When Vanguard closed its Dividend Growth Fund (VDIGX) to new investors in late July, it was a good example of how being a widely favored pick in a hot category -- in this case, funds that focus on dividend-paying stocks -- can sometimes bring in too much money too fast.
VDIGX “has just been overwhelmed with new money,” said Kevin McDevitt, senior manager research analyst for equities strategies at Morningstar. Between 2011 and 2015, VDIGX’s assets surged from $7.7 billion to $26.1 billion, and by the time Vanguard made its announcement on July 28, it had grown by another $4.5 billion year-to-date to $30.6 billion.
But because VDIGX remains open for existing shareholders, it’s still growing and has since reached $31.5 billion.
Getting that gusher of new money invested didn’t seem to be the problem, McDevitt said, noting that VDIGX buys large-cap stocks and that it had less than 1 percent of its assets in cash. Instead, he thinks Vanguard was “worried about hot money” -- cash that might just as quickly leave the fund.
Given how investors have been piling into the fund, you would think VDIGX must have spectacular returns. Actually, while it has been doing well, some of Vanguard’s other dividend-payer funds have been doing better, and they even have lower expense ratios. Vanguard also has a low-cost dividend exchange-traded fund (ETF) with a strategy that’s very similar to VDIGX.
VDIGX is an actively managed large blend fund (blending growth and value strategies). It posted a total return of 7.68 percent year-to-date and 14.34 percent on a one-year basis. But Morningstar data shows that the $23.2 billion Vanguard Equity Income (VEIPX) large value fund, which is also actively managed, had higher total returns of 9.94 percent year-to-date and 16.25 percent for one year.
Vanguard also has two passively managed dividend-payer mutual funds. The $20.9 billion High Dividend Yield Index (VHDYX) large value fund had a total return of 10.83 percent year-to-date and 17.37 percent for one year, according to Morningstar.
The other is VDIGX’s passively managed counterpart, which tracks the same Nasdaq U.S. Dividend Achievers Select Index that VDIGX uses as a benchmark. And even this fund -- the $27 billion Vanguard Dividend Appreciation Index (VDAIX) fund -- has posted better total-return performance year-to-date at 10.58 percent, and for one year at 15.16 percent.
Vanguard also has a passively managed $27 billion Dividend Appreciation ETF (VIG). It tracks that same index and has gained 10.63 percent this year.
Tom Roseen, the head of Lipper Research Services, noted that the net expense ratio on VDIGX is 33 basis points, while VEIPX is lower, at 26 bps, and VHDYX is lower still, at 16 bps. He rates all three of those mutual funds as 5’s -- Lipper’s highest ranking -- for their consistency over time but also for their low expenses.
And longer-term, his numbers show little difference in annualized returns at the three-year mark, with all three in the 11 percent-plus range. Even at the five-year mark, VDIGX had a total return of 13.93 percent, while VEIPX gained 14.48 percent and VHDYX was 14.77 percent.
So how did VDIGX become the star attraction in Vanguard’s dividend-payer stable?
It started to lead the pack in asset-gathering during the financial crisis, when it suffered less of a loss than most peers. That give birth to a reputation for offering downside protection in the worst of markets, said Richard Powers, who’s now Vanguard’s head of ETF product management. (Previously, he oversaw its yield-oriented mutual funds.)
In 2008, VDIGX lost 25.57 percent, but VEIPX lost 30.95 percent, he said. In 2009, VDIGX had more of a rebound, recouping 21.75 percent, while VEIPX gained back 17.1 percent. At the time, the dividend-grower funds suffered less of a loss because they had a smaller weighting in financial stocks. But it was also in their favor that the types of companies that focus on building their dividend streams tend to have “sturdier” balance sheets and “less cyclical profits,” Powers said.
The result was that “the Dividend Growth Fund actually became quite a popular fund among different publications as a fund that investors should consider,” he said, citing Morningstar, which ranks it as a gold medalist. It also got named to the Kiplinger 25, the magazine’s list of its favorite no-load funds.
Both have now substituted the $5.8 billion T.Rowe Price Dividend Growth Fund (PRDGX) as a recommendation, with Morningstar describing it as “a good downside performer.”
If downside protection is a concern, Morningstar also rates Capital Group’s American Funds Washington Mutual (AWSHX) as a gold medalist “for its ability to hold up well in cratering markets.” It has a front-end load, but it’s by far the largest mutual fund in the dividend-payer category, with $81.93 billion in assets.
Morningstar’s data shows a year-to-date total return of 7.7 percent, a one-year return of 13.29 percent and a 13.39 percent total return at five years.
This fund has “outpaced every single bear market since 1952,” when it was founded, said American Funds investment specialist Jacob Gerber. It excludes tobacco and alcohol stocks but bills itself as investing in “the bluest of the blue chips,” with a 94.6 percent weighting in large-cap stocks.
Its investment horizon is longer-term, starting with “a minimum of roughly three years,” and its goal is “to make money over time without scaring investors,” Gerber said.
For consistent, long-term returns, Roseen of Lipper ranks two other no-load dividend-payer mutual funds as being on a par with the three Vanguard funds he recommends as 5’s: The Invesco Dividend Income Fund (IAUYX) and the Parnassus Core Equity Fund (PRBLX).
According to his data, IAUYX had a one-year return of 16.42 percent, a three-year return of 13.31 percent and a five-year return of 12.4 percent, with an expense ratio of 89 bps.
The Parnassus fund’s one-year total return is 11.15 percent, and longer-term, its three-year return was 12.09 percent, and its five-year return was 14.87 percent, with an expense ratio of 87 bps, according to his data.
The Invesco fund doesn’t have a 10-year return, but the Parnassus fund does -- 9.9 percent. “Three, five or 10 years is really what’s important to me,” Roseen said.
He also believes investors should broaden their horizons and look at not just mutual funds, but also ETFs. “A lot of people don’t like to compare mutual funds with ETFs, but at Lipper, we do,” he said. “I think they should at least be looked at side-by-side.”
His list of ETFs with 5 ratings is led by two Invesco products: The PowerShares S&P 500 High Dividend Low Volatility Portfolio (SPHD), with a one-year return of 28.95 percent and a three-year return of 17.43 percent; and the PowerShares High Yield Equity Dividend Achievers Portfolio (PEY), with a one-year return of 26.92 percent and a three-year return of 17.76 percent.