (IP) components of this standard and as a result collects sizeable royalties on virtually every wireless device capable of connecting to 3G networks. The company controls less, but still quite meaningful, IP surrounding 4G standards. The combina-tion of these patent portfolios coupled with the likelihood of backward compatibility with future standards dictates that QCOM should enjoy an attractive royalty revenue stream for the next decade, possibly longer.



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QCOM’s licensing business enjoys +85% operating mar-gins and represents approximately 75% of the company’s overall operating income. The other component of QCOM’s business is semiconductor manufacturing where the company specializes in smartphone processors and baseband chipsets (the complex of chips allowing a given device to connect to cellular networks).

Prior to rumors of a proposed acquisition of NXP Semi-onductors (NXP) that surfaced during 3Q16, QCOM shares had been recovering from a host of concerns surrounding foreign regulation of its licensing business. Both Chinese and Korean regulatory bodies governing competitive practices in smartphone manufacturing opened investiga-tions around the pricing of licensing royalties. The central argument of these inquires is whether royalties should be calculated on the full retail price of a smartphone containing QCOM’s IP or a smaller base such as the com-bined value of connectivity chips. The Chinese regulator recommended a haircut to the full retail price that, while unfortunate for QCOM, upholds the value of its licensed IP going forward. A decision from the Korean regulator is still forthcoming.

In late September, the Wall Street Journal reported QCOM had engaged in discussions to purchase NXP for approximately $30 billion. It is generally thought that this purchase would be an appropriate use of QCOM’s largely foreign-domiciled cash hoard approximately equal to the rumored transaction price and would provide a measure of diversification from the company’s traditional smartphone technology business in the face of regulatory challenges just described. Given no formal announcement by either company of a proposed transaction was made prior to the end of the quarter, Bahl & Gaynor will continue to evaluate this and any other transpiring news items and their expected effect on company fundamentals as they become public.

Suffice it to say, QCOM has been an excellent steward of shareholder capital as represented by a +19.8% annualized dividend growth rate over the last five years. The high returns on invested capital of the licensing business supports this aggressive and attractive capital return policy and any future M&A transactions will be evaluated primarily on the expected effect they would have on capital return policies going forward.

Shares trade at approximately 16.5x trailing 12-month earnings and based on consensus earnings growth over

the next year of +15.0%, price-to-earnings growth resides at a compelling 1.1x. Although Bahl & Gaynor does not predicate investment decisions on rumored M&A, a diversifying combination with NXP could increase the combined company’s addressable markets with a reasonable risk-reward profile.

Cisco Systems (CSCO)Cisco Systems is the dominant data networking equipment and software company with meaningful brand equity, scale, switching costs and market share supporting its core verticals of switches and routers. The company is viewed by technology experts and mangers as the gold-standard in both the switches and routers it offers. This is reflected in a +15% market share advantage to the next-largest switch/router manufacturer, Hewlett- Packard (HPQ). In addition to local data networking, CSCO’s carrier routers are trusted by the world’s largest cable and telecom providers.

While switches and routers comprise over 60% of firm-wide revenues, CSCO is the poster-child for self-disrup-tion. In the world of technology, where hardware tends to become more commoditized and software takes its place in the value-add proposition, CSCO has continued to pro-vide high-quality hardware while growing its capabilities in software and services that are becoming increasingly important to network managers.

Software-defined networking, where the task of data routing on a network is handled by a software overlay rather than traditional hardware is now an area of tremen-dous opportunity for the company whereas it was once considered a grave threat. The software CSCO provides to complement its switches and routers is still respected as industry-leading, which has preserved profitability in this segment offering. Further, the increasing importance of network security has also become a core competency of the company. All told, nearly a third of CSCO’s combined revenues are derived from services, which have tended to be less volatile and of comparable or higher margin than the core switching and routing business.

Even in the face of self-disruption, CSCO has committed to paying its shareholders to hold on to shares through times of transition. The company is committed to returning approximately 50% of free cash flow to shareholders on an ongoing basis and this has driven a tremendous +34.1% annualized dividend growth rate over the last five years. Although this growth rate is not expected to continue at



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pace, the combination of an attractive current yield (3.3%) and well-supported future dividend growth constitute ma-jor reasons for ownership in the Income Growth strategy.

The theme we would note among the companies just outlined are the attractive investment characteristics both appreciated and ignored by the market. In any case, all of the companies reviewed contributed in some way to achieving the various goals of the Income Growth strategy. Although near-term price movements and fleeting investor attitudes will no doubt change the ranking of these companies from quarter-to-quarter by way of their contribution to performance, their role in achieving the strategy’s long-term goals remains intact.In light of the importance of dividend growth, listed below are the companies held in the strategy that increased their dividend during the quarter:

3Q 2016 Income Growth Dividend Increases

Company

% Increase Over Prior

RateCurrent

Yield

Altria Group (MO) +8.0% 3.9%

BB&T (BB&T) +7.1% 3.2%

Lockheed Martin (LMT) +10.3% 3.0%

Maxim Integ. Prod. (MXIM) +10.0% 3.3%

Microsoft (MSFT) +8.3% 2.7%

Occidental Petroleum (OXY) +1.3% 4.2%

Paychex (PAYX) +9.5% 3.2%

Philip Morris Int’l. (PM) +2.0% 4.3%

PNC Financial Svcs. (PNC) +7.8% 2.4%

Realty Income (O)1 +0.25% 3.6%Source: Bahl & Gaynor and Factset, 2016.1O increases dividend monthly.

The strategy’s third objective – capital appreciation – is a long-term objective. We seek to provide favorable risk-adjusted returns over a full market cycle. We believe this objective has been achieved to date as evidenced by the strategy’s long-term performance record and risk profile illustrated at right:

ReturnsAs of9/30/16

Income Growth (Gross)

IncomeGrowth(Net)2

S&P500

1Q2016 +3.78% +3.68% +1.35%

2Q2016 +5.08% +4.98% +2.46%

3Q2016 +1.37% +1.28% +3.85%

YTD +10.55% +10.23% +7.84%

1 Year +17.92% +17.48% +15.43%

3 Years1 +10.77% +10.32% +11.16%

5 Years1 +14.23% +13.79% +16.37%

7 Years1 +13.85% +13.41% +13.17%

10 Years1 +8.56% +8.14% +7.24%

S/I1,3 +9.19% +8.74% +7.53%1Annualized. Please see page 35 for GIPS performance disclosures. 2B&G net-of-fee figure is after management, trading and applicable bundled fees.3Inception: 12/31/2005.

Standard Deviation of Return Percentile Rankingsvs. Large Cap Core Peer Managers

As of 9/30/16

Income Growth (Gross)

Income Growth (Net)2

1 Year 4 7

3 Years1 4 6

5 Years1 3 4

7 Years1 1 1

10 Years¹ 1 1

S/I1,3 1 1Source: PSN.1Annualized.2B&G net-of-fee figure is after management, trading and applicable bundled fees.3Inception: 12/31/2005.

From an attribution perspective, tailwinds to performance during the quarter included:

1. Company selection in Energy. The announced merger of held company Spectra Energy (SE) +18.03% with Enbridge (ENB) constituted a premium offer price to the pre-announcement value of SE. This premium was extremely accretive to performance in a sector that advanced little during the quarter (S&P 500 Energy sector +2.25% vs. Income Growth Energy sector holdings +8.47% during 3Q16).

2. Underweight sector allocation in Telecommunications. The Income Growth strategy has had no direct exposure



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in the Telecommunications sector since eliminating our position in Bell Canada (BCE) during 3Q15. BCE was eliminated from the strategy because the depreciation of dividends paid in Canadian dollars was offsetting underlying dividend growth. The two major constituents of this sector, AT&T (T) -4.97% and Verizon Communi-cations (VZ) -5.98% were pressured during the quarter amid concerns of a benchmark interest rate increase on the part of the Fed (which did not occur). These companies are not owned in the Income Growth strategy because their paltry dividend growth is not sufficient to aid in Bahl & Gaynor’s efforts to grow a client’s overall income stream between +6.0% and +8.0% annually. T and VZ have only grown their dividends at a +2.3% and +3.0% annualized rate over the last five years, respectively.

3Q 2016 Income Growth Sector Contribution1. Energy2. Telecommunications3. Materials4. Health Care5. Financials6. Consumer Discretionary7. Utilities8. Consumer Staples9. Real Estate10. Industrials11. Information Technology

Note: Figures relative to the S&P 500 index.Source: Bahl & Gaynor, 2016.

The Income Growth strategy was hindered most by the following dynamics:

1. Underweight sector allocation and company selection in Information Technology. The S&P 500 Information Technology sector was the strongest-performing

sector during 3Q16 advancing +12.86% vs. the Income Growth strategy’s combined sector holdings return of +9.23%. Not owning Apple (AAPL) +18.89%, lagging performance of Paychex (PAYX) -1.98%, which was trimmed during the quarter and not owning Alphabet (GOOG/L) +12.31%/+14.29% and Facebook (FB) +12.24% pressured performance. Investors returned focus to absolute-growth/growth-at-any-price companies like GOOG/L and FB and punished higher-yielding com-panies in the face of rising interest rate expectations. Although frustrating, Bahl & Gaynor remains committed to investing in companies that pay growing dividends in this sector as enterprise quality and operating financial dynamics tend to be supportive of attractive dividend return policies. Other companies owned in the strategy performed admirably during the quarter, including Qualcomm (QCOM) +28.95%, Microsoft (MSFT) +13.27%, Maxim Integrated Products (MXIM) +12.80%, Texas Instruments (TXN) +12.63% and Cisco Systems (CSCO) +11.58%, but the higher weightings of these companies in the benchmark index did not afford as much relative accretion to strategy performance. MXIM, MSFT and PAYX announced dividend increases during the quarter.

2. Company selection in Industrials. All of the Income Growth strategy’s Industrial holdings lagged the S&P 500 sector return of +3.95% for the quarter. Fastenal (FAST) -5.21%, General Electric (GE)-5.18%, Lockheed Martin (LMT) -2.74% and 3M (MMM) +1.25% were all left behind by strong performance among lower-quality and more cyclical industrial companies that Bahl & Gaynor avoids due to lack of dividend growth stability. The less cyclical nature of owned companies in the strategy sup-ports the downside protection priority of our approach. Moreover, dividend growth was on display with LMT’s announced increase during the quarter.

3. Overweight sector allocation and company selection in Real Estate. The newly-created GICS sector came under significant pressure during the quarter amid concerns about rising benchmark interest rates. Real estate investment trusts (REITs) owned by the strategy, including Public Storage (PSA) -11.98%, Crown Castle (CCI) -6.22% and Realty Income (O) -2.64% were more pressured than the overall S&P sector return of -2.10%. O continued its monthly tradition of dividend increases during the quarter. In the presence of significant market disruption, the REIT group has historically provided at-tractive downside protection – a hallmark of the Income Growth strategy.

4. Higher-yielding companies underperformed their lower-yielding and non-dividend counterparts during the quarter given great concern among investors about rising interest rates. The Income Growth strategy in-


Source: Bahl & Gaynor, 2016.

Top Contributors1. Spectra Energy (SE)2. Qualcomm (QCOM)3. Cisco Systems (CSCO)4. Texas Instruments (TXN)5. Maxim Integ. Prod. (MXIM)

Top Detractors1. WEC Energy Group (WEC)2. Crown Castle (CCI)3. Altria Group (MO)4. NextEra Energy (NEE)5. Paychex (PAYX)

3Q 2016 Income Growth Top Contributors/Detractors


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vests in companies with a dividend yield of at least 2.0% at position initiation. The portion of the S&P 500 with a dividend yield exceeding 2.0% returned +2.88% for the quarter, worse than the return of companies with a yield greater than 0.0%, but less than 2.0%, which returned +3.59% and non-dividend companies, which returned +8.19%, all figures cap-weighted.

5. High-quality companies (companies with an S&P earnings and dividend quality ranking of B+ or better) underperformed low-quality companies (B or worse ranking). The high-quality portion of the S&P 500 returned +2.68% while the low-quality portion returned +6.15%, all figures cap-weighted. At quarter-end, approximately 72% of holdings in the Income Growth strategy had an S&P ranking of B+ or better, versus 65% for the S&P 500 index.

It is also worth reiterating several important points about the nature of the income stream generated by the strategy and overall portfolio characteristics before concluding with trades applied to the strategy during the quarter:

• High-quality, large-cap core, bottom-up strategy;• 10.75-year track record;• 100% of the 40 companies owned in the strategy pay a

dividend and grow it regularly;• Every company owned in the strategy possessed a divi-

dend yield exceeding 2.0% and a market capitalization of at least $1 billion at the time of purchase;

• No more than 5.0% of the portfolio’s overall capital is represented by a single company whether calculated by initial investment or current market value;

• No more than 6.0% of the portfolio’s overall income is generated by a single company;

• The strategy owns only common stocks traded on US exchanges. We hold no master limited partnerships (MLPs) due to the complex tax ramifications of owning these securities, nor do we own preferred, convertible, ETF or option securities as we prefer to focus on com-pany selection, not asset allocation decisions, within the strategy;

• Cash is a frictional holding in the strategy and generally does not represent more than 3.0% of portfolio value;

• As of 9/30/2016, 90.0% of the strategy’s income is cate-gorized as qualified dividend income, with the remainder considered ordinary income – mostly attributable to the strategy’s REIT holdings;

• 34.0% of aggregated strategy revenues are generated internationally (outside of the US), 12.8% are from emerging markets;

• Portfolio turnover was 3.14% during 3Q16.

We conclude with a review of the trades executed in the Income Growth strategy over the quarter just ended:

3Q 2016 Income Growth Trades Executed

Initiations Eliminations

Abbott Laboratories (ABT)

Amgen (AMGN)

Increases Reductions

AbbVie (ABBV)

Kimberly-Clark (KMB)

Paychex (PAYX)

Realty Income (O)

WEC Energy Group (WEC)


Bottom Line: The Income Growth strategy achieved its primary objective during the quarter of growing client income (+2.11% for 3Q16 and +6.20% YTD) but was challenged from a capital return standpoint amid investor concerns of rising interest rates. As indicated in our valuation white paper originally distributed in mid-September and reprinted with this quarterly update – Bahl & Gaynor remains confident in the Income Growth strategy’s positioning to deliver continuing growth of client income. Although macro events, such as a poten-tial rising interest rate cycle, may have some tangential impact on the investing climate, they do not represent “make-or-break” outcomes to our investment approach. Bahl & Gaynor believes our high-quality, dividend-growth approach remains a highly relevant strategy for today’s market dynamics and dynamics expected in the future.



