Analysis of T. Rowe Price Dividend Growth Fund (Update)
analysis, mutual fund

A recent piece in Barron’s features the T. Rowe Price Dividend Growth Fund (PRDGX). This $5.9 billion no-load fund sports a competitive 0.64% expense ratio and 25% turnover. According to the article, the fund

…has outperformed the Standard & Poor’s 500 index year to date and over one-, three-, 10-, and 15-year periods. So far this year, it has returned 10.21%, versus 8.4% for the S&P 500.

Unlike our previous analysis, which covered a longer-term performance of the fund, this evaluation will generally focus on a recent shorter time period.

The prospectus benchmark for the fund is the S&P 500® Index. One of the long-lived and efficient implementations of this index is the SPDR® S&P 500® ETF (SPY). Alpholio™’s calculations indicate that over the five-year interval through July 2016, the fund returned more than the ETF in only 16% of all rolling 36-month periods, 22% of 24-month periods and 47% of 12-month periods. The median cumulative (not annualized) return difference over a rolling 36-month period was minus 3%.

To adjust for the fund’s volatility, let’s employ the simplest variant of Alpholio™’s patented methodology. In this approach, a reference portfolio of ETFs with fixed both membership and weights is constructed such that its returns most closely track those of the fund. Here is the resulting chart and statistics of the cumulative RealAlpha™ for the T. Rowe Price Dividend Growth (to learn more about this and other performance measures, please visit our FAQ):

Cumulative RealAlpha™ for T. Rowe Price Dividend Growth Fund (PRDGX)

Over the five years through July 2016, the fund subtracted value on a risk-adjusted basis. The fund’s volatility, measured as a standard deviation of monthly returns, was comparable to that of the reference ETF portfolio. The RealBeta™ of the fund was slightly lower than that of a broad-based equity ETF.

The following chart with related statistics shows the constant composition of the reference ETF portfolio over the same analysis period:

Reference Weights for T. Rowe Price Dividend Growth Fund (PRDGX)

The fund had major equivalent positions in the Vanguard High Dividend Yield ETF (VYM), PowerShares Dynamic Large Cap Growth Portfolio (PWB), First Trust Large Cap Growth AlphaDEX® Fund (FTC), PowerShares S&P 500 Quality Portfolio (SPHQ), iShares U.S. Industrials ETF (IYJ), and Vanguard Dividend Appreciation ETF (VIG). The Other component in the chart collectively represents six additional ETFs with smaller weights (15.6% in total).

Over the three-year period through July 2016, the fund still failed to add a meaningful amount of value over its reference ETF portfolio:

Cumulative RealAlpha™ for T. Rowe Price Dividend Growth Fund (PRDGX) over 3 Years

The composition of the reference portfolio over this shorter period was different from the previous one, although the top-six equivalent positions also accounted for more than 80% of holdings.

Over the most recent three and five years, the T. Rowe Price Dividend Growth Fund failed to add a significant amount of value when compared to a static reference ETF portfolio. Similarly to 2014, the fund had a substantial long-term capital gain distributions in 2015, which diminished its suitability for taxable accounts. The relatively low expense ratio and modest turnover work in the fund’s favor.

To learn more about the T. Rowe Price Dividend Growth and other mutual funds, please register on our website.


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Analysis of Columbia Dividend Income Fund
analysis, mutual fund

The latest profile in Barron’s features the Columbia Dividend Income Fund (LBSAX; Class A shares). This $9.1 billion large-cap fund has a 5.75% maximum sales charge, 1.02% expense ratio and 27% turnover. According to the article

The fund has returned 8% annually over the past 10 years, beating the S&P and 95% of its large-value fund peers. Performance has been consistent in more recent periods, as well; the fund returned 9% in the past year, ahead of the S&P’s 4% rise and 93% of its peers.

The prospectus benchmark for the fund is the Russell 1000® Index. One of the low-cost and long-lived implementations of this index is the iShares Russell 1000 ETF (IWB). Alpholio™’s calculations indicate that from December 2002 through May 2016 the fund returned more than the ETF in approximately 52% of all rolling 36-month periods, 53% of 24-month periods and 39% of 12-month periods. The median cumulative (not annualized) outperformance over the 36-month period was only 1%, while the mean return difference was minus 2.1%.

