Month: July 2016

Fund Spotlight: Vanguard Wellesley Income (VWINX)

Mutual funds that generate interest income to any meaningful degree have become rare in today’s low rate environment. The Vanguard Wellesley Income Fund (VWINX) has earned 5 stars and Analyst Gold ratings from Morningstar and has weathered market volatility admirably. VWINX is among the longest-tenured funds in the Vanguard family of funds, with $46 billion under management. It is structurally similar to the highly regarded Vanguard Wellington Fund (VWELX), another fine investment option.

VWINX epitomizes the textbook definition of a conservative balanced fund. It offers a true blended portfolio mix of both equities and fixed-income securities to achieve relatively strong income growth, steady income returns and moderate capital appreciation. To manage risk through diversification, the largest holdings constitute 13 percent of total assets. The portfolio contains 60 different equity holdings and 919 different bonds. Average maturity on bonds is 9.9 years and a security is held roughly 6.8 years. Income yield is presently at 2.88 percent. The ratio policy of securities has generally been 30-35 percent in equities and 60 percent in bonds. Vanguard Wellesley Income shares its managers with Vanguard Wellington: John Keogh on the fixed income portfolio and Michael Reckmeyer on the equity portion.

Compared with other balanced funds of similar composition, VWINX ranked in the top 4 percent for 1-year, 32 percent for 3-years and 11 percent for 5-years.

Fund Strategy

The fund portfolio is allocated into four major categories: Intermediate Bond, Large Value, Large Growth and International Securities. The decades-long stability of VWINX is due to adherence by Reckmeyer and Keogh to the portfolio ratio mix and a resistance to “tactical shifts between stocks and bonds, unlike their peers,” according to CNBC.

The roughly 60 percent allocation into fixed income is spread across investment-grade corporate bonds (technically BBB- or better, but Keogh tends to prefer A to A- rated paper). A 20 percent allocation is invested in U.S. Treasury securities, which include short-term U.S. Treasury notes. The bond mix also includes mortgage-backed securities (both commercial and agency) and asset-backed securities. About 2.6 percent of bond holdings are classified as international securities. All fixed income securities in the portfolio are rated investment-grade by Moody’s and Standard & Poor’s.

The balanced fund approach of VWINX has demonstrated the reduced volatility and steady returns that many retirees find desirable. From 1995 to 2015, VWINX returned a total of 539.3 percent, with the only appreciable dip during the 2008 banking and mortgage crisis. In comparison, the S&P 500 returned a 627.3 percent total, but accelerated gains also saw consequential losses of 125 percent from 2001 to 2004 and over 200 percent from 2007 to 2009 before the latest run-up. To compare directly, the S&P 500 fell about 60 percent while VWINX only fell 27 percent from the October 2007 high to the February 2009 low. VWINX investors were better protected than those with heavy exposure to fast-growth stocks.

A $10,000 VWINX investment made in 2006 would be worth $20,573 as of June 17, 2016, based on the fund’s statistical gains over the past 10 years.

The equity portion of the portfolio has its largest allocations in technology, healthcare, consumer defensive, financial services and industrials. The selections also seek dividends to boost the income portion of the fund. Among the stocks Reckmeyer has held for VWINX that make up the Large Value allocation are Wells Fargo (WFC), Johnson & Johnson (JNJ), Exxon Mobil (XOM), General Electric (GE) and JPMorgan Chase (JPM). Caterpillar (CAT) is also a Reckmeyer favorite, and he has expressed a preference for buying CAT on price dips.

The Large Growth portion of the portfolio includes its largest position (1.86 percent of assets) in Microsoft (MSFT), as well as Merck (MRK), Pfizer (PFE), Cisco (CSCO), Intel (INTC) and Verizon Communications (VZ).

As stated above, 2.6 percent of the fixed income allocation is in international securities. The equity portion comprises 6.2 percent of the stock portfolio. The prospectus allows for up to 20 percent in foreign holdings. However, since the bulk of the other equity selections are multinational corporations, Vanguard Wellesley retains flexibility in its international portfolio in order to maintain the liquidity it would need in the event of a correction.

Management

Michael Reckmeyer has managed the stock portfolio for VWINX since January 2007, and John Keogh has managed the bond portfolio since February 2008. As co-managers of Vanguard Wellington, they have achieved superlative returns and their combined tenure exceeds half a century. Last year, Morningstar voted them Allocation Fund Managers of the Year for their work on the Vanguard Wellesley Income Fund.

Fees and Risks

With a minimum $3,000 investment and low fees (VWINX’s expense ratio is 0.23 percent, which is 72 percent lower than the average ratio of comparable balanced funds), the Vanguard Wellesley Income Fund poses relatively low risks compared with other balanced funds. Its Morningstar sustainability rating is 4 out of 5, and it ranks in the top 18 percent of its category. Morningstar has assessed its risk as below-average for 3 years and low for 5 and 10 years. Its return ratio across the board for all time frames is also highly ranked.

Returns

Since its 1970 inception, VWINX has averaged 9.95 percent in annualized returns, and more recent performance yields include 7.54 percent over the past 10 years, 8.11 percent for the past 5 years and 7.53 percent for the past 3 years. Over the past year, the fund has returned 7.62 percent through June 30, 2016. The fund’s 10-year return outperformed the S&P 500’s return over the same period.