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On a month-by-month basis, the strategy lagged the index in July (+2.81% gross / +2.75% net vs. S&P 500 +3.69%), led the index in August (+0.27% gross / +0.23% net vs. S&P 500 +0.14%) and lagged the index in September (-0.85% gross / -0.86% net vs. S&P 500 +0.02%).

We continue to manage the Quality Growth strategy toward quality and high rates of portfolio income growth.

Before we review performance and attribution of the strategy in greater depth, we reiterate the concomitant goals of the Quality Growth strategy:

• Capital Appreciation• Income Growth• Downside Protection

The strategy’s long-term performance record is presented below along with percentile rankings of risk (as measured by standard deviation of return) to aid in the evaluation of performance according to the goals outlined above. We would note that this performance record includes longer time periods in keeping with our thoughts on evaluation time periods presented in prior newsletters.

ReturnsAs of9/30/16

Quality Growth (Gross)

QualityGrowth(Net)2

S&P500

1Q2016 +1.71% +1.60% +1.35%

2Q2016 +3.64% +3.53% +2.46%

3Q2016 +2.21% +2.10% +3.85%

YTD +7.75% +7.39% +7.84%

1 Year +14.43% +13.93% +15.43%

3 Years1 +9.28% +8.79% +11.16%

5 Years1 +13.73% +13.21% +16.37%

7 Years1 +11.76% +11.25% +13.17%

10 Years1 +7.60% +7.11% +7.24%

15 Years1 +7.20% +6.75% +7.15%

20 Years1 +8.36% +7.79% +7.91%

25 Years1 +9.31% +8.77% +9.34%


Standard Deviation of Return Percentile Rankingsvs. Large Cap Growth Peer Managers

As of 9/30/16

Quality Growth (Gross)

Quality Growth (Net)2

1 Year 7 7

3 Years1 7 7

5 Years1 1 1

7 Years1 2 1

10 Years¹ 1 1

15 Years¹ 1 1

20 Years¹ 2 4

25 Years¹ 7 11

S/I1,3 8 12

Source: PSN.1Annualized. 2B&G net-of-fee figure is after management, trading and applicable bundled fees.3Inception: 6/30/1990.

As with our review of Income Growth performance previously, we have included our thoughts about the three worst and three best performing companies from a performance contribution standpoint below. We often receive questions from clients as to why certain compa-nies are owned in a strategy (especially when they are performing poorly from a capital appreciation standpoint). We hope the thoughts provided regarding these compa-nies will serve to highlight the common characteristics of quality and dividend growth, but moreover, the benefit we believe the given investment will serve in achieving the long-term goals of the strategy.

We begin by reviewing the three greatest detractors from performance during the quarter: Kroger (KR), NextEra Energy (NEE) and Church & Dwight (CHD).

Kroger (KR)In the past year, Kroger has vascillated between a top and bottom contributor. In our 4Q15 newsletter, the company was a top contributor and in the very next quarter (1Q16) ranked dead last as the strategy’s greatest detractor. Such is the case this quarter where a combination of poor price performance (-19.03% during 3Q16) and a significant weighting (2.7%) in the strategy has left KR the greatest detractor from performance. The most notable cause of

Quality Growth Update: +2.21% for 3Q16. 2.2% dividend yield as of 9/30/2016.The Quality Growth strategy lagged the S&P 500 during the quarter (+2.21% gross / +2.10% net vs. S&P 500 +3.85%).


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this volatile performance was discussed in our 1Q16 note – food price deflation.

Just as deflation is an ugly word in the company of central bankers, so too is the case among conventional grocers like KR. Net margins of traditional grocers are thin (1.8% in the case of KR) because of significant fixed costs in operating stores and supply chain/distribution facilities. It is important for these companies to drive volume and total sales so as to maximize dollars filtered through the income statement and yielding the most net income. Food priced deflation lowers total revenues while volume remains relatively unchanged, so total net income growth is challenged as a result. The current bout of deflation – mostly due to an oversupply of agricultural products – is one of the longer trends on record having persisted for several months.

Although the current environment is challenging for KR, it is likely an environment that will eventually revert to the norm of food price inflation. In the interim, KR possesses several advantages that should see the company through:

• Nearly half of KR’s locations sell gasoline, which allows the company to effectively compete with non-traditional grocers (like Wal-Mart and Target) that use groceries as a loss-leader to drive traffic. It is difficult for small-er-scale grocers to add this capability due to space, zoning and capital constraints, so KR should be able to maintain and perhaps grow traffic – an important ingredient in their financial model.

• The company possesses excellent distribution scale in many regions. The presence of many stores in close proximity to distribution centers allows KR to respond quickly to changes in local market competition as well as offer highly targeted promotions, both in service of driving sales. This can be a challenge for smaller grocers that lack comparable distribution arrangements and larger non-traditional grocers that may not have comparable regional density in terms of store locations.

• KR has driven penetration of private-label brands well ahead of competitors (25% versus the national average of 20%). Private label brands typically carry higher margins for KR than branded items. Further, KR inde-pendently manufactures approximately 40% of its private label SKUs giving the company more control over quality and generally leading to more differentiated products than competitors’ private label offerings.

In addition to the aforementioned strengths of KR’s business model, the company’s board has also taken the encouraging step of increasing the previously authorized share repurchase program by $500 million (representing ~1.7% of 9/30/2016 market cap) while management reduced a previously announced capital expenditure program from a range of $4.1 - $4.4 billion to $3.6 - $3.9 billion. The increased share repurchase program indi-cates the board is willing to take aggressive action in buying shares at depressed prices – a good investment for remaining shareholders with shares currently trading at 13.4x trailing 12-month earnings. The reduced capex program serves to allay investor fears of undertaking an aggressive program in a weak operating environment.

These dynamics and an eventual return to food price inflation should be supportive of the company’s attractive dividend growth record – annualized dividend growth of +15.9% over the last five years.

NextEra Energy (NEE)NextEra Energy is one of the largest electric power companies in North America with over 46,000 MW of generating capacity across 27 states and 4 Canadian provinces. The company provides electric services to 5.3 million customers and owns generation, transmission and distribution facilities to provide those services along with gas infrastructure assets. NEE operates through two subsidiaries: Florida Power & Light (a.k.a FLP, the largest regulated electric utility in Florida) and NextEra Energy Resources (a.k.a NEER, one of the largest generators of electric power in the US – mostly through renewable sources such as wind, solar and nuclear).

Like the Income Growth strategy’s holding of WEC Energy Group (WEC), NEE benefits from a favorable regulatory environment in the state of Florida (relatively high allow-able regulated rates of return) and from favorable capital expenditure recapture on renewable assets it builds out within its NEER subsidiary. In general, NEE benefits from regulation that encourages more energy in North America to be generated through renewable resources as opposed to legacy sources, principally coal.

Poor performance of NEE’s shares reflects a similar circumstance for WEC described in the Income Growth section of this newsletter where fear of rising interest rates among investors has pressured shares offering attractive yields. Despite concerns of rising interest rates, NEE’s long-term earnings and dividend growth guidance

Quality Growth Continued


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has not changed. Management expects to be able to deliver EPS growth between +6.0% and +8.0% annually through 2018 and dividend growth of +12.0% to +14.0% annually for the same period. NEE has grown its dividend at an attractive +9.6% annualized rate over the past five years. This stability and dividend growth, combined with a 2.8% current yield, support ownership of the company in the Quality Growth strategy.

Church & Dwight (CHD)Church & Dwight is a household and personal care product company with nine core brands including Arm & Hammer, Xtra, OxiClean, Spinbrush and Orajel. Arm & Hammer has been the firm’s longest-standing brand and cements the company as the world’s largest baking soda producer.

Over the past two decades, the company has invested heavily in R&D to drive innovation and marketing to increase brand awareness in order to take market share from larger competitors. CHD maintains a favorable balance of premium and value brands allowing it to compete in both good (trade up) and less favorable (trade down) economic environments.

Acquisitions have been a meaningful part of the compa-ny’s growth strategy over time. The company is often able to acquire underperforming brands from larger competi-tors, invest in innovation and advertising and grow market share steadily over time. CHD is also maniacally focused on cost reductions having been able to reliably expand margins over the years through a combination of manu-facturing process improvement, overhead consolidation (in the case of acquisitions) and tilting revenues toward higher-margin personal care offerings.

The company has returned substantial portions of its free cash flow to shareholders through a growing dividend (the dividend has grown at a +15.9% annualized rate over the past 5 years). Like many companies in the Consumer Staples sector, the recurring nature of product purchases make for stable revenue and profit growth though a market cycle offering investors a safe haven, especially in periods of volatility.

During the quarter, the three greatest contributors to performance were: Broadcom (AVGO), MarketAxess (MKTX) and Microsoft (MSFT).

Broadcom (AVGO)The last time Broadcom was featured, during our 4Q15 newsletter, the company was then known as Avago Tech-nologies and had just announced their intent to acquire Broadcom (BRCM). This has been the company’s largest acquisition to date, was immediately accretive to earnings and is progressing favorably as indicated by the combined company’s top-contributor role in the Quality Growth strategy during the quarter.

As was noted in our last review, the Avago portion of the company sells into the wireless communications, enter-prise storage and wired infrastructure end markets. The predecessor company earned 40% of revenues from hand-sets, specifically proprietary film bulk acoustic resonator (FBAR) filters that allow a smartphone connecting to a 4G network to discern multiple band frequencies transmitting data for processing. Avago has years of experience in deisgning and manufacturing these (often non-silicon) products and therefore possesses unique expertise in this market.

Broadcom provided an avenue for end market diversifica-tion through expansion into enterprise, service provider and data center networking, broadband and connectivity chipsets. Broadcom also possesses significant experience in smartphone chipset integration – an area of expertise quite useful to Avago’s smartphone business.

The combined company is now the third-largest semi-conductor manufacturer by revenue after Intel (INTC) and Qualcomm (QCOM) and is positioned to benefit from the increasing complexity of connectivity components for new smartphones and the 4G networks to which they connect.

AVGO will likely contine to make acquisitions a centerpiece of its business strategy, but the company has taken care to reward shareholders along the way. With a 1.2% dividend yield today, dividend distributions have grown at a break-neck +35.9% annualized rate over the last five years. The company typically increases its dividend each quarter in line with earnings growth.

The company currently trades at approximately 0.6x its expected FY2016 earnings growth rate of +25.6% (based on a 16.5x trailing P/E multiple). The combination of strong future growth prospects among the company’s diverse end markets and willingness to generously reward shareholders for their capital at risk represents our thesis for inclusion in the Quality Growth strategy.



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MarketAxess (MKTX)MarketAxess has been prominently featured as a top- performing holding of the Small Cap Growth strategy for the last two quarterly letters we have penned (1Q16 and 2Q16). Now the company has earned recognition as a top contributor in our Quality Growth strategy.

As previously mentioned, MKTX is revolutionizing the fixed-income trading landscape. Traditionally, the fixed-in-come markets have been some of the most opaque capital markets in the financial ecosystem. MKTX has developed and popularized the use of an electronic trading platform that allows market participants to efficiently trade all sorts of bond securities. The company counts over 1,000 institutional investors and broker-dealers as active users of its platform. Network effects dictate that this platform becomes more valuable (and more difficult to successfully replicate) as the number of users grows.

MKTX’s trading platform cuts out intermediaries in bond trades, allowing the holder of a bond to sell directly to a buyer, with MKTX collecting a nominal transaction fee. MKTX takes no risk of security ownership in the trade, it only seeks to connect a buyer to a seller and vice versa. The company’s platform has substantial reach, covering US high-grade corporate bonds, emerging market and high-yield bonds, European corporate bonds, US agency bonds and credit default swaps.

MKTX has a distinct capital problem – they have too much of it! The company carries no debt on its balance sheet and cash represents nearly 50% of assets. They have increased their dividend at a +23.6% annual rate over the last five years.

As proprietary trading desks and broker-dealer security inventories shrink amid regulation following the financial crisis, MKTX stands to gain additional share of trading volume both domestically and abroad. With little capital reinvestment needs and such strong secular tailwinds, the company is likely to enjoy high returns on invested capital for the foreseeable future.

The scale of MKTX’s opportunity is reflected in the company’s valuation. Earnings are expected to grow approximately +23.1% in FY2016. Shares currently trade at approximately 2.3x this growth rate based on a 54.1x trailing P/E multiple. As MKTX continues to grow scale and market share, the value of its trading platform should continue to increase. Further opportunities to serve geographies and assets outside of the company’s existing

offerings should provide a long runway for growth in the future.

Microsoft (MSFT)Microsoft last appeared as a top-contributor to the Quality Growth strategy in our 4Q15 newsletter. Much is the same with the company today as then. Microsoft is in the process of reinventing itself – and its future in the cloud appears to be a bright one. Long known for its flagship Windows operating system, today Microsoft is principally an enterprise company. The majority of its revenues and operating profits are generated from sales to small, medium and large businesses. Windows still remains the core offering of the company, but it is now a platform upon which value-added applications (like Office and CRM) are offered.

For much of MSFT’s history, the company has operated in an “on-premise” world, where software is accessed through a physical machine all owned and in close prox-imity to the user. Now, with the increasing adoption of cloud computing, processing capacity and applications are located anywhere in the world, within the infrastruc-ture of the cloud. Access to this computing capacity and associated applications occurs through internet-enabled devices like a laptop, thin client, smartphone or tablet and ownership takes the form of a subscription model.

MSFT enables its clients to access mission-critical applications without having to engage in the operation of supporting IT infrastructure. Effectively, the next few years will involve MSFT’s sizeable installed user base transition-ing from on-premise clients to subscription, cloud-based users. As the scale of the cloud business increases, margins are likely to follow.

In 2014, Satya Nadella, a long-time MSFT employee, became the third CEO in the company’s history. He has focused the company on becoming a cloud-first, mo-bile-first enterprise to maintain relevance, and ultimately thrive in the future. While this transition occurs, he and CFO Amy Hood have maintained a commitment to return-ing capital to shareholders.

MSFT shares currently yield 2.7% and dividend payments have grown at an impressive +14.3% annualized rate over the past five years. With significant ongoing free cash flow and a large hoard of cash in its balance sheet, MSFT has plenty of wherewithal to fund important strategic changes and maintain an attractive capital return policy for share-holders.



