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9 Morningstar FundInvestor July 2016
rate than Vanguard Large-Cap ETF VV. Dividend
growth funds also boasted the highest ROIC
and greatest exposure to wide-moat stocks of the
three groups. These strong and durable profits
can potentially fuel future dividend growth.
Performance
Despite differences in their portfolios, we didn’t find
a huge difference in performance among the three
groups from January 2006 through December 2015.
During that time, the dividend income strategy group
outpaced the dividend growth group by a small
margin (49 basis points annualized), with comparable
volatility. This result is interesting because large-
value stocks underperformed over this period and
income-oriented funds tended to have greater expo-
sure to these stocks.
However, these long-term averages mask short-term
variability in relative performance. The return gap
between the income and dividend growth funds was
larger over shorter horizons. For example, the divi-
dend income group outpaced the dividend growth
group by 1.9 percentage points annualized from
January 2006 through December 2011. But dividend
growth funds outperformed income funds by 1.8
percentage points from that point through December
2015. Dividend growth funds also tended to hold up a
little better during the bear market from October 2007
through February 2009, beating their income counter-
parts by 1.4 percentage points annualized. Overall,
one approach isn’t uniformly better than the other.
Very few funds in any of the groups beat corresponding
market-cap-weighted dividend benchmarks. We
used Nasdaq U.S. Dividend Achievers Select Index to
benchmark dividend growth funds. Vanguard Divi-
dend Appreciation ETF VIG tracks that index. FTSE
High Dividend Yield Index, which is available through
Vanguard High Dividend Yield ETF VYM , served
as the benchmark for the income group. We used
a blend of the two indexes for the income and
growth group.
Fees largely explain the low success rates among
the surviving funds. Gross of fees, these success rates
were considerably higher. It is difficult to select
managers who can overcome their fees and improve
performance through fundamental analysis. However,
we set the bar high by using indexes rather than index
funds, as index funds would be after an expense ratio,
too. All the funds that did outperform had lower-than-
average fees and tended to hold up better than most
of their peers during market downturns. This suggests
that strong risk management and reasonable fees are
critical for success for dividend investors of all stripes.
Fund Selection
To illustrate the importance of low fees, we divided
each of the three U.S. dividend strategy groups into
three fee subgroups from cheapest to most expensive.
We then tracked the performance of each fee group,
reconstituting the groups at the end of each year.
Among dividend growth funds, the cheapest cohort
outpaced the most expensive by 2.1 percentage
points per year. Cheaper dividend income and growth-
income groups also prevailed over their more expen-
sive counterparts. Here, the corresponding return
spreads between the cheapest and most expensive
cohorts were 114 and 60 basis points, respectively.
Investors can gauge risk by comparing a fund’s perform-
ance against an appropriate benchmark during
market downturns and by monitoring the valuations,
profitability, and dividend payout ratios of its hold-
ings. Vanguard Dividend Growth VDIGX and American
Century Equity Income TWEIX were among the
best performers in down markets over the past decade
in the dividend growth and dividend income groups,
respectively. For those who don’t wish to select and
monitor active managers, Vanguard Dividend Appre-
ciation ETF and Vanguard High Dividend Yield ETF are
good baseline U.S. dividend growth and income
strategies, respectively. These index funds both charge
a low 0.09% expense ratio. K
Contact Alex Bryan at
Exhibit 1 U.S. Dividend Funds: Portfolio Snapshot
Beta
Name
Dividend
Yield % P/B
Forward
P/E
Dividend
Payout%
ROIC %
(TTM)
(Long)
Historical
Dividend
Growth%
Wide
Moat
01/01/2011
to
12/31/2015
Dividend Growth 2.53 2.50 16.76 0.42 13.3 15.87 45.68 0.96
Dividend Growth and Income 3.17 2.17 15.86 0.50 12.44 5.66 43.96 0.93
Dividend Income 3.98 1.99 16.03 0.64 10.37 -1.96 36.06 0.85
Vanguard Large-Cap ETF 2.22 2.35 17.38 0.39 12.48 12.18 48.49 1.00
Source: Morningstar, Inc. Data as of 12/31/15.