Although useful, a comparison of rolling returns does not take the fund’s volatility into account. To adjust for the latter, let’s employ a simplest variant of Alpholio™’s patented methodology that constructs a reference ETF portfolio for the fund. This reference portfolio has both fixed membership and weights, which allows for a straightforward construction and maintenance. Here is the resulting chart of the cumulative RealAlpha™ and related statistics for the Columbia Dividend Income fund over the past 10 years:

Cumulative RealAlpha™ for Columbia Dividend Income Fund (LBSAX)

Over the entire analysis period, the fund produced approximately negative 1.2% of annualized discounted RealAlpha™ (to learn more about this and other performance measures, please visit our FAQ). This was mostly due to a significant decline in cumulative RealAlpha™ from mid-2010 through mid-2015. The fund’s standard deviation, a measure of annualized volatility of returns, was slightly above that o the reference portfolio. The fund’s RealBeta™ was about 18% below that attributed to a broad-based equity ETF.

The following chart and statistics provide the static composition of the reference ETF portfolio for the fund over the same evaluation interval:

Reference Weights for Columbia Dividend Income Fund (LBSAX)

The fund had major equivalent positions in the Consumer Staples Select Sector SPDR® Fund (XLP), iShares S&P 100 ETF (OEF), iShares Morningstar Large-Cap Value ETF (JKF), PowerShares Dynamic Large Cap Value Portfolio (PWV), First Trust Value Line® Dividend Index Fund (FVD), and iShares Morningstar Large-Cap ETF (JKD). The Other component in the chart collectively represents the additional six ETFs with smaller constant weights, listed in the above table.

Over the past 10 years, the Columbia Dividend Income Fund failed to add value for its investors on a truly risk-adjusted basis. A simple portfolio of ETFs produced about 20% higher cumulative return at a lower volatility. The fund’s steep front load further deteriorated its performance. In 2014 and 2015, the fund had significant capital-gain distributions, which made it less suitable for taxable accounts.

To learn more about the Columbia Dividend Income and other mutual funds, please register on our website.


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Analysis of Seafarer Overseas Growth and Income Fund
analysis, foreign equity, mutual fund

A recent piece in Barron’s features the Seafarer Overseas Growth and Income Fund (SFGIX; Investor Class shares). This $876 million (at the end of February 2016) no-load fund has a 1.15% expense ratio (after a fee waiver/reimbursement through August 2017) and 28% turnover. According to the article:

Seafarer’s only fund […] is down an average of 1% a year over the past three years, far better than its peers, which are down an average of 7%. Last year, the MSCI Emerging Markets index fell 14.9%, and the category sank 13.8%. Seafarer lost 4.3%.

Smaller losses are hardly a consolation to investors. Nevertheless, the fund has clearly exhibited some defensive qualities in a challenged asset class, by focusing on dividend-paying equities and fixed-income securities.

The fund’s benchmark is the MSCI Emerging Markets Index. One of accessible implementations of this index is the iShares MSCI Emerging Markets ETF (EEM). Alpholio™’s calculations indicate that since inception the fund returned more than the ETF in about 89% of all rolling 12-month periods, and 100% of 24- and 36-month periods. The median outperformance over a rolling 12-month period was 7.4%. It has to be noted, though, that the fund only has a four-year history.

To gain insight into risk-adjusted returns of the Seafarer Overseas Growth and Income Fund, let’s employ a variant of Alpholio™’s patented analysis methodology. In this approach, a reference portfolio of ETFs with a fixed membership but variable weights is constructed for each analyzed fund. The difference of returns of the fund and its reference portfolio constitutes the cumulative RealAlpha™, which is shown in the following chart:

Cumulative RealAlpha™ for Seafarer Overseas Growth and Income Fund (SFGIX)

The fund generated approximately 2.5% of the regular and 3.1% of the lag annualized discounted RealAlpha™ (to learn more about this and other performance measures, please visit our FAQ). However, most of this outperformance was produced in just a four-month period at the beginning of 2015. At 13%, the fund’s standard deviation exceeded that of the reference portfolio by 3%. The fund’s RealBeta™, measured against a broad-based US stock market ETF, was 0.74.

The following chart depicts changes of ETF weights in the reference portfolio for the fund over the same analysis period:

Reference Weights for Seafarer Overseas Growth and Income Fund (SFGIX)

The fund had major equivalent positions in the iShares 7-10 Year Treasury Bond ETF (IEF; average weight of 28.8%), iShares MSCI Emerging Markets ETF (EEM; 16.6%), iShares MSCI Hong Kong ETF (EWH; 10.4%), iShares MSCI Singapore ETF (EWS; 9.3%), PowerShares Dynamic Market Portfolio (PWC; 7.7%), and iShares Latin America 40 ETF (ILF; 6.3%). The Other component in the chart collectively represents additional six ETFs with smaller average weights.