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Reported earnings of the company in the coming year are expected to advance by approximately +4.0% from the prior year, which is an improvement from the flat earnings growth expected when the company was reviewed in our 4Q15 newsletter. These rising earnings growth estimates are related to the transition of on-premise business to subscription, cloud-based business. In coming years, MSFT should return to earnings growth on the order of +8.0% to +10.0% annually, but with a more stable, recur-ring revenue base. Using an expected earnings growth rate of +9.0% annually, the shares are currently valued at approximate 2.3x earnings growth (base on a 20.5x trailing P/E multiple).

MSFT is one of our highest-conviction holdings in the Quality Growth strategy. This is evidenced by our 4.5% position size and is supported by the company’s strong commitment to capital returns and well-considered efforts to move the company swiftly into the future.

From an attribution perspective, performance tailwinds included:

1. Underweight sector allocation in Telecommunications. The Quality Growth strategy has had no direct exposure in the Telecommunications sector since 2008 due to lack of sufficient dividend growth among investable constituents. The two major constituents of this sector, AT&T (T) -4.97% and Verizon Communications (VZ) -5.98% were pressured during the quarter amid con-cerns of a benchmark interest rate increase on the part of the Fed (which did not occur). These companies are not owned in the Quality Growth strategy because their paltry dividend growth is not sufficient to aid in Bahl & Gaynor’s efforts to grow a client’s overall income stream quickly. T and VZ have only grown their dividends at a +2.3% and +3.0% annual rate over the last five years, respectively.

2. Company selection in Health Care, somewhat offset by an overweight sector allocation. Accretive performance in this sector was driven as much by companies the strategy did not own as companies it did. Not owning Bristol-Mysers Squibb (BMY) -26.69% and Pfizer (PFE) -2.99% aided performance while owning Amgen (AMGN) +10.26%, Merck (MRK) +9.14% and Abbott Laboratories (ABT) +8.25% was also constructive. Bahl & Gaynor’s focus in this area has been among defensive companies with established and differentiated products, healthy pipelines of new drugs under development and valu-ations that are reasonable relative to the certainty of expected future growth.

3Q 2016 Quality Growth Sector Contribution1. Telecommunications2. Health Care3. Materials4. Real Estate5. Financials6. Utilities7. Energy8. Information Technology9. Industrials10. Consumer Staples11. Consumer DiscretionaryNote: Figures relative to the S&P 500 index.Source: Bahl & Gaynor, 2016.

The following dynamics represented challenges to performance during the quarter:

1. Company selection in Consumer Discretionary. Many Quality Growth holdings in this sector were uniformly weak during the quarter including Dollar General (DG) -24.18%, Johnson Controls (JCI) -9.61%, Lowe’s (LOW) -8.40% and TJX Companies (TJX) -2.86%. Weakness in the case of DG, LOW and TXJ was partly driven by weaker foot traffic while corporate restructuring at JCI has clouded the company’s outlook leading to its elimination from the strategy during the quarter. Not owning Amazon (AMZN) +17.00% also detracted from performance as the company appears to be a beneficia-ry of falling traffic at traditional retailers.

2. Overweight sector allocation and company selection in Consumer Staples. The strategy’s holdings of Kroger (KR) -19.03% and Church & Dwight (CHD) -6.52% lagged the overall S&P 500 Consumer Staples sector return of -2.63%. KR’s weakness stems from persistent food deflation described previously in this newsletter and CHD suffered from market share ceded to larger competitors during the quarter.

3. Company selection in Industrials. Many of the Quality Growth strategy’s Industrial holdings lagged the S&P


Top Contributors1. Broadcom (AVGO)2. MarketAxess (MKTX)3. Microsoft (MSFT)4. Cintas (CTAS)5. PNC Financial Svcs. (PNC)

Top Detractors 1. Kroger (KR) 2. NextEra Energy (NEE) 3. Church & Dwight (CHD) 4. Stryker (SYK) 5. T. Rowe Price Group

(TROW)

3Q 2016 Quality Growth Top Contributors/Detractors



continued >

500 sector return of +3.95% for the quarter. Fastenal (FAST) -5.21%, W. W. Grainger (GWW) -0.51%, United Technologies (UTX) -0.33%, Honeywell (HON) +0.75% and 3M (MMM) +1.25% were all left behind by strong performance among lower-quality and more cyclical industrial companies that Bahl & Gaynor avoids due to lack of dividend growth stability.

4. High-quality companies (companies with an S&P earnings and dividend quality ranking of B+ or better) underperformed low-quality companies (B or worse ranking). The high-quality portion of the S&P 500 returned +2.68% while the low-quality portion returned +6.15%, all figures cap-weighted. At quarter-end, approximately 81% of holdings in the Quality Growth strategy had an S&P ranking of B+ or better, versus 65% for the S&P 500 index.

5. Dividend-paying companies underperformed non-div-idend companies. Companies in the S&P 500 that paid a dividend returned +3.09% during the quarter, lagging the non-dividend segment, which returned +8.19% for the same period. All figures are cap-weighted.

Paying deference to one of the Quality Growth strategy’s three goals, income growth, below is a schedule of compa-nies that announced dividend increases during the quarter:

3Q 2016 Quality Growth Dividend Increases

Company


RateCurrent

Yield

Accenture (ACN) +10.0% 2.0%

BB&T (BBT) +7.1% 3.2%

Broadcom (AVGO)1 +2.0% 1.2%

Broadridge Fin’l. Sol. (BR) +10.0% 1.9%

Microsoft (MSFT) +8.3% 2.7%

Occidental Petroleum (OXY) +1.3% 4.2%

PNC Financial Svcs. (PNC) +7.8% 2.4%Source: Bahl & Gaynor and Factset, 2016.1AVGO increases dividend quarterly.

It is also worth reiterating several important points about the nature of the income stream generated by the strategy and overall portfolio characteristics before we conclude with trades applied to the strategy during the quarter:

• High-quality, large-cap growth, bottom-up strategy;• 26.25-year track record;• 100% of the 48 companies owned in the strategy pay a

dividend and grow it regularly;• Every company owned in the strategy possessed a

market capitalization of at least $1 billion at the time of purchase;


• The strategy owns only common stocks traded on US exchanges. We hold no master limited partnerships (MLPs) due to the complex tax ramifications of owning these securities, nor do we own preferred, convertible, ETF or option securities as we prefer to focus on compa-ny selection, not asset allocation within the strategy;


• As of 9/30/2016, 100.0% of the strategy’s income was categorized as qualified dividend income;

• 34.2% of aggregated strategy revenues are generated internationally (outside of the US), 13.4% are from emerging markets;


We conclude with a review of the trades executed in the Quality Growth strategy over the quarter just ended:

3Q 2016 Quality Growth Trades Executed


Comcast (CMCSA) J. M. Smucker (SJM)

Dollar General (DG) Johnson Controls (JCI)

Texas Instruments (TXN)


3M (MMM) Church & Dwight (CHD)

United Technologies (UTX) Walt Disney (DIS)

WEC Energy Group (WEC)




Bottom Line: Although the Quality Growth strategy generally invests in lower-yielding securities than its Income Growth counterpart, the strategy did not escape pressures mounted on income-producing securities during the quarter amid investor fears of rising bench-mark interest rates. Moreover, the Quality Growth being a high-quality portfolio, investors were more interested in lower-quality, highly-cyclical companies after spend-ing much of the first two quarters of the year focused on maintaining defensiveness. As has often been stated,

the Quality Growth strategy seeks to provide value to investors who will benefit from a faster overall rate of dividend growth than the Income Growth strategy, but still desire the favorable downside capture characteris-tics afforded by high-quality companies. We are confident that continuing to position the strategy for accelerated dividend growth and superior quality to its benchmark will lead to favorable risk-adjusted returns over a full market cycle.


In this newsletter we take the opportunity to introduce our smig® Small/Mid Cap Income Growth strategy. smig® seeks to own small and mid cap companies with a mini-mum market cap of $200 million and a maximum market cap of $15 billion at purchase. Like the large cap Income Growth strategy, the priorities of smig® are growth of in-come, downside protection and capital appreciation, in that order. We believe that this strategy is an excellent avenue through which an investor can gain exposure to higher growth rates offered by smaller companies, but with a high quality, dividend growth oriented approach. We begin be reviewing strategy performance for the quarter just ended.

The smig® strategy lagged its Russell 2500 benchmark during the quarter (+3.85% gross / +3.76% net vs. Russell 2500 +6.56%).

On a month-by-month basis, the strategy lagged the index in July (+3.76% gross / +3.68% net vs. Russell 2500 +5.22%), August (+0.50% gross / +0.49% net vs. Russell 2500 +0.80%) and September (-0.41% gross / -0.42% net vs. Russell 2500 +0.48%).

The strategy’s objectives, according to priority, are restated below:

smig® Small/Mid Cap Income Growth Objectives:

1. Income Growth2. Downside Protection3. Capital Appreciation

Growth of income is the primary objective of the smig® strategy. Bahl & Gaynor believes it can position the strategy to deliver rising income each year. This growth,

combined with a high current yield (3.0% at quarter-end) provides clients with a differentiated (relative to the Morningstar small cap core and mid cap core peer universe average dividend yields of 1.7% and 1.8%, respectively at quarter-end) absolute yield and real purchasing power accretion, as the income growth rate has generally exceeded the inflation rate since the strategy’s inception. During the quarter, the strategy’s income stream grew by +1.33% which amounts to +5.05% growth in income for the YTD period.

The strategy’s long-term performance record is presented below along with percentile rankings of risk (as measured by standard deviation of return) to aid in the evaluation of performance according to the goals outlined above.

ReturnsAs of9/30/16

smig®

(Gross)smig®

(Net)Russell

2500

1Q2016 +6.29% +6.18% +0.38%

2Q2016 +5.58% +5.49% +3.57%

3Q2016 +3.85% +3.76% +6.56%

YTD +16.54% +16.21% +10.79%

1 Year +19.99% +19.55% +14.42%

2 Years1 +11.58% +11.22% +7.17%

3 Years1 +12.26% +11.99% +7.77%


smig® Small/Mid Cap Income Growth +3.85% for 3Q16. 3.0% dividend yield as of 9/30/2016.

continued >


Standard Deviation of Return Percentile Rankingsvs. Small/Mid Cap Core Peer Managers

As of 9/30/16

smig® (Gross)

smig® (Net)

1 Year 1 1

2 Years1 1 1

3 Years1 1 1


As in previous quarters, we provide commentary below highlighting our bottom three and top three performing companies held in smig®.

We begin by reviewing the three greatest detractors from performance during the quarter: Cracker Barrel (CBRL), Computer Programs & Systems (CPSI) and Virtu Financial (VIRT).

Cracker Barrel Old Country Store (CBRL)Cracker Barrel was founded in 1969 with its first store located in Lebanon, TN, and is a wholly-owned chain of combined restaurants and gift stores. The combined restaurant and store chain is designed to appeal to both the traveler and local customer with moderate price points, and has prided itself on delivering customers consistent quality, value and friendly service. CBRL places emphasis on its effective management, training, and screening processes. For example, each restaurant employs a full-time manager and provides them with an opportunity to share in store profits incentivizing sales and operational improvement on an individual store level.

As of September 2016, CBRL operated 640 stores in 43 states, none of which are franchised. Cracker Barrel stores have a trademarked old country store design, which offers a home-style country food menu, accompanied by signature decorative pieces and functional items that can be seen at all stores, including oversized checkers, stone fireplaces, antique furnishings, and rocking chairs lining the outside porch. On average, the dining section and shop each represent ~25% of a location’s square footage with the remaining layout dedicated to kitchen, storage and training areas.

Restaurant sales comprise ~80% of overall firm revenues with the balance derived from merchandise sales. Lunch represents 39% of restaurant revenue, followed by dinner

and breakfast at 24% each. The average check was $10.63 in 2016, representing a +3.5% YoY increase.

CBRL opened four new stores in FY2016, and plans to open seven more in the next twelve months. The company also launched a new fast casual concept this year called Holler & Dash Biscuit House, focusing on biscuit-inspired entrées and a menu of alcoholic and non-alcoholic beverage options. This concept is a comparatively smaller footprint than the traditional CBRL format, and will focus primarily on serving breakfast and lunch.

CBRL’s earnings announcement on September 15th reflected pressures observed in the fast casual dining industry overall, notably decelerating sales growth and labor wage inflation. Company shares declined approxi-mately -6.6% following the weak earnings announcement, but many analysts noted that CBRL shares had been outperforming peers up until the earnings announcement.

Relieving some of the aforementioned headwinds, management expects operating margins to benefit from increases in pricing combined with a food cost deflation tailwind. Egg prices have been volatile over the past year after an outbreak of avian influenza created a shortage. However, supplier reaction to this event has elevated future supply, and should now benefit the company as it is a major consumer of eggs.

CBRL continues to widen its differentiation gap versus its fast casual dining peers, with annualized revenue growth of +2.20%, improving operating income/margins, and healthy free cash flow. These metrics are supportive of rewarding shareholders through dividend increases and merits inclusion in the smig® strategy. CBRL has increased its dividend at a +35.7% annualized rate over the last five years. Shares currently trade at 16.9x trailing 12-month earnings, yielding a 2.2x PEG based on FY2017 consensus earnings growth of +7.7%.

Computer Programs & Systems (CPSI)Computer Programs & Systems, based in Mobile, AL, delivers solutions for the technological needs of rural and community hospitals. CPSI successfully operates a closed system business model, which uses internally developed technological solutions tailored to each client, especially as it pertains to meeting the demands of government mandates. CPSI’s target market includes acute care community hospitals with 300 or fewer beds and small specialty hospitals. Hospitals with 100 or fewer acute care beds comprise approximately 94% of CPSI’s customers.

smig® Continued

continued >


Customer adoption of CPSI systems and services take between nine and 12 months, with contract “booking,” on average, taking three months.

CPSI has grown through organic expansion by way of creating specialized wholly-owned subsidiaries to serve niche markets. Examples include TruBridge, created in 2013, which offers business office outsourcing services, and Evident, created in 2015, which is a leading provider of electronic health records (EHR) systems and services. EHR services have seen tremendous growth since the inception of the national EHR adoption initiative under the American Recovery and Reinvestment Act (ARRA) of 2009. CPSI offered the services now provided by Evident prior to the subsidiary’s creation, but believed that the creation of a new company offered the best opportunity to meet its strategic initiatives and improve the overall customer experience. In January, CPSI announced a bolt-on acqui-sition of HHI to add to its existing EHR business while also providing clinical information management solutions to over 350 existing hospital customers.

