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Raising the Bar on Equity-Income Strategies Morningstar Research | Russel Kinnel

Objectives, Champs, and Disappointments Looking at the large-value funds with “income” in their names, I found 40 funds that had a sufficient track record for a close look. I began with the Sortino ratio as a way to measure risk-adjusted performance over the time period and annualized total returns. As it turns out, the funds shook out pretty similarly on both measures. Based on that, I found a few stars that really outdid Vanguard High Dividend Yield Index beginning with Madison Dividend Income BHBFX , a tiny fund that we don’t cover but certainly appears promising. Close by was Silver-rated Neuberger Berman Equity Income NBHIX , which clocked in at a Sortino ratio of 0 . 74 and annualized total returns of 7 . 74% . Vanguard High Dividend Yield Index, in contrast, had a Sortino of 0 . 45 and annualized returns of 6 . 26% . The fund was one of the top performers in 2008 , thanks to sizable investments in convertible bonds. Those securities can boost yield and sometimes pare risk at the same time. The fund also boosts yield with REIT s and utilities. However, the mix that served it well in 2008 held it back in 2013 . A quintet of strong Morningstar Medalists follows in the form of JPMorgan Equity Income HLIEX , American Century Equity Income TWEIX , Vanguard Equity Income VEIPX , Columbia Divi- dend Income GSFTX , and Oppenheimer Equity Income OAEIX . Each one put up solid risk- adjusted performance. Which funds didn’t make the cut? Invesco Growth and Income ACGIX and T. Rowe Price Equity Income PRFDX , both rated Bronze, were slightly behind with Sortino ratios of 0 . 41 and 0 . 38 , respec- tively. Their returns were also modestly behind. However, a number of Neutral-rated funds were well behind the pack. Columbia Diversified Equity Income INDZX , Fidelity Advisor Equity Income EQPIX , Putnam Fund for Growth and Income PGRWX , Fidelity Equity Dividend Income FEQTX , and Fidelity Equity-Income FEQIX were in the bottom 10 on both returns and Sortino ratio.

Are equity-income fund managers lucky or smart? Equity-income funds have had some solid perform- ance lately, but I wanted to know whether that’s a matter of fishing in the right pond or actually adding value. Some relatively new equity-income indexes and index funds make that task easier. Vanguard High Dividend Yield Index VHDYX was launched in late 2006 , so I used it as a benchmark then ran data on performance to see which funds were up to the challenge and which were not. Specifi- cally, I looked at returns from January 2007 through May 2014 . It’s not a bad time period to examine per- formance as it covers the bear market and the sub- sequent rally. I looked at returns, risk-adjusted returns, and downside capture, which is another way to look at risk. You can see the whole run on the facing page. I chose two overlapping groups to subject to the test. The first was based on goals. I figured any large- value fund with “income” in its name must be up for the challenge. In the second, I limited it to funds that behaved like the Vanguard fund. Specifically, I looked for funds with R-squared figures versus the Vanguard index fund above 90 , but not with meaning- fully higher R-squareds versus the Russell 1000 Value, the standard index for large-value funds. For those that are much better fits with Russell 1000 Value, I figure the broad category and Russell 1000 Value are sufficient benchmarks. My focus here was on performance and risk, but as you know that’s not the whole story. Management, fees, and parent are also vital pieces of the puzzle. For example, if a fund had stellar results in my study but the manager just left, I’d naturally think less of its potential. The results are intriguing. Some long- time favorites did well, but there were some surprises, too.