The IEF position represents fixed-income holdings of the fund:

Nearly a quarter of the fund’s assets are in preferred stock, convertibles, and debt.

Over its lifespan, the Seafarer Overseas Growth and Income Fund added a considerable amount of value. However, this outperformance was achieved over a relatively short sub-period of time and at the expense of an elevated volatility as compared to that of the fund’s reference ETF portfolio. The fund’s historical distributions were modest except for a surprising 2.2% short-term capital gain in 2013. Only time will tell if the fund is suitable for taxable accounts.

To learn more about the Seafarer Overseas Growth and Income and other mutual funds, please register on our website.


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Analysis of Henderson Global Equity Income Fund
active share, analysis, app, mutual fund

A recent piece in Barron’s covers the Henderson Global Equity Income Fund (HFQAX; Class A shares). This $3.7 billion fund has a front sales charge of up to 5.75% and a relatively low expense ratio of 1.09%. According to the article

International stocks often pay dividends annually rather than quarterly, allowing the fund’s managers to move in and out of stocks based on the timing of their payouts. That’s how the fund manages a robust 6.03% trailing 12-month yield, even though the average yield among the fund’s holdings is around 2.8%. Of course that also leads to a high turnover rate – at 103% it’s nearly twice the category average. This is a fund best-suited to a tax-advantaged account. The globe-hopping dividend fund has a four-star rating from Morningstar and has outpaced 95% of its peers over the past five years, with an average annual return of 8.33%.

The primary benchmark for the Henderson Global Equity Income fund is the MSCI World Index. One of the accessible implementations of this index is the iShares MSCI World ETF (URTH). Alpholio™’s calculations show that since that ETF’s inception in January 2012, the fund returned more than the ETF in about 18% of all rolling 12-month periods and 6% of rolling 24-month periods. However, this ETF has arguably too short a lifespan to serve as an adequate reference for the fund whose inception date was in November 2006.

The fund’s strategy to capture and pay out infrequent dividends can be emulated from a total return perspective. In the simplest application of Alpholio™’s patented methodology, both the membership and weights of ETFs in the reference portfolio for the analyzed fund are fixed over the entire analysis period. Here are the cumulative RealAlpha™ chart and the related statistics for the fund, generated by the Mutual Fund Service of the Alpolio™ App for Android:

Cumulative RealAlpha™ for Henderson Global Equity Income Fund (HFQAX)

Statistics for Henderson Global Equity Income Fund (HFQAX)

The fund added a miniscule amount of value over the static reference portfolio but did so at the expense of slightly higher volatility (standard deviation of returns).

Here is the reference portfolio for the fund over the same analysis period:

Statistics for Henderson Global Equity Income Fund (HFQAX)

The fund had equivalent positions in the iShares Europe ETF (IEV), iShares MSCI United Kingdom ETF (EWU), iShares Global Consumer Staples ETF (KXI), iShares Global Telecom ETF (IXP; weight of 8.6%), iShares U.S. Telecommunications ETF (IYZ; 8.3%), iShares Global Healthcare ETF (IXJ; 6.0%), and five additional ETFs with smaller weights. The equivalent positions in the iShares 1-3 Year Treasury Bond ETF (SHY) and iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD; 5.4%) represented the fixed-income holdings of the fund.

According to the current factsheet, to date the Henderson Global Equity Income Fund

…has provided 100% dividend income and has not returned shareholder capital

Therefore, the article’s statement on the fund’s unsuitability for taxable accounts is somewhat misguided, especially given the current tax treatment of dividends received by moderate income investors. Nevertheless, the above analysis has demonstrated that so far the fund could have been effectively substituted, from a total return perspective, by a fixed portfolio of ETFs. It is also worth noting that the high active share of the fund (over 90%, according to the factsheet) is undoubtedly a result of a frequent equity hopping to sustain its high dividend. This is an example of a strategy whose high active share does not necessarily result in a significant risk-adjusted outperformance.

To learn more about the Henderson Global Equity Income and other mutual funds, please register on our website.