CPSI has seen its revenues shift from mostly traditional perpetual revenue license arrangements to a significant number of non-recurring contract engagements, espe-cially in its EHR solutions business. Although this revenue mix allows for strong growth when market dynamics are favorable, negative market shifts in the community healthcare market can lead to top line volatility as seen in the first half of 2016 with a slowdown in sales and a delay in its integration of HHI.

During its 3Q16 earnings announcement, CPSI cut is dividend by 47%, from $0.64/share to $0.34/share. The company’s +100% 12-month dividend payout ratio and greater-than-expected need for post-acquisition working capital caused CPSI to rethink its dividend strategy, and announce new dividend payout guidance of 70% of non-GAAP EPS from each prior quarter. At Bahl & Gaynor, a dividend cut from a strategy holding triggers an automatic elimination from the given strategy and CPSI’s elimina-tion from smig® in this case is no exception. Further, a variable dividend policy would introduce income growth volatility that would run counter to the primary objective of the smig® strategy. Dividend cuts from small and mid cap companies are more common because of strategic chang-es, volatile operating environments and other issues not as worrisome to larger cap peers. CPSI plans to use this cash savings to pay down debt and increase investment in new product development, including its efforts to localize its products for Canadian market expansion.

CPSI shares dropped -33.69%, below the Healthcare sector’s +10.61% return and the overall Russell 2500 benchmark return of +6.56%.

Virtu Financial (VIRT)Virtu Financial recently began life as a publicly-traded company, first offering its shares to the public in April 2015. In its simplest form, VIRT is a technology-driven market maker and liquidity provider to global financial markets.

What does this mean, specifically? As a result of increased financial regulation, many traditional broker-dealers have reduced their inventories of securities as part of their dealer operations. A traditional broker-dealer’s inventory of securities requires capital reserves to offset the change of losses incurred on held securities. With the reduction in dealer inventories, other market makers have stepped in, including hedge funds and companies like VIRT, that attempt to make markets in financial instruments through connecting buyers and sellers.

Although VIRT makes markets in fundamentally volatile securities, it does not seek to profit off of trading these securities with its own capital, rather the company struc-tures its market-making activities to be “market neutral,” meaning VIRT is not dependent upon the direction of any particular market. In short – they do not speculate. Rather, the company collects a small bid/ask spread on securities transacted. This revenue becomes meaningful when executed across a large volume of transactions.

In addition to abstaining from speculation, VIRT seeks to reduce operational risk by limiting the notional size of transacted positions, hedging of primary instruments transacted (or approximate hedging through economically equivalent instruments) and sophisticated risk-man-agement technology that is designed to freeze trading strategies that generate revenues out of preset limits (the idea being that above-average revenue generation in a particular transaction likely involves a greater degree of incurred risk in executing said transaction).

VIRT has a capital problem – it has too much of it! At the end of 2Q16, VIRT held approximately $150 million of cash on its balance sheet, equivalent to 7.5% of the company’s market capitalization. In addition, it generated cash from operations during FY2015 of $260 million, but only incurred capital expenditures of $24 million, representing free cash flow of approximately $236 million. To the extent that VIRT’s market-making activities are market neutral,

smig® Continued

continued >


and the company’s ongoing capital expenditures are small relative to cash generated by the enterprise, VIRT should generate significant amounts of excess capital to fund attractive shareholder returns.

VIRT shares were pressured as the environment for market makers remained challenged. Volume and volatili-ty are the key drivers to VIRT’s net trading income (NTI), or income generated after deducting expenses directly tied to those operations. These two drivers in the third quarter were at or near all-time lows since VIRT’s IPO. However, volume and volatility can pick up quickly, and catalysts in the next quarter point to the US Presidential election, Fed benchmark interest rate uncertainty and general rebound in volatility after a summer lull in trading, which will help VIRT shares. VIRT has been able to produce positive operating profits even in this environment, showing the strength of their model and dismissing any secular concerns for the business.

Although VIRT’s shares presently trade below their initial offering price, the company’s services are still very relevant. Shares trade for a modest 14.4x trailing 12-month earnings.

The three greatest contributors to performance during the quarter were Microchip Technology (MCHP), Scotts Miracle-Gro (SMG) and Science Applications International (SAIC).

Microchip Technology Incorporated (MCHP)Spun out of General Instrument in 1989, Microchip Tech-nology is a Phoenix-based developer and manufacturer of specialized semiconductor products. They are a leading supplier of microcontrollers (MCUs), which are comprised of 8-bit, 16-bit, and 32-bit peripheral interface controller (PIC®) microcontrollers and 16-bit dsPIC® digital signal controllers, while maintaining a small arm of business dedicated to licensing their IP. MCHP owns a majority of their manufacturing resources, which gives the company a high degree of operational control. This has resulted in MCHP being one of the lowest-cost producers in the MCU space.

In essence, MCUs are “small computers” used in con-trolled products such as garage door openers, implantable medical devices and car power control windows. Primary end markets for MCUs include consumer, automotive, industrial, office automation and telecommunications. MCHP markets and sells their products through a network of technically-oriented direct sales personnel and distrib-

utors that focus primarily on major strategic accounts in three geographical markets: the Americas, Europe and Asia.

A leader of consolidation within the semi-space, MCHP has also completed 15 M&A transactions in the last seven years, which have collectively resulted in significant EPS accretion. The company has a history of over-delivering on M&A accretion targets. In August, management increased its realized accretion target for their $2.98 billion acquisi-tion of Atmel which closed in April of this year.

MCHP shares gained +23.14% during the quarter, beat-ing out the Technology sector’s +14.38% return and the Russell 2500 index’s +6.56% return.

2Q16 earnings reported in August represented the 103rd consecutive quarter of profitability and positive free cash flow. MCHP remains committed to its dividend and well positioned as a holding in the smig® strategy. Shares currently trade at a forward 12-month P/E of 17.2x, with consensus earnings growth of 12.3% in FY2017, yielding a 1.4x PEG ratio.

Scotts Miracle-Gro (SMG)Scotts Miracle-Gro is a leader in the manufacture, market-ing and sale of branded consumer lawn and garden care products. Primary customers span most of the consumer retail channel, from home centers, warehouses, hardware stores and chains, to small garden centers and nurseries. The company has grown to be the undisputed leader in the $7 billion US lawn and garden industry through a series of mergers and acquisitions over the life of the company. Last December, SMG’s LawnService merged with Tru-Green to create the largest lawn care company with ~2.3 million customers and over $1.3 billion in annual reve-nues. SMG will own ~30% of the combined company and is expected to receive $200 million in cash. SMG continues to grow via acquisitions and investments to extend their product offerings into adjacent verticals, including plant nutrients, hydroponic planting and edible gardening.

Geographically, over 90% of profits are generated in the US, with the balance generated in Canada and Western Europe. SMG enjoys +60% market share for each of their four-strongest brands: Scotts, Miracle-Gro, Ortho and Roundup, benefitting from unrivaled consumer brand awareness (on average, 89% of customers are aware of SMG brands) and customer relationships in a historically stable consumer product category.

smig® Continued

continued >


SMG’s market and scale-enabled competitive advantages from its supply chain, innovation and marketing execution should continue to deliver strong performance, especially given a favorable US macro backdrop (specifically the strong consumer). Additionally, in the latest quarter, management noted higher product pricing, lower costs of goods sold from commodity deflation, and distribution efficiencies as drivers of both gross and EBITDA margin expansion.

The company maintains manageable leverage of 3.0x total-debt-to-EBITDA given its acquisitive growth strategy. SMG’s combination of growth and cash flow generation justifies its positioning in Bahl & Gaynor’s smig® strategy. Management has committed to returning more cash to shareholders through maintaining a healthy dividend and targeting $300 million in share repurchases.

Shares gained +19.84% in the quarter, outpacing the benchmark sector’s return of +7.39% and the overall Russell 2500 index return of +6.56%.

In August, SMG raised its dividend +6.0%, marking its seventh consecutive year of a dividend increase and resulting in a +10.8% annualized dividend growth rate over the last five years. Shares currently trade at 29.6x trailing 12-month trailing earnings, yielding a 2.3x PEG based upon +13.0% FY2017 consensus earnings growth.

Science Applications International (SAIC)Science Applications International, split from Leidos in 2013, and today is a leading provider of technical, engineering and enterprise information technology services primarily to the US government (including DoD, intelligence community and federal civilian agencies). Specifically, the company provides engineering, systems integration and IT offerings for large, complex government projects and a broad range of services with a targeted emphasis on higher-end, differentiated technology. SAIC’s expertise and solutions typically span the entire IT infra-structure.

Government expenditures are a sensitive subject in public opinion and reducing expenses through efficiency gains in technology investment is a high priority for many agencies. The government contracting process is ex-tremely complex and SAIC has developed a competency in navigating this landscape.

SAIC seeks out indefinite delivery/indefinite quantity (IDIQ) contracts, which serve as “hunting licenses” for

accumulating task orders. To the extent SAIC is proficient in winning IDIQ awards, their chances of receiving mean-ingful task orders increases. The company has maintained contract relationships with some government agencies for +20 years.

67% of SAIC employees hold some sort of government security clearance. A workforce like this would be difficult to replicate, creating a meaningful barrier to entry for any potential competitor. To add, a similar percentage of employees work on-site with contracting government agencies developing close ties with these clients and intimately understanding their needs. This represents a strong defense from entry of competition through en-trenchment in client operations and gives SAIC a unique ability to recommend solutions to clients given their specific operational knowledge.

SAIC shares advanced +19.50% in the third quarter, ahead of both the Technology sector’s +14.38% return and the overall Russell 2500 index’s +6.56% return. SAIC currently has a 1.8% dividend yield and trades at a 12-month trailing P/E of 24.4x.

The company expects FCF to grow in-line with revenues over time and aside from debt pay down, has prioritized share repurchase and dividend payments. In the most recent quarter SAIC reported interest expense savings of $8 million from debt refinancing, freeing up cash that could support further dividend increases. Additionally, the company reiterated its long-term growth targets and delivered a stronger-than-forecasted book-to-bill ratio, aided by a large recompete contract win with NASA. Bahl & Gaynor is attracted to SAIC’s strong and predictable generation of free cash flow, making it a suitable holding in the smig® strategy.

From an attribution perspective, performance tailwinds included:

1. Company selection in Financials. Community Bank Systems (CBU) +17.88% advanced on the heels of a strong earnings announcement in the quarter, exceed-ing earnings, loan growth and net interest margin ex-pectations. Evercore Partners (EVR) +17.27% benefited from another quarter of healthy M&A volume, resulting in record advisory revenues for the quarter. Mainsource Financial (MSFG) +13.88% completed its transaction of CHEV while standalone performance was solid via a rebound in fees and annualized loan growth of +7%.

smig® Continued

continued >


2. Company selection in Energy. The strategy’s sole holding in the sector, SemGroup Corp (SEMG) +10.28%, outpaced the overall sector return of +6.96%. SEMG benefitted from a general rebound in crude prices and a late-quarter rally following shareholder approval of its Rose Rock Midstream LP acquisition. Security perfor-mance dispersion was high within the sector during the quarter; therefore, avoiding poorly-performing compa-nies like First-Solar (FLSR) -18.54% was also accretive to strategy performance.

3. Underweight sector allocation in Utilities. The Utility sector was the worst-performing sector in the Russell 2500 index during the quarter with a return of -4.48% due to an outsized presence of “bond proxy” securities particularly sensitive to changing interest rate expec-tations. The strategy’s significant underweight in this sector was the primary driver of accretion. Strategy holdings within this sector, Atmos Energy (ATO) -7.92% and WEC Energy Group (WEC) -7.57%, have traditionally provided excellent downside protection in volatile mar-kets, but sensitivity to interest rate expectation volatility pressured these companies more than the overall sector during the quarter.

3Q 2016 smig® Sector Contribution

1. Financial Services2. Energy3. Utilities4. Materials & Processing5. Producer Durables6. Technology7. Consumer Staples8. Consumer Discretionary9. Health CareNote: Figures relative to the Russell 2500 index. Source: Bahl & Gaynor, 2016.

From an attribution perspective, performance headwinds included:1. Underweight sector allocation and company selection

within Health Care. Ownership of Computer Programs & Systems (CPSI) -33.69% was the greatest detractor from performance within the sector due to rapid fundamental deterioration and an unexpected dividend cut. Ownership of Patterson (PDCO) -3.61% was also drag on performance after industry peer Henry Schein (HSIC) management commented on a softening dental market in June and July. Additionally, despite a positive quarter for National Healthcare Corp (NHC) +2.64%, it underperformed the broader +10.61% benchmark sector return. CPSI was eliminated from the strategy during the quarter.

2. Company selection in Consumer Discretionary. Cracker Barrel Old Country Store (CBRL) -20.71% fell after earnings that revealed sales growth deceleration and wage inflation pressures for the quarter (explained previously as a top detractor for the smig® strategy). Neither Hasbro (HAS) -4.95% nor Wyndham Wordlwide (WYN) -4.81% are constituents of the Russell 2500 index, exacerbating negative company selection effect within the sector.

3. Overweight sector allocation in Consumer Staples, somewhat offset by company selection. Consumer Staples was the second-worst-performing sector with a benchmark sector return of -1.14% vs. the overall benchmark return of +6.56% for the quarter. The strat-egy’s sector overweight was harmful in this circum-stance, however this was somewhat offset by strong performance of Pinnacle Foods (PF) +9.00% and not owning Hain Celestial (HAIN) -28.48%, Flowers Foods (FLO) -18.49% and TreeHouse Foods (THS) -15.06%, all negatively impacted by an unusually long stretch of food price deflation.

4. High-quality companies (companies with an S&P earnings and dividend quality ranking of B+ or better) underperformed low-quality companies (B or worse ranking). The high-quality portion of the Russell 2500 returned +2.91% while the low-quality portion returned +7.96%, all figures cap-weighted. At quarter-end, approximately 63% of holdings in the smig® strategy had an S&P ranking of B+ or better, versus approxi-mately 28% for the Russell 2500 index.

