Dividend-paying stocks remain a very attractive option for core holdings, despite the likelihood of increasing interest rates. Dividend-paying companies tend to be financially stronger than their competitors and are typically under pro-shareholder management. Over the long term, a significant portion of returns is generated by dividends, especially in a flatter year, such as 2015. Unless stocks end the year with a strong rally, dividends could easily deliver 50 percent or more of the year’s returns.
Established in 2005, the Invesco Diversified Dividend Investor Fund (LCEIX) primarily seeks long-term capital growth with a secondary focus on current income. To accomplish these goals, the fund invests in dividend-paying stocks that the portfolio manager, Meggan Walsh, and analysts believe are undervalued based on numerous metrics. In addition to domestic issues, the five-star Morningstar-rated large value fund may invest up to 25 percent of assets in foreign securities. More than $1 million of the fund manager’s personal assets and a portion of the management team’s deferred compensation are invested in LCEIX, resulting in a strong alignment between the personal goals of the management and that of its investors.
Investment Strategy
The team focuses on firms with stable management, healthy balance sheets and free cash flow growth as well as strong earnings over the next 2-to-3-year period. When selecting dividend-paying stocks, managers and analysts focus on companies that pay steady or increasing dividends. The stocks should also be at least 35 percent undervalued based on several discounting models and valuation measures. Investment ideas are run through several downside market scenarios to measure overall risk versus reward, seeking stocks with at least a 3-to-1 upside potential. Holdings are considered for removal from the portfolio when fundamentals deteriorate or the stock price drops 15 percent below the cost basis for an extended period. This measure enables the fund to generate total returns by balancing capital appreciation and income with capital preservation. The portfolio typically holds 70 to 85 stocks that cover all sectors.
The fund uses a “winning by not losing” philosophy to keep its earnings and performance up in down markets. While the fund has underperformed in strong bull markets, the tenet has enabled the fund to beat the underlying index 83 percent of the time in bear markets. LCEIX focuses on high-quality stocks with a concentration in defensive sectors. It also holds a large cash position to protect against a broad decline in the market. While limiting its upside potential, the philosophy has enabled the fund to succeed over the long term. LCEIX has 3-year upside and downside capture ratios of 86.26 and 74.65, compared with the equivalent large-value category averages of 91.76 and 109.47, respectively.
Portfolio Composition and Holdings
As of October 30, 2015, the fund has $11.79 billion under management. The fund has a 78 percent exposure to U.S. stocks and a 12 percent investment in foreign shares held entirely in the United Kingdom and developed Europe. In addition to a 31 percent exposure to giant-cap shares, the fund holds 39 percent of assets in large-caps, along with 27 percent and 3 percent in mid- and small-cap shares, respectively. The portfolio has an average market cap weighting of $28.5 billion compared with the category average of $75.6 billion, plus a price-to-earnings ratio of 18.17 and a 1.99 price-to-book ratio.
The sector weightings reflect the fund’s defensive risk/reward attitude. The portfolio is overweight consumer staples and utilities and underweight energy, healthcare, technology and financial services. The fund holds 86 individual issues, which makes it more concentrated than the average of its category peers. The top 10 holdings make up slightly more than 23 percent of total assets. In descending order, they are General Mills (GIS), Campbell Soup Company (CPB), Coca-Cola (KO), Heineken (HEINY) and AT&T (T), Eli Lilly (LLY), Kraft Heinz (KHC), Walgreens Boots Alliance (WAG), PPL Corp. (PPL) and Target (TGT). The fund has a very low 6 percent annual turnover rate, well under the Morningstar large-value category.
Historical Performance and Risk
LCEIX has above-average returns and low risk ratings from Morningstar. As of the end of October, LCEIX has delivered total 1-, 3- and 5-year returns of 5.99 percent, 14.86 percent and 12.49 percent, respectively. These compare with the category returns over the same periods of 0.80 percent, 13.10 percent and 11.18 percent. While lagging the S&P 500 slightly over the past 3- and 5-year periods, LCEIX beat the major market index over the most recent 1-year period and is on par with the index year-to-date. Strong stock picking has helped drive these results. The fund’s consumer defensive stocks have been the primary contributors to the recent performance because the sector has outperformed year-to-date.
LCEIX has a 3-year beta and standard deviation ratings of 0.77 and 8.76, respectively. These compare with the large value category averages of 0.98 and 10.84.
Fees, Expenses and Distributions
LCEIX has a 0.76 percent expense ratio and a 12b-1 expense of 0.18 percent. The fund has a minimum initial investment of $1,000 and a subsequent investment minimum of $50. The most recent quarterly income distribution occurred on September 17, totaling $0.069 per share with a reinvestment price of $18.35. Capital gain distributions are paid annually in December. The 2014 distribution equaled $0.3642 per share. The current 12-month SEC yield is 1.69 percent.
Outlook
While the fund’s prudent approach generates returns that lag the Russell 1000 in stronger markets, the investment strategy has limited its downside during bear markets. It also comes with a relatively low expense ratio for an actively managed fund. Although distributions have been limited and the yield is a bit on the low side for a dividend fund, returns have been solid. The result is a strong long-term risk-versus-reward profile that has beaten the Russell 1000 Value Index on a risk-adjusted basis since the fund’s inception. This should continue in the future as the fund’s performance during the market’s recent volatility confirms that its portfolio and prudent investment strategy are well positioned to weather a sustained market correction.