Forecasting where the market will end up in 2016 is a very difficult task, as innumerable variables will intercede over the course of the next twelve months. The actions of the Federal Reserve in particular are going to be a heavy influence on income investors as they seek to position their portfolios for capital preservation and dependable dividend streams.
If this year has taught us anything, it’s that there is a high degree of risk in individual high-yield sectors such as master limited partnerships and junk bonds.
These groups have erased years of accumulated gains in a manner of months as credit headwinds weigh on investors’ minds. In addition, the trendless direction of interest rates will likely lead to above-average volatility in high quality fixed-income holdings as well.
My top income themes for 2016 are centered around large, diversified and proven investment vehicles that circumvent the hit-or-miss proposition of individual sectors. That may seem boring to those who like to tempt fate with the glory of a turnaround story or make assumptions in continued strength of momentum names.
Nevertheless, I think you will find these actively managed mutual funds and low-cost exchanged-traded funds offer attractive characteristics as core holdings for nearly every style of income investor.
Essential Income Funds: Vanguard High Dividend Yield ETF (VYM)
Expense Ratio: 0.10%
30-Day SEC Yield: 3.25%
If you are looking for an essential equity income fund to own in 2016, then Vanguard High Dividend Yield ETF (VYM) should be near the top of your list.
VYM has exposure to virtually every sector of the stock market, which means that it is a highly diversified and transparent investment vehicle. I like to think of this fund as the “S&P 500 of dividend stocks,” because of its market-cap weighted structure and broad index construction methodology.
Currently VYM has a 30-day SEC yield of 3.25% and income is paid quarterly to shareholders. The embedded expense ratio of this fund is just 0.10% and it has over $11 billion in total assets.
I have owned this ETF as a core holding in my Strategic Income Portfolio for several years and expect that it will continue to add value in 2016 as well. It’s simply difficult to find a better investment vehicle for those that crave a low-cost, dividend-focused stock fund.
Essential Mutual Funds: Pimco Income Fund (PONDX)
Expense Ratio: 0.79%
SEC Yield: 3.03%
Most bond investors have their core holdings in passive indexes such as the Vanguard Total Bond Market ETF (BND). However, in my opinion, an over allocation to a passive fixed-income basket may lead to weak performance over the course of the next several years.
One of my favorite actively managed bond funds to supplement or replace existing passive strategies is Pimco Income Fund Class D (PONDX). This portfolio is governed by Daniel Ivascyn and Alfred Murata of Pimco, who were named MorningStar’s 2013 U.S. Fixed-Income Managers of The Year.
The PONDX strategy is built on the foundation of a flexible, multi-sector approach with the goal of income and long-term capital appreciation. It takes a global slant by incorporating themes from overseas markets and has been known to use hedges to control risk and limit interest rate sensitivity as well. The effective duration of PONDX is just 3.09 years and it has a current 30-day SEC yield of 3.03%.
This fund has an admittedly higher expense ratio than a comparable ETF at 0.79%. However, the performance over the last several years has compensated investors well for the superior security selection and risk management techniques.
PONDX has gained 2.81% vs. 0.81% in BND on a year-to-date basis in 2015. Over the last three years, PONDX has returned 17.02% vs. just 4.02% in BND. The fund is rated 5-stars by Morningstar and has been consistently ensconced in the top of its peer group over the last three and five years.
I own this fund in my own account alongside my clients, and feel that the manager’s expertise navigating credit and interest rate volatility will make for a solid bond holding in 2016.
(Note: Larger investors, or those working with an advisor, may benefit from the institutional share class PIMIX, which charges an expense ratio of 0.45%.)
Essential Mutual Funds: Vanguard Wellesley Income Fund Admiral Shares (VWIAX)
Expense Ratio: 0.18%
SEC Yield: 2.83%
For those seeking a conservative multi-asset income fund with a solid track record and low fees, look no further than Vanguard Wellesley Income Fund Admiral Shares (VWIAX). This fund is one of the few actively managed offering from Vanguard that has been in existence for over 40 years. Yet true to the Vanguard approach of minimal cost, the expense ratio of VWIAX is only 0.18%.
The fund invests in a mix of income generating assets that fluctuate between 35% to 40% stocks and 60% to 65% bonds. The stock allocation consists of 59 large-cap names such as Wells Fargo Inc (WFC) and Merck & Co (MRK) to name a few.
The bond sleeve consists of high quality corporate and government securities with an average maturity of 6.5 years. VWIAX has a current 30-day SEC yield of 2.83% and dividends are paid quarterly to shareholders.
In a world filled with aggressive income strategies trying to position themselves as high-yield standouts, this stalwart mutual fund aims for a quality and dependable asset allocation mix that has survived the test of time.
This helps keep volatility low and risks in an acceptable range that retirees or other capital preservation-focused investors can appreciate. Furthermore, it has been rated 5-stars by Morningstar over three-, five- and 10-year time horizons.
The bottom line is that these three income funds offer solid value in 2016 by sticking with investment themes that have historically provided dependable results. They can also be supplemented with tactical or alternative investment themes to enhance the overall yield of your portfolio or capitalize on a relative value opportunity.
David Fabian is Managing Partner and Chief Operations Officer of FMD Capital Management. As of this writing, he did not hold a position in any of the aforementioned securities. Learn More: Why I love ETFs, And You Should Too.