Famed Hollywood director Howard Hawks is said to have defined a good film as one with three good scenes and no bad ones. The management team behind American Century Equity Income (symbol, TWEIX) takes a similar approach when it comes to undervalued large-company stocks. "Any value index will have stocks that do poorly and go to zero. If you avoid those firms that are significantly impaired or that have poor balance sheets, you'll do better than the index with less volatility," says comanager Phil Davidson. The fund's strategy goes beyond filtering out losing firms, but its performance reflects that basic tenet. Over the past 15 years, the fund's 8.2% annualized return beat that of its benchmark Russell 3000 Value index by 0.4 percentage point. Over the period, Equity Income was 33% less volatile than the benchmark and 29% less volatile than the broad stock market. (Returns are through September 30.)
The avoidance of stock market horror shows and a focus on high-quality, dividend-paying stocks have led to the fund's superior downside performance. For instance, the fund lost only 39.2% during the 2007-09 bear market, when Standard & Poor's 500-stock index plunged 55.3%. More recently, the fund surrendered 13% during the S&P's near-20% downdraft in late 2018.
The fund's four comanagers and 15 analysts favor financially healthy firms that trade cheaply relative to measures such as earnings and free cash flow (cash profits left over after capital outlays). Top holdings include medical device maker Medtronic (MDT), telecom giant Verizon (VZ) and PNC Financial Services Group (PNC).
The managers further tamp down volatility by allocating nearly 20% of assets to preferred stocks, convertible securities and bonds, all of which tend to be less volatile than common stocks. These investments also help boost the fund's yield, which currently stands at 2%.
The value-oriented fund has lagged the broad stock market over the past decade, a period that has seen fast-growing stocks outperform undervalued names. "But investors looking for a diversified portfolio with sustainable yields will appreciate our fund's ability to hold up in tougher markets," says Davidson.
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