5. Higher-yielding companies underperformed their lower-yielding and non-dividend counterparts during the quarter given great concern among investors about rising interest rates. The smig® strategy invests in companies with a dividend yield of at least 2.0% at

smig® Continued

Top Contributors1. Microchip Tech. (MCHP)2. Scotts Miracle-Gro (SMG)3. Science Applications (SAIC)4. Orion Egn. Carbons (OEC)5. Xilinx (XLNX)

Top Detractors 1. Cracker Barrel (CBRL) 2. Computer Prog. (CPSI) 3. Virtu Financial (VIRT) 4. Reis (REIS) 5. Fastenal (FAST)

3Q 2016 smig® Top Contributors/Detractors


continued >


position initiation. The portion of the Russell 2500 with a dividend yield exceeding 2.0% returned +4.00% for the quarter, worse than the return of companies with a yield greater than 0.0%, but less than 2.0%, which returned +5.97% and non-dividend companies, which returned +9.12%, all figures cap-weighted.

Paying deference to the smig® strategy’s primary objec-tives, income growth, below is a schedule of companies that announced dividend increases during the quarter:

3Q 2016 smig® Dividend Increases

Company


RateCurrent

Yield

Broadridge Fin’l. Sol. (BR) +10.0% 1.9%

Community Bank Sys (CBU) +3.2% 2.7%

Healthsouth (HLS) +4.4% 2.4%

Harris (HRS) +6.0% 2.3%

Microchip Tech. (MCHP)¹ +0.4% 2.3%

Maxim Integ. Prod. (MXIM) +10.0% 3.3%

Pinnacle Foods (PF) +11.8% 2.3%

Resmed (RMD) +10.0% 2.0%

J. M. Smucker (SJM) +11.9% 2.2%

Scotts Miracle-Gro (SMG) +6.4% 2.4%

W. P. Carey (WPC)¹ +0.5% 6.1%Source: Bahl & Gaynor and Factset, 2016.1MCHP and WPC increase their dividends quarterly.

It is also worth reiterating several important points about the nature of the income stream generated by the strategy and overall portfolio characteristics before we conclude with trades applied to the strategy during the quarter:

• High-quality, large-cap growth, bottom-up strategy;• 3.25-year track record;• 100% of the 48 companies owned in the strategy pay a

dividend and grow it regularly;• Every company owned in the strategy possessed a

market capitalization of at least $200 million but not greater than $15 billion at the time of purchase;


• The strategy owns only common stocks traded on US exchanges. We hold no master limited partnerships (MLPs) due to the complex tax ramifications of owning

these securities, nor do we own preferred, convertible, ETF or option securities as we prefer to focus on company selection, not asset allocation within the strategy;


• As of 9/30/2016, 90.0% of the strategy’s income was categorized as qualified dividend income;


We conclude with a review of the trades executed in the Quality Growth strategy over the quarter just ended:

3Q 2016 smig® Trades Executed


Cyrusone (CONE) Computer Prog. (CPSI)

Healthsouth (HLS) Genuine Parts (GPC)

Williams-Sonoma (WSM) Paychex (PAYX)

Thor Industries (THO)


Hasbro (HAS) Stag Industrial (STAG)

Mainsource Financial (MSFG)

Maxim Integ. Prod. (MXIM)

PacWest Bancorp (PACW)

Polaris Industries (PII)

Semgroup (SEMG)

Virtu Financial (VIRT)


Bottom Line: Like the Income Growth strategy, Bahl & Gaynor’s smig® strategy achieved its primary objective during the quarter of growing client income (+1.33% for 3Q16 and +5.05% YTD) but was challenged from a capital return standpoint amid investor concerns of rising interest rates. Although macro events, such as a potential rising interest rate cycle, may have some tangential impact on the investing climate, they do not represent “make-or-break” outcomes to our investment approach. Bahl & Gaynor believes our high-quality, divi-dend-growth approach remains a highly relevant strategy for today’s market dynamics and dynamics expected in the future. Further, we believe the smig® strategy provides an attractive way to access an often-overlooked segment of the equity market cap range. This portfolio of high-quality, dividend-companies companies should continue to provide clients with the dual benefits of rising income and favorable risk-adjusted returns over a full market cycle.

smig® Continued

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On a month-by-month basis, the strategy lagged the index in July (+4.39% gross / +4.36% net vs. Russell 2000 Growth +6.54%), led the index in August (+3.01% gross / +2.98% net vs. Russell 2000 Growth +1.06%) and lagged the index in September (+0.67% gross / +0.65% net vs. Russell 2000 Growth +1.44%).

Before reviewing performance of the strategy during the quarter, it is good to consider the Small Cap Growth strategy’s objectives (in no particular order):

• Capital Appreciation• Downside Protection• Income Growth

Regarding capital appreciation, the Small Cap Growth strategy seeks to provide favorable risk-adjusted returns over a full market cycle. The strategy’s long-term performance record is presented below:

ReturnsAs of9/30/16

Small Cap Growth (Gross)

Small Cap Growth (Net)2

Russell 2000

Growth

1Q2016 +2.53% +2.44% -4.69%

2Q2016 +5.67% +5.57% +3.24%

3Q2016 +8.25% +8.16% +9.22%

YTD +17.28% +16.98% +7.47%

1 Year +22.43% +22.03% +12.11%

3 Years1 +10.38% +10.09% +6.58%

5 Years1 +17.00% +16.75% +16.14%

7 Years1 +15.24% +15.04% +13.31%

10 Years1 +10.98% +10.81% +8.28%


As we often remind investors, the performance record stated above must be characterized by the level of risk taken to achieve it. Across a variety of periods, the Small Cap Growth strategy remains in the top decile of its small cap growth peers in terms of how little risk it takes to achieve such a performance record:

Standard Deviation of Return Percentile Rankingsvs. Small Cap Growth Peer Managers

As of 9/30/16

Small Cap Growth (Gross)

Small Cap Growth (Net)²

1 Year 6 5

3 Years1 5 4

5 Years1 1 1

7 Years1 1 1

10 Years¹ 1 1


During the quarter, the three greatest detractors from performance were: Texas Roadhouse (TXRH), Virtu Financial (VIRT), PriceSmart (PSMT).

Texas Roadhouse (TXRH)Texas Roadhouse is a Louisville-based restaurant com-pany that operates primarily in the casual dining market segment. Since the company’s beginnings with its first restaurant in Clarksville, IN, opened in 1993, TRXH has pursued a strategy of positioning restaurants as the local hometown favorite for a broad segment of customers.

The company’s operating strategy focuses on offering high-quality, freshly prepared food to customers and performance-based compensation to its restaurant man-agers. TXRH places great emphasis on the quality of food it serves. The vast majority of steaks are hand-cut in the restaurant and store managers are expected to inspect every entrée before it leaves the kitchen. Further, manag-ers earn a performance bonus based on their restaurant’s pre-tax income which allows TXRH to retain and properly motivate talented managers.

The company intends to grow primarily by expanding its base of operating restaurants. Today, TXRH operates 483 restaurants in 49 states and 4 foreign countries. The company reiterated plans to add 30 stores in 2016 with an average capital investment requirement of $4.7 million.

Small Cap Growth Update: +8.25% for 3Q16. 1.5% dividend yield as of 9/30/2016.The Small Cap Growth strategy lagged its Russell 2000 Growth benchmark during the quarter (+8.25% gross / +8.16% net vs. Russell 2000 Growth +9.22%).


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New sites generally reach a steady level of cash flow generation approximately 3 to 6 months after opening, allowing the company to expand operating cash flows quickly.

TXRH shares gave up some of their 2016 gains during the third quarter after a total return of +28.59% in the first six months of the year. Shares came under pressure, notably after 2Q16 earnings, as management cited increased la-bor cost pressure while falling short of analyst consensus same store sales growth for the last month of the quarter. Food deflation was a tailwind resulting in gross margin expansion. Beef represents 40% of TXRH’s cost of sales, and prices declined -7% YoY and is expected to continue through 2017, helping to offset employee wage pressure.

TXRH explicitly specifies its intent to increase its quarterly dividend regularly over time in its SEC filings. Such an explicit declaration is actually a fairly rare occurrence that Bahl & Gaynor views as well-supported by the company’s track record of growing payouts on an +18.9% annualized basis over the last five years.

TXRH’s earnings are expected to advance +29.9% during FY2016. This results in a PEG ratio of 0.8x based on a trailing 12-month P/E ratio of 24.4x. The combination of substantial dividend growth and profit growth justify TXRH’s position in the Small Cap Growth strategy.

Virtu Financial (VIRT)Virtu was one of the worst-performing securities in both the smig® and Small Cap Growth strategies. Please see the overview of VIRT in the smig® section above for a discussion of this position.

PriceSmart (PSMT)Spun out as a result of the 1993 Price Co. and Costco Wholesale Club merger, PriceSmart is the largest operator of “US-style” membership warehouse clubs in Central America, the Caribbean and, recently, South America with its introduction of new clubs in Colombia. PSMT currently operates 38 total clubs across 13 countries, and plans to explore new organic expansion opportunities in Central America, the Caribbean and Colombia.

PSMT is essentially a smaller version of Costco, with stores averaging 75,000 square feet (about half of Cost-co’s average warehouse size). It offers US brand-name

and locally-sourced products at low prices to its over 2.8 million cardholders, with 80% of sales generated through retail and 20% direct-to-business. The company’s primary strategy is to deliver value to its member-customers through a pipeline that leverages economies of scale in aggressive buying from suppliers, streamlined logistics and lean operations.

Membership comes in three tranches: Diamond, Busi-ness and Platinum (Costa Rica only). Diamond members represent 94% of all accounts at $35 per year. The cost of this membnership can be reduced or eliminated through a co-branded credit card, much like in the US. PSMT targets retail customers of higher income and middle class families, and has demonstrated average total membership growth of close to +14.0% annually over the past seven years. Not only that, PSMT demonstrates an ability to maintain members with an 88% retention rate (ex Colombia – its newest market).

PSMT continues to see positive net sales growth, but the drop in oil and other commodity prices have presented headwinds for its petrocurrency markets, specifically Colombia. Over 40% of Colombia’s exports are fossil fuels, whose price decline has driven the Colombia peso lower versus the US dollar. Sales translate at a reduced value when converting from a weakened currency like the peso to dollars, while imported goods from the US become more expensive as the relative purchasing power of the weaker currency declines.

Although PSMT uses currency hedging, the latest quarter reported for PSMT showed a -20.7% sales drop in Colom-bia from the previous year when reported in US dollars, but at a lesser decline of -3.8% when measured in local currency. Management continues to see Colombia as an attractive long-term investment and believes a recovery is underway in the Colombian market. Management believes these currency headwinds have subsided that and ex-pects growth to bounce back as a result of their focus on distribution, warehouse expansion, e-commerce platform enhancement and locally-sourced goods.

PSMT is not exposed to the amount of competitive pres-sures seen in the US, this is evidenced by the wider gross margin the company enjoys relative to comparable US peers like Costco. The company maintains a clean balance sheet with a net cash position of $105 million (10% of total

Small Cap Growth Continued


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assets and has seen healthy operating cash flow over the past decade, supporting its dividend payout and its position in the Small Cap Growth strategy.

Shares currently trade at 29.4x trailing 12-month earn-ings, yielding a 2.8x PEG based on consensus +10.5% FY2017 EPS growth.

The three greatest contributors to performance during the quarter were: Thor Industries (THO), Flexsteel Industries (FLXS) and Cirrus Logic (CRUS).

THOR Industries (THO)Thor Industries, founded in 1980 by Wade Thompson and Peter Orthwein, is the largest North American RV manu-facturer. After its IPO in 1984, THO has grown organically and through strategic acquisitions in both recreational vehicles (RV) and buses (THO subsequently exited the bus industry in 2013 when it sold this business to Allied Specialty Vehicles). THO functions as the sole owner of multiple operating subsidiaries, with the goal of delivering the best products and experiences to their customers.

THO separates itself into the following segments: Towable RVs, Motorized RVs and Other (“Other” consists of oper-ations from Postle Aluminum – a key supplier for the RV industry acquired by THO in May 2015).

The company’s towable RV business represents the largest share of total sales at 72% and also represents the largest growth opportunity for THO with 88% of the RV ad-dressable market represented by this form factor accord-ing the most recent RVIA shipment data. This opportunity set is up from about 50% of the total market since 2000. The trend away from motor RVs to towables is attributed to the lower cost and weight of materials. Trailers are now made of aluminum instead of steel, and are light enough to be towed by family vehicles such as minivans and SUVs. THO, historically the leader in towable RV market share, spent a few years second in share to focus on operational efficiencies. However, the company’s latest acquisition of Jayco in 2016 brings their market share to 47% of the towable RV industry.

THO’s Motor Home segment is delineated between Class A and Class C RVs. The primary differences between the two classes are size, fuel economy, and starting price.

THO continues to benefit from strong growth in the RV business and the rebound of the consumer since the end of the financial crisis. RV unit shipments since the crisis have grown +31% annually through 2015, according to industry data by RVIA. 2016 RV industry shipments are expected to grow +8.3% in 2016 and surpass the prior 2006 pre-crisis peak. (THO management does not provide future guidance to investors).

Sales and backlog growth for THO benefits from multiple factors, including dealer optimism, lower fuel prices, easier consumer access to credit, low interest rates, launch of successful new products, and an increasingly favorable shift to younger demographics in the camping industry. THO’s focus on targeting first-time buyers with more affordable price-points should allow the company to smooth out the inherent cyclicality of its business and expand the company’s addressable market.

THO has enjoyed annualized sales growth rate of +17% since the industry nadir in 2009 accompanied by signifi-cant margin expansion over the same period. FY2016 was no exception as sales increased +14% and EPS climbed to a record high with growth of +29%. Their latest quarter of reported earnings beat consensus earnings estimates by +15% as business market conditions continue to be healthy. Company shares rose +30.83% during the quarter, outpacing the overall Consumer Discretionary sector return of +3.69% and the Russell 2000 Growth index return of +9.22%.

THO has been able to grow its dividend at a +24.6% annualized rate over the last five years. The company touts a healthy balance sheet, and has just recently added debt to finance their acquisition of Jayco. Shares currently trade at 17.6x trailing 12-month earnings with consensus earnings growth of +18.7% in FY2017, yielding a 0.9x PEG. Flexsteel Industries (FLXS)Flexsteel is one of the oldest and largest furniture man-ufacture, import and marketing companies in the United States. The company offers both commercial and resi-dential upholstered and wooden furniture such as sofas, chairs, recliners, convertible bedding units, desks, dining tables and bedroom furniture. These furniture pieces serve home, office, hotel, healthcare and other commer-cial applications. Most of FLXS’s upholstered furniture features a flexible steel drop-in seat spring which is how the company derived its name.