Conclusion

While maintaining equity and bond exposures separately is generally the most prudent option, strong management and an impressive track record make Wellesley Income (VWINX) a solid option. Vanguard Wellington (VWELX) is also worthy of consideration. VWINX allocates an additional third of its portfolio to bonds, offering a viable option for retirees or more equity-wary investors who tend to favor bonds. Currently, we have issued a Strong Buy recommendation for VWINX with a ranking of 94.

Market Perspective for July 11, 2016

The S&P 500 Index opened at a new all-time high on Monday following last week’s strong economic data.  Positive earnings reports could propel the rally throughout the week.

Japan’s Prime Minister Abe won a supermajority in the upper house of parliament. The victory was seen as an endorsement of the debt financing and debt monetization policies pursued by Abe and the Bank of Japan (“Abenomics”). Investors bid up Japanese stocks and sold the yen in the wake of the vote.

U.S. stocks continued to benefit from last Friday’s better-than-expected jobs report. Homebuilders rallied last week and homebuilder funds are at or near all-time highs. Consumer discretionary also broke out to a new high, and technology is on the cusp of a new all-time high.

The Job Openings and Labor Turnover Survey (JOLTS) will be released on Tuesday.  Analysts expect it will confirm recent strength in the labor market, although the consensus calls for a slight drop from April, to 5.7 million job openings. Updated crude inventory levels, the mortgage purchase applications index and the Federal Reserve Beige Book will all be available on Wednesday.

Inflation and retail sales data, both critical economic indicators, will be released on Friday. Economists forecast the CPI increased 0.3 percent in June, with core CPI up 0.2 percent. Analysts expect a 0.1 percent rise in June retail sales (0.5 percent ex-autos). Industrial production and capacity utilization for June will also be out on Friday and could impact GDP forecasts. Both are expected to show an increase in production.

Alcoa (AA) reported quarterly earnings per share (EPS) of $0.15 on revenues of $5.3 billion on Monday, exceeding expectations of $0.09 EPS on $5.2 billion. Investors will continue to focus on the company’s plan to split into two separate business units.

Several major banks are scheduled to report earnings later in the week. Big banks reported strong lending growth last quarter, despite weak investment and trading activity. Regional banks derive a larger portion of revenue from lending and could enjoy similar second quarter benefits. Analysts expect EPS of $1.44 on revenues of $24.1 billion from JP Morgan Chase on Thursday. Citigroup (C) is expected to deliver EPS of $1.14 on consensus revenues of $17.71 billion, while Wells Fargo (WFC) is expected to report EPS of $1.01 on revenues of $22.21 billion. Two larger regional banks, PNC Financial (PNC) and U.S. Bancorp (USB) are also set to report this week.

Analysts expect EPS of $0.74 on $3.08 billion in sales from Yum Brands (YUM) on Wednesday. Transportation index component, CSX Corp (CSX), will also report on Wednesday; analysts anticipate double-digit declines in earnings and sales from a year ago.

Market Perspective for July 8, 2016

Stocks pushed to all-time highs on Friday following a jobs report that exceeded expectations.

The Dow Jones Industrial Average finished the week above 18,100 points, while the S&P 500 Index breached its all-time high of 2125 to ultimately close at 2129.90. June’s jobs report alleviated labor market concerns that have loomed since May’s weak data. 287,000 new jobs were created last month, solidly ahead of the median forecast of 173,000. Another good sign from the report was the uptick in the unemployment rate to 4.9 percent. We expect to see a rising unemployment rate as the jobs market continues to strengthen because discouraged workers are not counted by the government statisticians as unemployed. As they start looking for work again, they will be added to the unemployment report.  Additionally, initial jobless claims fell by 16,000 last week to a nearly three-month low of 254,000.

Earlier in the week, markets were bolstered by positive action from the Bank of England (BoE). Citing uncertainty following the Brexit vote, the central bank relaxed regulatory requirements for banks and reduced capital requirements, raising the lending limit to ?150 billion. Elsewhere, the Royal Bank of Australia held interest rates steady at 1.75 percent; speculators are pricing in a possible rate cut next month.

The U.S. manufacturing and nonmanufacturing PMIs from the Institute of Supply Management (ISM) reached their highest levels in the past sixteen and seven months respectively. The latest Chinese Service Purchasing Managers Index (PMI) released Tuesday reported to be 50, signaling the midpoint between expansion and contraction. UK services’ PMI fell to 53.5, but still remaining in expansionary territory.

The U.S. trade balance expanded to $41.1 billion in May as exports declined. Although weekly crude oil inventory fell and the report also indicated a reduction in domestic production, ample gasoline supplies might dent demand going forward. The price of oil dropped nearly $4 on the week, to $45.12 per barrel.

On Thursday, PepsiCo (PEP) delivered better-than-expected EPS of $1.38 and revenues of $2.01 billion. Pepsi also raised its forecast for the year, based on strong sales in North America. Shares of the company rose on the news and extended the rally in to Friday. Walgreens (WBA) reported earnings per share of $1.18 on revenues of $29.5 billion. Profits increased by 14.7 percent versus year-ago levels, but revenues missed estimates. Despite the strong earnings, investors focused on the revenue miss, and shares of WBA fell in the wake of the report.