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Analysis of T. Rowe Price Dividend Growth Fund
analysis, mutual fund

A recent Q&A article in Barron’s covered the T. Rowe Price Dividend Growth Fund (PRDGX). This $4.7 billion, no-load fund sports a sensible 0.66% expense ratio and an ultra-low 3.3% turnover rate. According to the article

Annualized total returns of 14.01%, 17.2% and 14.89% over the past one, three and five years, respectively, have slightly lagged the benchmark S&P 500 index, but have outpaced peer funds tracked by Morningstar. The fund’s goal is to beat the market over a full market cycle, as the benefits of losing less in bad times outweigh the underperformance in a bull market. In this, it has succeeded, returning almost 7% annualized dating back to the market peak in October 2007, compared with the S&P 500’s 6.3% annualized returns.

The prospectus benchmark for the T. Rowe Price Dividend Growth fund is the S&P 500® index. One of the long-life practical implementations of this index is the SPDR® S&P 500® ETF (SPY). The current manager started with the fund at the end of March 2000. Alpholio™’s calculations indicate that since then, the fund returned more than the ETF in about 55% of all rolling 12-month periods, 52% of 24-month periods and 59% of 36-month periods. However, these statistics do not take the fund’s volatility into account.

With a plain adjustment for risk, only one factor (“the market”) is used. According to Alpholio™’s calculations, the fund exhibited an alpha of 0.26%, beta of 0.86, Sharpe ratio of 0.47, and maximum drawdown of 45.3% vs. a broad-market ETF. Its benchmark ETF had a Sharpe ratio of 0.27 and maximum drawdown of 50.8% (since SPY virtually represents “the market,” its alpha was around 0% and beta about 1). To fully adjust for the fund’s risk, more factors need to be used.

In the simplest variant of Alpholio™’s patented methodology, both the membership and weights of ETFs in the reference portfolio are fixed. This type of analysis shows that since late 2004 the fund generated only 0.11% of annualized discounted cumulative RealAlpha™ (to learn more about RealAlpha™, please visit our FAQ). The fund’s top-five equivalent positions were in the iShares Morningstar Large-Cap ETF (JKD; fixed weight of 21.6%), SPDR® S&P® 500 Value ETF (SPYV; 14.0%), iShares Morningstar Large-Cap Growth ETF (JKE; 13.8%), iShares U.S. Consumer Services ETF (IYC; 10.5%), and iShares U.S. Industrials ETF (IYJ; 10.5%).

In a more elaborate variant, the reference portfolio has a fixed ETF membership but variable weights. Here is the resulting chart of cumulative RealAlpha™ for the fund:

Cumulative RealAlpha™ for T. Rowe Price Dividend Growth Fund (PRDGX)

Since late 2004, the fund produced only annualized 0.02% of regular and 0.83% of lag RealAlpha™. At around 13.7%, the fund’s standard deviation was about 0.4% lower than that of the reference ETF portfolio. The fund’s RealBeta™ was about 0.92.

The following chart illustrates changes of ETF weights in the reference portfolio over the same analysis period:

Reference Weights for T. Rowe Price Dividend Growth Fund (PRDGX)

The fund had top equivalent positions in the iShares Russell 1000 Value ETF (IWD; average weight of 23.5%), iShares Core S&P Total U.S. Stock Market ETF (ITOT; 16.1%), iShares Morningstar Large-Cap ETF (JKD; 13.7%), SPDR® Dow Jones® Industrial Average ETF (DIA; 12.2%), iShares Morningstar Large-Cap Growth ETF (JKE; 7.8%), and Vanguard Consumer Discretionary ETF (VCR; 6.1%).

The Other component in the chart collectively represents six additional ETFs with smaller average weights. Of those, the iShares 1-3 Year Treasury Bond ETF (SHY; 4.9%) is a short-term fixed-income equivalent position in this otherwise stock-oriented fund. Such a position typically indicates that the fund held a non-trivial amount of cash in an effort to time its equity purchases.

Over the past 15 years under current management, the T. Rowe Price Dividend Growth fund delivered unimpressive results on a truly risk-adjusted basis. This is, in part, offset by its low turnover rate and expense ratio. Except for a substantial long-term capital gain at the end of 2014, the fund’s historical distributions have been small, which should make it suitable for taxable accounts.

To learn more about the T. Rowe Price Dividend Growth and other mutual funds, please register on our website.