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FLXS’s top-line growth has benefited from the tailwind of a strong residential housing market. New order trends have continued to display strength along with the company’s backlog of existing orders. FLXS’s product offerings are diverse and have broad appeal to a variety of end cus-tomers at numerous price points. The company’s ability to participate in favorable market trends is compounded by two important strategic efforts: improvement of both logistics and improving information system infrastructure. These investments should allow the company to lower costs of goods sold and operating expenses, expanding the company’s overall margins.

Because of cyclicality in certain end markets, the company has always managed their finances conservatively. The company carries no debt and therefore funds the majority of capital needs through cash from operations. This philosophy of conservative financial management allows FLXS to remain competitive throughout a full market cycle, especially when less financially stable competitors are weakened by a challenged economy.

FY2016 has been no exception to FLXS’s positive earnings growth of the past few years. It was the third consecutive year of record net sales and seventh consecutive year of growth. Residential and commercial segments experi-enced +7.1% and +7.3% growth, respectively. Residential growth was driven by increased sales volume in uphol-stered and ready-to-assemble products, while Commer-cial benefitted from a positive mix of volume and price increases. Management expects continued growth as part of their 2017 outlook.

FLXS has grown dividend payments to shareholders by approximately +14.9% annually over the last five years, continued by its +11.1% increase in September (its 298th consecutive quarter of paying a dividend). There is incen-tive for these payments to increase at an attractive rate in the future given 8.2% of the company’s outstanding shares are owned by insiders.

The stock rose +31.05% during the quarter, topping the Consumer Discretionary sector return of +3.69% and the Russell 2000 growth return of +9.22%. Shares trade at 16.7x 12-month trailing earnings. The company’s conser-vative financial management, competitive market position-ing and host of cyclical tailwinds make the company an attractive holding in the Small Cap Growth strategy.

Cirrus Logic (CRUS)Cirrus Logic is an Austin-based developer of high per-forming, low power integrated-circuits (ICs) for voice signal processing applications. CRUS’s end markets include smartphones, tablets, earphones, “wearables” and increasingly smart home applications as technology continues to drive the connectivity of devices. Worldwide, CRUS holds over 2,200 pending and issued patents, serving 3,100 end customers.

End products from CRUS can be divided into two seg-ments: Portable Audio and Non-Portable Audio (e.g. auto, home entertainment systems energy, industrial).

CRUS is a fab-less semiconductor manufacturer, meaning it outsources the fabrication of ICs, allowing the company to focus on design, customers and exhibit supply chain agility to changing markets needs and preferences. This “asset-light” model supports the company’s ability to generate significant free cash flow as a result of lighter capex needs.

Bahl & Gaynor met with CRUS’s CFO and Investor Rela-tions Director this past quarter and came away optimistic about the firm’s future growth prospects, particularly the strength of their relationship with Apple, the company’s largest customer. Apple tends to hold significant leverage over its suppliers, but there are reasons to believe CRUS is insulated from risks associated with this outsized influence. The two companies jointly own high-end, propri-etary codec technology that is used exclusively in iPhones, Macs, iPads and other Apple products – Apple is unlikely to move away from technology it owns and controls near-term. Another factor is that CRUS’s content cost to Apple represents a small percentage (~1%) of an iPhone’s overall bill of materials (BOM). Apple tends to pressure suppliers whose products represent a larger percentage of manufacturing costs, like processor chip suppliers.

Apple’s release of iPhone 7 on September 7th showcased innovations and enhancements tied to CRUS, specifically the elimination of the headphone jack and new stereo speakers, both an incremental positive for content expansion within the iPhone and consequently CRUS’s revenue growth.

Apart from Apple, opportunities exist as Samsung aims to improve their audio quality for mid and higher-end smartphone offerings, leveraging their 2014 acquisition



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of sound specialist, Wolfson. Samsung is CRUS’s second-largest client at 12% of firmwide revenues.

CRUS shares benefited from strong June quarterly results. Reported revenue came in above the company’s prior sales outlook, while gross margin registered at the high end of guidance. Following the revenue beat, CRUS raised their forecast for the following quarter, citing an improved outlook in their portable audio segment.

Shares jumped +37.02% in the quarter, exceeding the Technology sector’s +17.65% return and the overall +9.22% return for the Russell 2000 Growth.

CRUS maintains a strong balance sheet and has gen-erated consistent positive free cash flow. Although the company could pay a dividend to shareholders, the Board has not indicated a desire to do so currently. Rather, they and management have prioritized strategic acquisitions, debt pay-down and an opportunistic share repurchase program. Despite the lack of dividend, Bahl & Gaynor finds value in CRUS’s asset-light business model, balance sheet strength and attractive free cash flow conversion – all characteristics that support ownership in the Small Cap Growth strategy.

Shares currently trade at 23.2x trailing 12-month earn-ings, but with a consensus expectations of +51.3% FY2017 EPS growth, CRUS carries an attractive 0.5x PEG ratio.

The following factors benefited performance from an attribution perspective during the quarter:

1. Company Selection in Financials, somewhat offset by an overweight sector alocation. MarketAxess (MKXT) ad-vanced +14.07% on the heels of another announcement of record sales, earnings and market share growth. MKTX is not a Russell 2000 Growth index constituent, so strong share performmace was additionally accretive. Evercore Partners (EVR) +17.27%, as noted from the smig® strategy commentary, benefited from another quarter of healthy M&A volume, resulting in record advisory reve-nues for the quarter. Not owning DuPont Fabros (DFT) -13.23% or CoreSite Realty (COR) -15.94% also benefited strategy performance.

2. Company selection in Consumer Discretionary. The two top-contributing securities for the strategy during the quarter are both found in the Consumer Discretionary sector: Flexsteel Industries (FLXS) +31.05% and Thor Industries (THO) +30.83%. THO has benefited from record sales in its recreational vehicle (RV) market due to the continued consumer strength. It also reported accelerated backlog growth spurred by dealer optimism, lower interest rates, favorable credit conditions and a slate of new RV products. FLXS continued to post strong order trends. In the latest quarter, FLXS’s residential and commercial segments experienced +7.1% and +7.3% growth, respectively. FLXS announced a dividend increase during the quarter.

3. Underweight sector allocation in Utilities. The Small Cap Growth strategy has historically avoided traditional regulated utility companies due to lack of attractive growth prospects. Whereas the strategy’s underweight detracted from performance last quarter in the face of capital market volatility, volatility of interest rate expec-tations pressured this sector in the quarter just ended, benefiting the strategy by way of its lack of exposure.

3Q 2016 Small Cap Growth Sector Contribution

1. Financial Services2. Consumer Discretionary3. Utilities4. Consumer Staples5. Producer Durables6. Energy7. Materials & Processing8. Technology9. Health Care

Note: Figures relative to the Russell 2000 Growth index. Source: Bahl & Gaynor, 2016.


Top Contributors1. Thor Industries (THO)2. Flexsteel Industries (FLXS)3. Cirrus Logic (CRUS)4. Intersil (ISIL)5. LeMaitre Vascular (LMAT)

Top Detractors 1. Texas Roadhouse (TXRH) 2. Virtu Financial (VIRT) 3. PriceSmart (PSMT) 4. West Pharma. Svcs. (WST) 5. Monotype Imaging (TYPE)

3Q 2016 Small Cap Growth Top Contributors/Detractors



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The following dynamics represented a challenge to performance during the quarter:

1. Underweight sector allocation and company selection in Health Care. West Pharmaceuticals (WST) -1.67% pulled back late in the quarter following management commentary of tempered margin expansion expectations in 2017. Patterson (PDCO) -3.61% (as mentioned in smig® commentary) was a drag on performance after industry peer Henry Schein (HSIC) management commented on a softening dental market in June and July relative to earlier in the year. Neither WST nor PDCO are constitu-ents of the Russell 2000 Growth index, which exacerbated negative selection effect. Not owning Sarepta Therapeu-tics (SRPT) +222.02% and having no exposure in biotech, which were strong as a group during the quarter, also negatively impacted strategy performance. WST an-nounced a dividend increase during the quarter.

2. Company selection in Technology. Monotype Imaging Holding (TYPE) -9.78% fell after adjusting guidance due to Brexit disruptions and amid investor concern regard-ing the price paid for their acquisition of Olapic in July. Blackbaud (BLKB) -2.12% underperformed the sector after missing analyst earning estimates and reducing annual operating cash flow guidance. Reis (REIS) -17.15% fell after reported sales fell -13.4% YoY versus difficult comps from a strong 2015. Not owning names like Cavium (CAVM) +50.78%, Lumemtum (LITE) +72.60%, and Microsemi (MSCC) +28.46% compounded the relative underperformance for the strategy.

3. Company selection in Materials & Processing. Watsco (WSO) +0.76%, Apogee Enterprises (APOG) -3.32% and PolyOne (POL) -3.69% all underperformed the broader Russell 2000 Growth benchmark sector return of +9.22%. Additionally, WSO is not an index constituent, which represented an added drag on performance.

4. High-quality companies (companies with an S&P earn-ings and dividend quality ranking of B+ or better) under-performed low-quality companies (B or worse ranking). The high-quality portion of the Russell 2000 Growth returned +2.25% while the low-quality portion returned +11.01%, all figures cap-weighted. At quarter-end, approximately 60% of holdings in the Small Cap Growth strategy had an S&P ranking of B+ or better, versus approximately 20% for the Russell 2000 Growth index.

In addition to the attribution influences outlined above, an important deliverable for the quarter – dividend growth – is embodied in the companies announcing increases listed below:

3Q 2016 Small Cap Growth Dividend Increases

Company


Rate Current Yield

Atrion (ATRI) +16.7% 1.0%

Brinker International (EAT) +6.3% 2.7%

Flexsteel Industries (FLXS) +11.1% 1.5%

Healthcare Svcs. (HCSG)1 +0.7% 1.9%

Littlefuse (LFUS) +13.8% 1.0%

Bank of the Ozarks (OZRK)1 +3.2% 1.7%

Ritchie Bros. Auction. (RBA) +6.3% 1.9%

SYNNEX (SNX) +25.0% 0.9%

West Pharma. Svcs. (WST) +8.3% 0.7%Source: Bahl & Gaynor and Factset, 2016.1OZRK and HCSG increase their dividend quarterly.

It is also worth reiterating several important points about overall portfolio characteristics.

• High-quality, small-cap growth, bottom-up strategy;• 10.75-year track record;• 91% (61 companies) of the 67 companies owned in the

strategy pay a dividend;• Every company owned in the strategy possessed a

market capitalization of at least $100 million at the time of purchase;

• No company owned in the strategy had a market capitalization in excess of $5.0 billion;


• The strategy owns only common stock traded on US exchanges. We hold no master limited partnerships (MLPs) due to the complex tax ramifications of owning these securities, nor do we own preferred, convertible, ETF or option securities as we prefer to focus on compa-ny selection, not asset allocation within the strategy;


• The strategy witnessed turnover of 4.48% during 3Q16.


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We conclude with a review of the trades executed in the Small Cap Growth strategy over the quarter just ended:

3Q 2016 Small Cap Growth Trades Executed


HIECO (HEI) G&K Services (GK)

Littlefuse (LFUS) Intersil (ISIL)


Apogee (APOG) G&K Services (GK)

Cirrus Logic (CRUS) Intersil (ISIL)

Evercore Partners (EVR) MarketAxess (MKTX)

Mesa Laboratories (MLAB) Monro Muffler Brake (MNRO)

PolyOne (POL)

Raven Industries (RAVN)

RE/MAX Holdings (RMAX)

Simpson Mfg. (SSD)


Bottom Line: Investors shifted to a risk-on posture during the quarter which challenged capital appreciation of the Small Cap Growth strategy. This represents a reversal from the first two quarters of the year that demonstrated the importance of a high-quality approach in the face of market volatility and especially in the case of several richly-valued sectors and industries that underwent significant re-ratings amid market volatility. The Small Cap Growth strategy continues to provide access to a portfolio of high-quality companies designed to address these challenges, yielding favorable risk-adjusted returns over a full market cycle. Given the current cycle is likely closer to its end than beginning, Bahl & Gaynor believes the Small Cap Growth strategy represents an especially attractive approach in addressing investor challenges in this environment.


In upstate New York, a man bravely rushed into a neighbor’s burning home to save their trapped dog from a furious blaze…or so he thought.

Source: NewsChannel 13 and Sony Pictures, 2016.

Michael Orchard was arrested in Halfmoon, NY for third-degree criminal mischief and second-degree burglary after plowing his BMW through a neighbor’s fence, breaking into their home through the rear entrance and wresting away their dog from the premises. The blaze Mr. Orchard perceived turned out to be a hallucination brought on by a potent mixture of cough syrup and LSD ingested earlier in the day.

The 43-year-old was very cooperative upon arrest and was subsequently arraigned and remanded to Saratoga County Jail on $15,000 bail. The dog was uninjured during the incident.

You Can't Make This Stuff Up! Supremely entertaining obscure news.


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Halloween being just around the corner, Dacre Stoker, the great-grandnephew of “Dracula” author Bram Stoker, is opening the doors of Bram Castle, located in Transylvania, for a one-night stay on All Hallows’ Eve.

Mr. Stoker will be playing the role of Jonathan Harker, one of the protagonists from the novel, and will greet winners of the Airbnb contest as they arrive by horse-drawn carriage to the castle. Guests will enjoy a candlelight dinner before being shown to the crypt where they will be invited to retire in velvet-lined coffins.

Source: Associated Press, 2016.

Guests are asked to observe the following house rules during their stay at the castle:

• No garlic, or garlic-scented items allowed;

• Silver jewelry should be left at home;

• Refrain from placing anything in a cross formation;

• Be mindful of bats in the castle tower;

• Please close all curtains prior to sunrise;

• The Count is not a fan of mirror selfies.

In keeping with the Halloween season, London-based fashion house, Lyst, recently announced a new clothing line – Over My Dead Body – oriented toward individuals who desire to be buried in stylish outfits as part of their final wishes.

A survey conducted by the company earlier in the year revealed:

• 52% of women surveyed would opt for a high fashion couture outfit to be worn as their final resting outfit and with pain no longer an issue, 45% of ladies would choose to be buried in stilettos.

