Solid Foundations
Conservative investors usually have an eye for income and low volatility, making equity-income funds an ideal core investment. Here are three of our favorites.
With a mandate to focus on companies that boast solid financials and sustainable dividends, American Century Equity Income (TWEIX) offers one of the highest yields in its category at 2.77 percent. But that mandate is a double-edged sword.
Quality companies are rarely on the leading edge of rallies; the fund missed the run-ups that followed both this decade’s recessions. Accordingly, the fund fell to the bottom of its category last year, underperforming the S&P 500 by almost 12 percent. That being said, its focus on quality led it to the top of Morningstar’s Large Value category. The fund’s three-year performance is in the top 6 percent of its peers, while its five-year track record puts it in the top 12 percent.
Why invest in the fund? The management team of Phillip Davidson, Kevin Toney and Michael Liss executes a value-oriented strategy that generates consistent results over the long term. In this case, boring is good.
Fidelity Equity-Income (FEQIX) is the one of the fund giant’s largest offerings. Managed by Steve Petersen since 1993, the fund suffered a hard hit in 2008 after bets on the financial sector’s recovery proved ill-timed. Nevertheless, Petersen continued to add to his financial holdings, and several turned out to be big winners last year.
A disciplined value investor, Petersen looks for stocks that trade at valuations below their historical average or their sector’s current average. And to keep the fund’s yield near or above that of the S&P 500, Petersen invests almost exclusively in dividend-paying stocks.
The fund’s portfolio mostly consists of large-cap names, as these companies are more likely to pay dividends and have a large enough float for the fund to easily move in and out of its positions. Petersen keeps the portfolio well diversified, though financial services names currently account for over a quarter of its investable assets. That’s hardly surprising given the fund’s value investing strategy. Most of the financial names have been in the portfolio for over 18 months.
Historically, Petersen has been one of the top performing managers in the Large Value category, typically ranking in the top 10 percent. But after an absolutely brutal performance in 2008, the fund ranks in the bottom third of its category on a three- and five-year basis. That being said, 2008 was an anomaly; the fund may be down, but we see no reason to believe that it’s out.
Vanguard Equity-Income (VEIPX) didn’t get caught in the value trap posed by financial stocks in 2008 and early 2009, enabling it to weather the bear market with relative ease. Nevertheless, the fund missed out on the huge rally in financial stocks last year, and its lackluster performance in 2009 placed it in the 85th percentile of its category. On a three- and five-year basis, however, the fund still ranks in the top quarter of its peer group.
The fund divides its assets between two management companies, each of which uses a distinct approach to managing its slice of the assets. In this case, the split is between Wellington Management and Vanguard’s own Quantitative Equity Group (QEG).
Michael Reckmeyer of Wellington Management, perhaps one of the best known asset managers in the industry, uses a classic value approach to manage his slice of the fund’s assets. Reckmeyer focuses primarily on large-cap names with high projected earnings and dividend growth rates that have fallen out of favor with the markets and trade at significant discounts. He’s also known for sticking with holdings as long as they maintain a strong position in their industry and display positive upward momentum.
QEG’s James Stetler has been responsible for the other 60 percent of the fund’s assets since 2003 and prefers stocks that offer high dividend yields and superior growth potential relative to their peers.
Conservative investors appreciate the fund’s low volatility, and it looks set to outperform this year–its exposure to the financial sector is limited, while the manager has ratcheted up its stakes in energy, health care and industrial names.
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