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Inflation- and Dividend-Adjusted Market Peaks
market

With a strong performance of equities in 2013, major market indices have reached peak levels. In an attempt at accuracy, many articles in the financial media adjust index values for inflation. The conclusion is that the market, as measured by the Dow Jones Industrial Average (DJIA), has surpassed record levels from early 2000 only very recently on an inflation-adjusted basis. On the other hand, a broader market benchmark, the S&P 500® index, is still about 15% below its inflation-adjusted 2000 peak. Having suffered significant downturns in both 2000 and 2008, the NASDAQ-100 index is significantly below both its nominal and inflation-adjusted historical highs.

The problem is that in all of these assessments, a price level of each index is used. Would the findings be different if indices were also adjusted for reinvested dividends to account for total returns? To determine that, Alpholio™ compiled inflation- and dividend-adjusted prices of two representative exchange-traded funds: the SPDR® Dow Jones® Industrial Average ETF (DIA) and SPDR® S&P 500® ETF (SPY). These ETFs are long-lasting and popular implementations of their respective indices. To adjust for inflation, the Consumer Price Index – All Urban Consumers (CPI-U) was used.

A conventional price chart shows that DIA has indeed just matched an inflation-adjusted record high from January 2000:

DIA Price Performance with Inflation Adjustment

However, a chart for DIA with reinvested dividends indicates that the previous inflation-adjusted peak from October 2007 was already surpassed in mid-January 2013:

DIA Price Performance with Inflation Adjustment

Similarly, a price-only chart illustrates that SPY is still about 13% below its inflation-adjusted top from March 2000:

SPY Price Performance with Inflation Adjustment

On the other hand, the chart with dividends factored in demonstrates that SPY already exceeded the previous inflation-adjusted maximum level in May 2013:

SPY Total Performance with Inflation Adjustment

According to S&P Capital IQ, since the late 1920s dividends constituted about 45% of the total return of the stock market. Therefore, any assessment of the current market level has to adjust not only for inflation but also for reinvested dividends. From that standpoint, historical market peaks were quietly surpassed much earlier this year. Time and again, media focus is on generating simplified headlines rather than noting true events.

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Comparison of Dividend-Oriented ETFs
analysis, exchange-traded fund

A recent article in The Wall Street Journal attempts to compare the Vanguard Dividend Appreciation ETF (VIG) to iShares Select Dividend ETF (DVY) and other “peer dividend ETFs.” As is typical for such cursory analyses, the article lumps together ETFs with the word “dividend” in their name, and focuses on short-term (up to three years) returns to draw conclusions about the funds’ performance. The article only briefly touches on the difference of holdings of the two funds.

So, what are the proper ways to compare these funds? Here is one alternative comparison based on Sharpe Ratios (all figures calculated and published by Morningstar):

ETF Ticker Category 3-Year SR 5-Year SR
Vanguard Dividend Appreciation VIG Large Blend 0.99 0.46
iShares Select Dividend Index DVY Mid-Cap Value 1.31 0.40
PowerShares FTSE RAFI US 1000 PRF Large Value 0.83 0.42
WisdomTree LargeCap Dividend DLN Large Value 1.20 0.36
SPDR S&P Dividend SDY Large Value 1.10 0.53
iShares High Dividend Equity HDV Large Value N/A N/A

In the longer 5-year period, which spanned a major market downturn, the Vanguard ETF exhibited a return/risk characteristic superior to that of the iShares ETF. However, the SPDR S&P Dividend ETF beat both according to that measure.

Another way to compare the first two of these ETFs is to use the dividend discount model to arrive at the expected rate of return. According to the article, the Vanguard ETF’s holdings currently yield about 2% in dividends and are expected to generate over 9% of earnings growth in the next three to five years. Assuming that the current dividend payout ratios and earnings growth rates stay approximately constant in the future, the ETF should return about 11% per year in total. For the iShares ETF, these figures are 7%, 4%, and also 11%, respectively. However, these identical results stem from vastly simplifying assumptions.

Finally, the two ETFs address different segments of the equity market. According to Morningstar, in the last three years the Vanguard ETF was most closely matched by the US Core Total Return index, while the iShares ETF’s best fit index was the Dow Jones Industrial Average Price Return index. This indicates that since the iShares ETF effectively tracked a much more narrowly focused index, it should not necessarily be compared to the more broadly-oriented Vanguard ETF. Indeed, Morningstar classifies the Vanguard ETF into the Large Blend category, while it puts the iShares ETF in the Mid-Cap Value category. Hence, the two ETFs are not really peers. Only the rest of the above dividend ETFs could be considered peers by virtue of the common, Large Value, category.

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