• 24% of respondents would spend +£1,000 on their final outfit, 45% between £350 and £499 and 30% <£100.

• Men tended to hew toward more casual adornments with 20% preferring to wear flip-flops and 36% wishing to wear a baseball cap.

Source: Lyst, 2016.

Katherine Ormerod, editorial director of Lyst, says: “Life is too short for boring clothes; we agreed and took that one step further. Death is too long to get your last outfit wrong!”

Thanks for reading!

You Can't Make This Stuff Up! Supremely entertaining obscure news.


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Important Disclosures Legal Stuff

This material is distributed by Bahl & Gaynor, Inc., and is for information purposes only. Bahl & Gaynor, Inc., does not represent that the information is accurate or complete and it should not be relied on as such. It is provided with the understanding that no fiduciary relationship exists because of this report. Bahl & Gaynor, Inc. assumes no liability for the interpretation or use of this report. Investment conclusions and strategies suggested in this report may not be suitable for all investors and consultation with a qualified investment advisor is recommended prior to executing any investment strategy. No part of this document may be reproduced in any manner without the written permission of Bahl & Gaynor, Inc. Copyright Bahl & Gaynor, Inc., 2016. All rights reserved.

Thanks Your continued support and interest is much appreciated.

Everyone at Bahl & Gaynor would like to thank you for the opportunity to serve your investment needs. Please feel free to contact any member of the Institutional Client Service Team through the information provided below if you have questions.

Sincerely,

The Institutional Team

William F. Bahl, CFA, CICOffice: 513.287.6115Email: [email protected]

Nicholas W. Puncer, CFA, CFPOffice: 513.618.4026Email: [email protected]

Scott D. Rodes, CFA, CICOffice: 513.287.6123Email: [email protected]

Christopher M. Rowane, CFAOffice: 513.287.6119Email: [email protected]

Jim Russell, CFAOffice: 513.842.2189Email: [email protected]

John B. Schmitz, CFA, CICOffice: 513.287.6102Email: [email protected]

Stephanie S. Thomas, CFAOffice: 513.618.4014Email: [email protected]

Edward A. Woods, CFA, CICOffice: 513.287.6128Email: [email protected]


continued >IGNT 4Q15 Version 1.0

BAHL & GAYNOR INVESTMENT COUNSEL, INC. SCHEDULE OF RATES OF RETURN AND STATISTICS INCOME GROWTH TAX EXEMPT COMPOSITE JANUARY 1, 2006 (INCEPTION) THROUGH DECEMBER 31, 2015

Year Ended December

31

Gross Composite Return (%)

Benchmark Return (%)

S&P 500

Number of

Accounts

Composite Dispersion

(%)

3 Year Annualized Ex-Post Standard Deviation Total

Composite Assets ($MM)

Composite Equity

Segment Carve Out

(%)

Non-fee

Paying Assets

(%)

Total Firm

Assets ($MM)

Total UMA

Assets ($MM)†

Composite (%)

S&P 500 (%)

2006 18.52 15.80 7 N/A N/A N/A 16.9 17.57 4.1 3,089.1 0.0 2007 5.63 5.49 13 0.55 N/A N/A 31.7 22.70 2.3 3,157.6 0.0 2008 -24.45 -37.00 14 0.94 13.0 15.1 24.5 13.40 2.6 2,386.6 0.0 2009 17.22 26.46 13 0.98 16.7 19.6 29.3 10.48 2.5 2,658.1 19.6 2010 16.62 15.06 27 0.34 18.2 21.9 76.4 N/A 1.1 3,042.1 94.4 2011 15.71 2.11 40 0.72 14.8 18.7 118.1 N/A 6.9 3,733.5 1,328.9 2012 9.73 16.00 74 0.28 11.1 15.1 333.0 N/A 2.7 4,809.2 2,760.6 2013 24.20 32.39 86 0.60 9.0 11.9 501.1 N/A 3.1 6,461.8 4,504.8 2014 13.63 13.69 90 0.28 7.9 9.0 558.2 N/A 2.4 7,544.9 5,586.5 2015 0.45 1.38 99 0.41 9.9 10.5 783.0 N/A 1.7 7,965.6 5,946.0

NOTES TO THE SCHEDULE OF RATES OF RETURN AND STATISTICS †UMA assets are presented as supplemental information PERIODS FROM JANUARY 1, 2006 (INCEPTION) THROUGH DECEMBER 31, 2015 ORGANIZATION AND PRESENTATION STANDARDS Bahl and Gaynor Investment Counsel, Inc. (the “Firm”) was established in 1990 as a registered investment advisor, and is an independent, privately held corporation. Registration does not imply a certain level of skill or training. Bahl and Gaynor manages a variety of equity, fixed income and balanced assets for primarily Institutional and High Net Worth clients. The composite of Income Growth Tax Exempt investment accounts under management was created in January 2006. Bahl & Gaynor Investment Counsel, Inc. claims compliance with the Global Investment Performance Standards (GIPS®) and has prepared and presented this report in compliance with the GIPS standards. Bahl & Gaynor Investment Counsel, Inc. has been independently verified for the periods June 30, 1990 to December 31, 2014. Verification assesses whether (1) the firm has complied with all the composite construction requirements of the GIPS standards on a firm-wide basis and (2) the firm’s policies and procedures are designed to calculate and present performance in compliance with the GIPS standards. The Income Growth Tax Exempt composite has been examined for the periods December 31, 2006 to December 31, 2014. The verification and performance examination reports are available upon request. SCHEDULES OF PERFORMANCE The currency used to express performance is U.S. dollars. The composite includes portfolios that were charged a bundled fee by their respective custodians. Bundled fees take the place of a transaction fee structure and represent a percentage fee charged against assets under management. These bundled fees include all charges for trading costs, portfolio management, custody, and other administrative fees. The composite was comprised of 24.0% bundled fee paying accounts as of Dec. 31, 2015, 17.6% as of Dec. 31, 2014, 19.3% as of Dec. 31, 2013, 16.1% as of Dec. 31, 2012, 6.9% as of Dec. 31, 2011, 2.1% as of Dec. 31, 2010, 1.0% as of Dec. 31, 2009, 1.0% as of Dec. 31, 2008, 1.0% as of Dec. 31, 2007. Prior to 2007, there were no bundled fee accounts. Composite dispersion measures represent the consistency of a firm’s annual composite performance with respect to the individual account annual returns within a composite. The dispersion of annual returns is measured by standard deviation across asset-weighted accounts. Dispersion includes only those accounts which have been included in the composite for the entire year. This eliminates any inaccuracies created by annualizing partial year returns. The three-year annualized standard deviation is not presented as of December 31, 2007 or prior because the composite does not yet have 36 monthly returns as of this date. Additional information regarding policies for valuing portfolios, calculating performance and preparing compliant presentations are available upon request. Past performance is not indicative of future results. Other methods may produce different results and the results for individual accounts and for different periods may vary depending on market conditions and the composition of the account. Care should be used when comparing these results to those published by other investment advisers, other investment vehicles and unmanaged indices due to possible differences in calculation methods. No alteration of the composite as presented here has occurred because of changes in personnel or other reasons at any time. COMPOSITE STYLE Income Growth Tax Exempt Composite seeks to generate a high level of current income that grows over time along with favorable downside capture characteristics and capital appreciation. Prior to 1/1/2010 Bahl and Gaynor "carved out" the equity segments of balanced accounts and cash held by these balanced accounts. The cash was allocated based upon the ratio of equity to fixed income securities as of the beginning of each quarter. The equity segment of carved out accounts that met identical criteria as the equity only accounts included in the composite, were also included in the composite. As of 1/1/2010 each segment is managed separately with its own cash. A complete list and description of Firm composites and performance results is available upon request. BENCHMARKS The S&P 500 Index is a capitalization-weighted index that measures the performance of 500 large capitalization domestic stocks representing all major industries. The S&P 500 Index is the most appropriate benchmark to best reflect broad market performance. Bahl & Gaynor’s Income Growth Tax Exempt composite may be compared to the S&P 500 Index. Index information was obtained by Informa Investment Solutions. Benchmark returns are not covered by the report of the independent verifiers. ADVISORY FEES The Schedule presents gross of fee performance before advisory fees, but after all trading costs and any bundled fees. Net of fee performance reflects the deduction of each composite account’s actual quarterly management fee as well as trading costs and any bundled fees. Advisory fees vary depending on account size. The standard advisory fee charged on an annual basis is 0.90% for the first $1,000,000, 0.80% on the next $1,000,000, 0.70% on the next $2,000,000, 0.60% on the next $1,000,000, and 0.50% on the balance over $5,000,000; though varying terms may be negotiated. Assuming a constant gross annual return of 10% and fees at our standard fee schedule, the cumulative, compound effect of fees on the performance of the initial investment of $1,000,000 would be $9,800, $31,854, $57,695, and $143,345 for the 1, 3, 5, and 10 year time periods, leaving an after fee market value of $1,090,200, $1,296,029, and $1,541,113, and $2,378,911 for the 1, 3, 5, and 10 year periods respectively. A complete schedule of advisory fees is contained in the Form ADV-II on file with the Securities and Exchange Commission, which is available upon request.


continued >

QG 4Q15 Version 1.0

NOTES TO THE SCHEDULE OF RATES OF RETURN AND STATISTICS †UMA assets are presented as supplemental information PERIODS FROM JULY 1, 1990 (INCEPTION) THROUGH DECEMBER 31, 2015 ORGANIZATION AND PRESENTATION STANDARDS Bahl and Gaynor Investment Counsel, Inc. (the “Firm”) was established in 1990 as a registered investment advisor, and is an independent, privately held corporation. Registration does not imply a certain level of skill or training. Bahl and Gaynor manages a variety of equity, fixed income and balanced assets for primarily Institutional and High Net Worth clients. The composite of Large Cap Quality Growth investment accounts under management was created in July 1990. Bahl & Gaynor Investment Counsel, Inc. claims compliance with the Global Investment Performance Standards (GIPS®) and has prepared and presented this report in compliance with the GIPS standards. Bahl & Gaynor Investment Counsel, Inc. has been independently verified for the periods June 30, 1990 to December 31, 2014. Verification assesses whether (1) the firm has complied with all the composite construction requirements of the GIPS standards on a firm-wide basis and (2) the firm’s policies and procedures are designed to calculate and present performance in compliance with the GIPS standards. The Large Cap Quality Growth composite has been examined for the periods June 30, 1990 to December 31, 2014. The verification and performance examination reports are available upon request. SCHEDULES OF PERFORMANCE The currency used to express performance is U.S. dollars. The composite includes portfolios that were charged a bundled fee by their respective custodians. Bundled fees take the place of a transaction fee structure and represent a percentage fee charged against assets under management. These bundled fees include all charges for trading costs, portfolio management, custody, and other administrative fees. The composite was comprised of 20.2% bundled fee paying accounts as of Dec. 31, 2015, 24.1% as of Dec. 31, 2014, 18.0% as of Dec. 31, 2013, 3.7% as of Dec. 31, 2012, and 3.7% as of Dec. 31, 2011. Prior to 2011, there were no bundled fee accounts. Composite dispersion measures represent the consistency of a firm’s annual composite performance with respect to the individual account annual returns within a composite. The dispersion of annual returns is measured by standard deviation across asset-weighted accounts. Dispersion includes only those accounts which have been included in the composite for the entire year. This eliminates any inaccuracies created by annualizing partial year returns. The three-year annualized standard deviation is not presented as of December 31, 2010 or prior because quarterly, not monthly returns were calculated. Additional information regarding policies for valuing portfolios, calculating performance and preparing compliant presentations are available upon request. Past performance is not indicative of future results. Other methods may produce different results and the results for individual accounts and for different periods may vary depending on market conditions and the composition of the account. Care should be used when comparing these results to those published by other investment advisers, other investment vehicles and unmanaged indices due to possible differences in calculation methods. No alteration of the composite as presented here has occurred because of changes in personnel or other reasons at any time. COMPOSITE STYLE Large Cap Quality Growth Composite seeks to provide favorable downside capture characteristics and capital appreciation while emphasizing a growing income stream. The minimum account size for the composite is $750,000, an account dropping below 75% of the composite’s minimum threshold shall be removed from the composite at the beginning of the quarter it declined in market value. Prior to 1/1/2010 Bahl and Gaynor "carved out" the equity segments of balanced accounts and cash held by these balanced accounts. The cash was allocated based upon the ratio of equity to fixed income securities as of the beginning of each quarter. The equity segment of carved out accounts that met identical criteria as the equity only accounts included in the composite, were also included in the composite. As of 1/1/2010 each segment is managed separately with its own cash. A complete list and description of Firm composites and performance results is available upon request. BENCHMARKS The Russell 1000 Growth Index measures the performance of U.S. large cap growth stocks with the highest price to book ratios and forecasted growth within the Russell 1000 Index. The S&P 500 Index is a capitalization-weighted index that measures the performance of 500 large capitalization domestic stocks representing all major industries. The Russell 1000 Growth Index is one of the most appropriate benchmarks to best reflect large cap growth performance. The S&P 500 Index is the most appropriate benchmark to best reflect broad market performance. Bahl & Gaynor’s Quality Growth composite may be compared to both benchmarks. Index information was obtained by Informa Investment Solutions. Benchmark returns are not covered by the report of the independent verifiers. ADVISORY FEES The Schedule presents gross of fee performance before advisory fees, but after all trading costs and any bundled fees. Net of fee performance reflects the deduction of each composite account’s actual quarterly management fee as well as trading costs and any bundled fees. Advisory fees vary depending on account size. The standard advisory fee charged on an annual basis is 0.90% for the first $1,000,000, 0.80% on the next $1,000,000, 0.70% on the next $2,000,000, 0.60% on the next $1,000,000, and 0.50% on the balance over $5,000,000; though varying terms may be negotiated. Assuming a constant gross annual return of 10% and fees at our standard fee schedule, the cumulative, compound effect of fees on the performance of the initial investment of $1,000,000 would be $9,800, $31,854, $57,695, and $143,345 for the 1, 3, 5, and 10 year time periods, leaving an after fee market value of $1,090,200, $1,296,029, and $1,541,113, and $2,378,911 for the 1, 3, 5, and 10 year periods respectively. A complete schedule of advisory fees is contained in the Form ADV-II on file with the Securities and Exchange Commission, which is available upon request.

