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ETF Specialist

A Tale of Two Dividend Growth Funds

While these two funds pursue similar strategies, the active fund may have an edge over its index-based counterpart.

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Expense ratios are one of the best predictors of relative fund performance. This lends support to low-cost index investing. But sometimes it can be beneficial to pay a little more for active management.  Vanguard Dividend Appreciation ETF (VIG) and  Vanguard Dividend Growth (VDIGX) offer an excellent case in point. Both funds target stocks with strong records of dividend growth, but where the exchange-traded fund tracks an index, Vanguard Dividend Growth applies active management to achieve the same goal. Yet despite its higher expense ratio, Vanguard Dividend Growth has outpaced its ETF counterpart by 1.3% annualized since April 2006, when Vanguard launched the ETF (and its associated mutual fund share classes).

Don Kilbride, the manager of Vanguard Dividend Growth, shops for stocks that are trading at reasonable valuations with a history of dividend growth and the capacity to sustain that growth. Vanguard Dividend Appreciation attempts to replicate this strategy with mechanical rules. It simply invests in stocks that have increased their dividends in each of the past 10 years and applies some proprietary screens to filter out stocks that may not be able to continue that growth. This fund weights its holdings by market capitalization, subject to a 4% cap.

Alex Bryan does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.