BAHL & GAYNOR INVESTMENT COUNSEL, INC. SCHEDULE OF RATES OF RETURN AND STATISTICS LARGE CAP QUALITY GROWTH COMPOSITE JANUARY 1, 2001 THROUGH DECEMBER 31, 2015

Year Ended December

31



Russell 1000 Growth


S&P 500

Number of

Accounts


(%)

3 Year Annualized Ex-Post Standard Deviation

Total Composite

Assets ($MM)

Composite Equity

Segment Carve Out

(%)

Non-fee Paying Assets

(%)

Total Firm

Assets ($MM)

Total UMA

Assets ($MM)†

Composite (%)

Russell 1000

Growth (%)

S&P 500 (%)

2001 (7.44) (20.42) (11.93) 48 1.73 N/A N/A N/A 326.0 15.27 N/A 2,191.8 0.0

2002 (12.57) (27.89) (22.06) 51 1.76 N/A N/A N/A 298.1 14.51 N/A 2,002.9 0.0

2003 19.91 29.76 28.68 55 2.45 N/A N/A N/A 366.0 16.67 N/A 2,431.7 0.0

2004 11.78 6.30 10.88 56 2.23 N/A N/A N/A 382.5 16.33 N/A 2,595.7 0.0

2005 3.60 5.26 4.91 65 0.73 N/A N/A N/A 392.2 15.80 0.3 2,770.8 0.0

2006 10.57 9.08 15.80 67 0.55 N/A N/A N/A 480.1 19.31 0.3 3,089.1 0.0

2007 8.16 11.81 5.49 50 0.59 N/A N/A N/A 301.2 16.64 0.7 3,157.6 0.0

2008 (24.39) (38.44) (37.00) 51 0.61 N/A N/A N/A 224.6 20.24 0.7 2,386.6 0.0

2009 19.30 37.20 26.46 52 0.94 N/A N/A N/A 262.5 17.32 0.8 2,658.1 19.6

2010 13.10 16.72 15.06 56 0.64 N/A N/A N/A 272.5 N/A 0.5 3,042.1 94.4

2011 4.97 2.63 2.11 61 0.59 16.2 17.8 18.7 275.8 N/A 2.5 3,733.5 1,328.9

2012 10.15 15.25 16.00 67 0.48 13.4 15.7 15.1 305.8 N/A 2.4 4,809.2 2,760.6

2013 28.69 33.49 32.39 67 0.88 10.3 12.2 11.9 334.3 N/A 2.8 6,461.8 4,504.8

2014 11.70 13.05 13.69 59 0.72 8.5 9.6 9.0 271.6 N/A 3.7 7,544.9 5,586.5

2015 0.00 5.67 1.38 63 0.66 10.6 10.7 10.5 303.3 N/A 2.9 7,965.6 5,946.0


4Q15 SMIG Version 2.0

BAHL & GAYNOR INVESTMENT COUNSEL, INC. SCHEDULE OF RATES OF RETURN AND STATISTICS SMALL/MID CAP INCOME GROWTH COMPOSITE APRIL 1, 2013 (INCEPTION) THROUGH DECEMBER 31, 2015

Year Ended December 31



Russell 2500

Number of

Accounts


(%)

3 Year Ex-Post Standard Deviation

Total Composite

Assets ($MM)

Non-fee Paying

Assets (%)

Total Firm Assets ($MM)

Total AUA ($MM)‡

Composite (%)

Russell 2500 (%)

2013† 19.36 21.23 ≤5 N/A N/A N/A 0.5 100.0 6,461.8 4,616.6 2014 12.78 7.08 12 N/A N/A N/A 21.0 2.8 7,544.9 5,701.5 2015 -1.33 -2.90 15 0.36 N/A N/A 33.5 1.7 7,965.6 6,051.1

NOTES TO THE SCHEDULE OF RATES OF RETURN AND STATISTICS ‡Assets Under Advisement (AUA) are presented as supplemental information PERIODS FROM APRIL 1, 2013 (INCEPTION) THROUGH DECEMBER 31, 2015 ORGANIZATION AND PRESENTATION STANDARDS The firm is defined as Bahl & Gaynor Investment Counsel, Inc. (Bahl & Gaynor), an independent, privately held corporation registered as an investment adviser under the Investment Advisers Act of 1940. Based on the way the firm holds itself out in the marketplace and in order to adhere to both the requirements and the spirit of the GIPS standards, we have adopted the broadest possible definition of the firm. The firm includes all accounts managed by the firm. Bahl & Gaynor manages both institutional and high net worth accounts. Registration does not imply a certain level of skill or training. The Small/Mid Cap Income Growth composite was created in March 2013. Bahl & Gaynor claims compliance with the Global Investment Performance Standards (GIPS®) and has prepared and presented this report in compliance with the GIPS standards. Bahl and Gaynor has been independently verified for the periods June 30, 1990 to December 31, 2015. Verification assesses whether (1) the firm has complied with all the composite construction requirements of the GIPS standards on a firm-wide basis and (2) the firm’s policies and procedures are designed to calculate and present performance in compliance with the GIPS standards. The Small/Mid Cap Income Growth composite has been examined for the periods April 1, 2013 to December 31, 2015. The verification and performance examination reports are available upon request. SCHEDULES OF PERFORMANCE The currency used to express performance is U.S. dollars. The composite includes portfolios that were charged a bundled fee by their respective custodians. Bundled fees take the place of a transaction fee structure and represent a percentage fee charged against assets under management. These bundled fees include all charges for trading costs, portfolio management, custody, and other administrative fees. The composite was comprised of 0.0% bundled fee paying accounts as of Dec. 31, 2015, 1.4% as of Dec. 31, 2014. Prior to 2014, there were no bundled fee accounts. Composite dispersion measures represent the consistency of a firm’s annual composite performance with respect to the individual account annual returns within a composite. The dispersion of annual returns is measured by standard deviation across asset-weighted accounts. Dispersion includes only those accounts which have been included in the composite for the entire year. This eliminates any inaccuracies created by annualizing partial year returns. Dispersion prior to December 31, 2015 is not presented because there were fewer than five portfolios in the composite for the entire year. The three-year annualized standard deviation is not presented as of December 31, 2015 or prior because the composite does not yet have 36 monthly returns as of this date. Additional information regarding policies for valuing portfolios, calculating performance and preparing compliant presentations are available upon request. Past performance is not indicative of future results. Other methods may produce different results and the results for individual accounts and for different periods may vary depending on market conditions and the composition of the account. Care should be used when comparing these results to those published by other investment advisers, other investment vehicles, and unmanaged indices due to possible differences in calculation methods. No alteration of the composite as presented here has occurred because of changes in personnel or other reasons at any time. COMPOSITE STYLE The Small/Mid Cap Income Growth Composite follows a philosophy of investing in quality, dividend-paying stocks, but focuses on companies at purchase with market capitalization between $200 million - $12 billion, which is a mix of Small Cap and Mid Cap, and places more emphasis on current dividend yield and annual growth of income. As of January 1, 2016 the minimum account size is $100,000, an account dropping below 75% of the composite’s minimum threshold shall be removed from the composite at the beginning of the quarter it declined in market value. There was no account minimum prior to 2016. A complete list and description of Firm composites and performance results is available upon request. BENCHMARKS The Russell 2500 Index measures the performance of the small to mid-cap segment of the U.S. equity universe. It includes approximately 2500 of the smallest securities based on a combination of market cap and current index membership. The Russell 2500 Index is constructed to provide a comprehensive and unbiased barometer for the small to mid-cap segment. The Index is completely reconstituted annually to ensure larger stocks do not distort the performance and characteristics of the true small to mid-cap opportunity set. Benchmark returns are not covered by the report of the independent verifiers. ADVISORY FEES The Schedule presents gross of fee performance before advisory fees, but after all trading costs and any bundled fees. Net of fee performance reflects the deduction of each composite account’s actual quarterly management fee as well as trading costs and any bundled fees. Advisory fees vary depending on account size. The standard advisory fee charged on an annual basis is 0.90% for the first $5,000,000, 0.70% on the next $5,000,000, and 0.65% on the balance over $10,000,000; though varying terms may be negotiated. Assuming a constant gross annual return of 10% and fees at our standard fee schedule, the cumulative, compound effect of fees on the performance of the initial investment of $1,000,000 would be $9,900, $32,456, $59,260, and $150,482 for the 1, 3, 5, and 10 year time periods, leaving an after fee market value of $1,090,100, $1,295,385, and $1,539,330, and $2,369,536 for the 1, 3, 5, and 10 year periods respectively. A complete schedule of advisory fees is contained in the Form ADV-II on file with the Securities and Exchange Commission, which is available upon request. †Represents partial year. Information presented is from the composite inception date 4/1/2013.


SC 4Q15 Version 1.0

BAHL & GAYNOR INVESTMENT COUNSEL, INC. SCHEDULE OF RATES OF RETURN AND STATISTICS SMALL CAP QUALITY GROWTH COMPOSITE JANUARY 1, 2006 (INCEPTION) THROUGH DECEMBER 31, 2015

Year Ended December 31



Russell 2000 Growth

Number of

Accounts


(%)

3 Year Annualized Ex-Post Standard Deviation

Total Composite

Assets ($MM)

Non-fee Paying Assets

(%)

Total Firm Assets ($MM)

Total UMA Assets ($MM)†

Composite (%)

Russell 2000 Growth (%)

2006 11.60 13.35 ≤5 N/A N/A N/A 0.4 100.0 3,089.1 0.0 2007 4.81 7.05 ≤5 N/A N/A N/A 0.5 100.0 3,157.6 0.0 2008 -26.64 -38.54 ≤5 N/A 16.9 21.6 0.3 100.0 2,386.6 0.0 2009 29.39 34.47 ≤5 N/A 20.6 24.8 0.4 100.0 2,658.1 19.6 2010 29.19 29.09 ≤5 N/A 23.0 27.7 4.4 12.9 3,042.1 94.4 2011 3.79 -2.92 11 0.02 20.6 24.3 9.2 7.9 3,733.5 1,328.9 2012 11.44 14.59 18 0.08 16.6 20.7 18.8 4.4 4,809.2 2,760.6 2013 44.62 43.29 18 0.45 13.9 17.3 27.7 9.3 6,461.8 4,504.8 2014 4.74 5.61 21 0.15 11.9 13.8 33.6 6.6 7,544.9 5,586.5 2015 -1.33 -1.38 23 0.28 13.4 15.0 45.4 4.8 7,965.6 5,946.0

NOTES TO THE SCHEDULE OF RATES OF RETURN AND STATISTICS †UMA assets are presented as supplemental information PERIODS FROM JANUARY 1, 2006 (INCEPTION) THROUGH DECEMBER 31, 2015 ORGANIZATION AND PRESENTATION STANDARDS Bahl and Gaynor Investment Counsel, Inc. (the “Firm”) was established in 1990 as a registered investment advisor, and is an independent, privately held corporation. Registration does not imply a certain level of skill or training. Bahl and Gaynor manages a variety of equity, fixed income and balanced assets for primarily Institutional and High Net Worth clients. The composite of Small Cap Quality Growth investment accounts under management was created in January 2006. Bahl and Gaynor claims compliance with the Global Investment Performance Standards (GIPS®) and has prepared and presented this report in compliance with the GIPS standards. Bahl and Gaynor has been independently verified for the periods June 30, 1990 to December 31, 2014. Verification assesses whether (1) the firm has complied with all the composite construction requirements of the GIPS standards on a firm-wide basis and (2) the firm’s policies and procedures are designed to calculate and present performance in compliance with the GIPS standards. The Small Cap Quality Growth composite has been examined for the periods December 31, 2005 to December 31, 2014. The verification and performance examination reports are available upon request. SCHEDULES OF PERFORMANCE The currency used to express performance is U.S. dollars. Composite dispersion measures represent the consistency of a firm’s annual composite performance with respect to the individual account annual returns within a composite. The dispersion of annual returns is measured by standard deviation across asset-weighted accounts. Dispersion includes only those accounts which have been included in the composite for the entire year. This eliminates any inaccuracies created by annualizing partial year returns. The three-year annualized standard deviation is not presented as of December 31, 2007 or prior because the composite does not yet have 36 monthly returns as of this date. Additional information regarding policies for valuing portfolios, calculating performance and preparing compliant presentations are available upon request. Past performance is not indicative of future results. Other methods may produce different results and the results for individual accounts and for different periods may vary depending on market conditions and the composition of the account. Care should be used when comparing these results to those published by other investment advisers, other investment vehicles and unmanaged indices due to possible differences in calculation methods. No alteration of the composite as presented here has occurred because of changes in personnel or other reasons at any time. COMPOSITE STYLE Small Cap Quality Growth Composite follows the philosophy of investing in quality, dividend-paying stocks, but invests in companies with market capitalizations less than $5 billion. Typically, this results in a portfolio with less risk than the benchmark for this space. A complete list and description of Firm composites and performance results is available upon request. BENCHMARKS The Russell 2000 Growth Index measures the performance of the small-cap growth segment of the U.S. equity universe. It includes those Russell 2000 companies with higher price-to-value ratios and higher forecasted growth values. The Russell 2000 Growth Index is constructed to provide a comprehensive and unbiased barometer for the small-cap growth segment. The Index is completely reconstituted annually to ensure larger stocks do not distort the performance and characteristics of the true small-cap opportunity set and that the represented companies continue to reflect growth characteristics. Index information was obtained by Informa Investment Solutions and Russell Investments. Benchmark returns are not covered by the report of the independent verifiers. ADVISORY FEES The Schedule presents gross of fee performance before advisory fees, but after all trading costs and any bundled fees. Net of fee performance reflects the deduction of each composite account’s actual quarterly management fee as well as trading costs and any bundled fees. Advisory fees vary depending on account size. The standard advisory fee charged on an annual basis is 0.90% for the first $5,000,000, 0.70% on the next $5,000,000, and 0.65% on the balance over $10,000,000; though varying terms may be negotiated. Assuming a constant gross annual return of 10% and fees at our standard fee schedule, the cumulative, compound effect of fees on the performance of the initial investment of $1,000,000 would be $9,900, $32,456, $59,260, and $150,482 for the 1, 3, 5, and 10 year time periods, leaving an after fee market value of $1,090,100, $1,295,385, and $1,539,330, and $2,369,536 for the 1, 3, 5, and 10 year periods respectively. A complete schedule of advisory fees is contained in the Form ADV-II on file with the Securities and Exchange Commission, which is available upon request.

continued >

3q 2016 review and outlook - constant...

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